It has long been established that a contract which arises out of the illegitimate use of superior economic power can be avoided on the grounds of economic duress. What is less clear is the level of illegitimacy required to invoke the power of the court to police the contract in this way and, in particular, the extent to which entirely lawful actions can render contracts voidable. A recent case shows how - even in the cut and thrust of commercial dealings - lawful but illegitimate conduct may render an underlying agreement voidable in certain circumstances.(1)
A shipowner concluded a charterparty for the carriage of a cargo of shredded scrap from the United States to China on a specified vessel. The agreement did not give the shipowner the right to substitute the vessel, the identity of which was important to the charterer and the receiver of the goods.
Despite this, after the charter had been concluded and in breach of the agreement, the shipowner fixed the vessel to another charterer. When the original charterer discovered this, it did not treat that repudiatory breach as terminating the contract. The contract therefore remained alive, although by that stage there was no realistic prospect of fulfilling the agreement with the specified vessel or within the specified timeframe.
The shipowner conceded that it had made a mistake, and that it would find an alternative vessel and compensate the charterer for all resultant damage. However, the terms of the offer were not formalised at this stage and matters did not conclude on that basis. After the charterer had renegotiated its onward supply contracts, the shipowner's position changed. It made a 'take it or leave it' offer of a substitute vessel and a specified discount for the cargo, but required the charterer to waive all claims for resultant loss and damage. This was plainly inconsistent with the shipowner's previous assurances. However, by this point the charterer had no practical alternative but to accept the terms of this offer. The charterer notified the shipowner that it would accept this revised and inferior offer, given the "exigencies of the circumstances and… the urgent need to mitigate [its] losses and accommodate [its] customer in China".
In a subsequent arbitration, it was found that the charterer had not only been entitled to believe that a vessel would be forthcoming, but also, as the days passed, had been increasingly "driven into a corner" from which it could not escape, having been "lulled into a false sense of security" by the shipowner's commitment to compensate it. By the time that the offer of full compensation was withdrawn, the charterer had no alternative but to accept the much more limited offer if it was to have any chance of fulfilling the renegotiated onward sale contracts and properly mitigating its loss.
The majority of the arbitrators held that in these circumstances, the charterer's agreement - under protest - to waive all of its claims for damages in respect of the repudiatory breach was procured by economic duress and was therefore voidable on that basis. Although the arbitrators exonerated the shipowner from wrongful conduct in the context of the settlement negotiations, they found that the shipowner had committed a repudiatory breach of charter.
On appeal to the High Court, the shipowner argued that notwithstanding the earlier breach of the charterparty, it was not bound to enter into any variation or new contract with the charterer. It therefore maintained that it was entitled to insist on any terms that it wished, and to drive - through whatever lawful means - as hard a bargain as it could.
The charterer, by contrast, maintained that the course of conduct had begun with an unlawful act (ie, the repudiatory breach) which had coloured all subsequent actions. Even if there had been no binding agreement which the shipowner had threatened to break, the unlawful act of repudiating the charter, coupled with the later actions which were tainted by it, had driven the charterer into a position where it had no alternative but to waive its claims and accept the 'take it or leave it' deal, with the result that the deal had been procured under economic duress.
The High Court recalled earlier Court of Appeal approval of the principle that lawful acts can amount to economic duress and can lead to the avoidance of contracts.(2) Lord Justice Steyn had referred to the "critical enquiry" as being "not whether the conduct is lawful but whether it is morally or socially unacceptable". However, he had also made clear that the court should not set its sights too high and that it would be a relatively rare case in which "lawful act duress" could be established, particularly in a commercial context.
Taking this into account, the judge in the present case concluded on the law that illegitimate pressure can, in principle, involve acts which are not unlawful in themselves, although this would be unusual in commercial cases.
On the facts, the judge found that the shipowner's refusal to supply a substitute vessel and meet the charterer's needs, in circumstances in which those needs had been created by the shipowner's breach and subsequent misleading activity, could readily be found by the arbitrators to amount to "illegitimate pressure". In the judge's view, the decision was not only one that the arbitrators were entitled to reach, but was also the right decision on the facts.
As the judge held: "[T]he more serious the impropriety and the greater the moral obloquy which attaches to the conduct, the more likely the pressure is to be seen as illegitimate."
In the cut and thrust of commercial dealings, the court will be extremely reluctant to permit the avoidance of contracts on the basis of conduct which deviates from social morality, but which is itself lawful.
Although the settlement agreement in this case was not tainted by unlawfulness, the court found that the whole episode had been tainted by the earlier repudiatory breach; had that breach not occurred, the result might have been different. However, even on that analysis, the decision serves as a warning to parties that breach agreements and then seek to take a tough stance in subsequent settlement negotiations. In these circumstances, it is imperative to appreciate that the rules of the game may have changed. If unlawfulness is manifest at any juncture, this may indirectly 'infect' the validity of subsequent, hard-fought settlement agreements.
Accordingly, defaulting parties must take care not to back counterparties into a corner through the offer of empty promises. Innocent parties that find themselves in such a position as a result of commercial manoeuvring by the party in breach should make clear that they are accepting the settlement under protest, and should formally challenge the validity of the agreement as soon as possible thereafter.