This Court of Appeal decision contains important lessons for those drafting termination clauses. It also affects anyone who needs to decide how to respond to a breach.

Background

Stocznia, a shipbuilder, had financial trouble and did not complete several vessels. Gearbulk, its client, wrote to terminate the contracts. Gearbulk terminated and claimed the return of instalments paid, and interest, under a specific clause in the contracts. It then also claimed damages at common law for loss of bargain. Although it won at arbitration, the High Court disallowed the loss of bargain claim. It held that Gearbulk had affirmed the contract and lost the right to claim common law damages when it served notice relying on the contract terms. It took an appeal to the Court of Appeal to restore the full damages award.

Contract terms

“Article 5.10 - Refund Guarantee

(a) The instalments of the contract price paid by Gearbulk prior to delivery of the vessel … shall be in the nature of advances to Stocznia. In the event that Gearbulk shall exercise its right to terminate this contract pursuant to any of the provisions hereof, Stocznia shall forthwith refund to Gearbulk the aggregate amount of such instalments, together with interest thereon at the rate of one month LIBOR per annum.

(b) It is a fundamental term of this contract that Stocznia’s obligation to make such refund of any of the pre-delivery instalments, with interest, shall be secured under and pursuant to the refund guarantee issued in favour of Gearbulk.

Article 10 - Delay in delivery and deficiencies: seller’s default

The contract price of the vessel shall be adjusted by way of reduction in the event of any of the contingencies set out in this Article. Such adjustment shall be effected by way of reduction in the amount of the delivery instalment of the contract price … by way of liquidated damages and not by way of penalties.

Gearbulk shall not be entitled to claim any other compensation and Stocznia shall not be liable for any other compensation for damages sustained by reason of events set out in this Article and/or direct consequences of such events other than liquidated damages specified in this Article.”

[The total liquidated damages due were limited to a maximum of 5 per cent of the contract price.]  

Article 10.1 – Delay in delivery

(a) In the event that delivery of the vessel should be delayed beyond the delivery date, the contract price shall be reduced as follows:  

(i) no adjustment shall be made for the first 30 days  

…  

(v) the maximum reduction of the contract price under this Article 10.1(a) shall not exceed $930.000.  

(b) If the delay in delivery of the vessel shall comprise a period of more than 150 days beyond the delivery date, Gearbulk may, at its option, terminate this contract.  

(c) Without any prejudice to, and separately from, the foregoing, Gearbulk shall also be entitled, at its option, to terminate this contract in the event that, for any reason whatsoever, the vessel shall not have been delivered to Gearbulk on or prior to 15 August 2003 (the “drop dead date”).  

Article 10.6 – Stocznia’s default

“Gearbulk shall also be entitled, but not bound, to declare Stocznia in default and terminate the contract:

(a) if there is a major breach by Stocznia of its obligation hereunder to proceed with the construction of the vessel such that, in the reasonable opinion of Gearbulk (supported by the opinion of the Classification Society), the vessel cannot be completed and delivered to Gearbulk on or before the date specified in Article 10(1) (c)…

Upon the occurrence of any such event of default Gearbulk shall be entitled to terminate this contract with the consequences hereinafter provided.”

Article 10.7 - Effect of termination

“Upon termination of this contract by Gearbulk in accordance with the provisions of Article 10 or any other provision of this contract expressly entitling Gearbulk to terminate this contract, Stocznia shall forthwith pay to Gearbulk all sums previously paid to Stocznia under this contract, together with interest accrued thereon calculated at the rate of one month LIBOR per annum from the respective date(s) of payment of such sums until the date of refund … if Gearbulk terminates this contract under this Article, Gearbulk shall not be entitled to any liquidated damaged under Article 10.1 …”  

The Court of Appeal decided three key issues.  

(i) Did the contractual code in Article 10 exclude all other rights to terminate?

The Court of Appeal analysed the scheme applying to defaults by Stocznia set out in Article 10. The overall intention was that, where there were relatively minor delays in delivery (or indeed minor deficiencies in speed, fuel consumption or capacity), Gearbulk had a right to claim liquidated damages. However, if the delay or other deficiencies exceeded specified levels, Gearbulk had an express right to end the contract.

This dichotomy essentially reflected the position at common law. In other words, if a breach is serious enough to deprive a party of substantially the whole benefit it intended to obtain from the contract, this gives that party a common law right to treat the contract as discharged. It can then recover damages for loss of bargain. Here, the parties had agreed the point at which any delay or deficiency would be serious enough to entitle Gearbulk to terminate the contract. The usual consequences of accepting a repudiatory breach should then apply, unless the contract had validly excluded those consequences. Moore-Bick LJ, giving the leading judgment, held that “where contractual and common law rights overlap, it would be too harsh to regard the use of a contractual mechanism of termination as ousting the common law mechanism”.  

(ii) Did Article 10 exclude damages for loss of bargain?

The court confirmed that it would, in principle, be possible for the parties to agree to exclude Gearbulk’s right to loss of bargain damages following a breach triggering a contractual or common law right to terminate the contract. This was a question of interpreting the contract. But the effect of such a provision would be to allow Stocznia to refuse to perform the contract without any liability, other than the obligation to refund instalments already paid. The court thought it was inherently unlikely any purchaser would have agreed to such a position. Moore-Bick LJ said “The court is unlikely to be satisfied that a party to a contract has abandoned valuable rights arising by operation of law unless the terms of the contract make it sufficiently clear that that was intended. The more valuable the right, the clearer the language will need to be.”  

Here, the second introductory paragraph of Article 10 seemed to limit Gearbulk’s remedy for any delay in delivery to a reduction in the price. But despite this clear language, the court thought the limitation applied only to the parts of Article 10 covering the more minor events which resulted in an obligation on Stocznia to pay liquidated damages. They did not apply where Gearbulk had a right to end the contract, because Article 10.7 expressly provided that liquidated damages were then not payable. The implication from this was that, in those circumstances, Gearbulk was entitled to recover any losses in the usual way.  

(iii) Could Gearbulk treat the contract as discharged at common law?

Here, the Court of Appeal departed from the judge at first instance. The exercise of Gearbulk’s contractual right to recover instalments did not amount to an election on its part to affirm the contract. The right to recover those instalments (and to claim under the bank guarantee) arose only on termination of the contract. This provision survived termination of the contract, in a similar way to the arbitration clause.  

Stocznia’s argument was in effect that Gearbulk had to choose between alternative and inconsistent remedies. In other words, it could recover the instalments of the price, supported by the guarantee, or it could claim common law damages. The latter would involve arbitration with an uncertain outcome against a potentially insolvent party. Once it chose the guarantee route, Gearbulk could not additionally pursue that option.  

The Court of Appeal disagreed. The court said that, in circumstances such as these, Gearbulk was clearly entitled to recover instalments paid, under the doctrine of failure of consideration. This right was distinct from any right to recover damages for loss of bargain. There was no inherent inconsistency in the two claims. Interpreting the contract as putting Gearbulk to such an election did not make good commercial sense. There was nothing in Article 10 or the rest of the contract to suggest the parties intended this.

Lessons for drafting termination provisions

Consider carefully at the outset what rights you intend a party to have in the event of different types of breaches. The parties here clearly addressed their minds to the various options, but then failed to make the position clear in drafting the contract. For example, they could have made it much clearer when the right to liquidated damages would apply and, conversely, when the right to terminate and claim normal loss of bargain damages would arise.  

The parties also included the introductory words at the start of Article 10, seemingly limiting Gearbulk’s remedy to liquidated damages for any event covered by the Article. But this provision covered both minor defaults and breaches of a repudiatory nature. The court thought the parties could not have intended the limitation to apply to serious breaches. Always check the drafting to ensure that exclusions apply only to the extent you intend.  

The Court of Appeal made clear that it is possible, in principle, to exclude a party’s common law right to damages for loss of bargain following a repudiatory breach. But you need to use very clear wording to achieve this effect. If this is your intention, spell out unambiguously what remedy the “innocent” party will be entitled to and that loss of bargain damages are excluded.  

Finally, ensure your termination provision is as comprehensive as possible. Another recent case has confirmed the difficulties of implying a term (there that a party could bring the contract to an end on reasonable notice) where the agreement contained express provisions dealing with termination. See Servicepower Asia Pacific Ltd v. Servicepower Business Solutions Ltd [2009] EWHC 179 (Ch).

Lessons for ending a contract

In this case the Court of Appeal decided that Gearbulk’s rights (a) under the contract and (b) at common law coexisted and gave rise to identical consequences. In each case Gearbulk could accept the repudiatory breach as discharging the contract and claim its loss of bargain. But this may not always be so. In other cases, the contract and the general law may provide an injured party with alternative rights leading to different consequences. For a recent example, see Dalkia Utilities Services Plc v. Celtech International Ltd [2006] 1 Lloyd’s Report 599. There, the contract entitled Dalkia to terminate for “material breach” and claim a £3 million termination payment. Dalkia exercised that right when Celtech missed three monthly instalments. The court held that this was a material breach for the purposes of the contract, even though the agreement was for significant payments over a total of 15 years. Dalkia had validly invoked the contractual termination provision. But the court thought the same facts did not give rise to a repudiatory breach entitling Dalkia to terminate at common law.

Therefore, where the innocent party has alternative rights giving rise to different remedies, it must elect between them and word its termination notice accordingly.  

Stocznia Gdynia SA v. Gearbulk Holdings Ltd [2009] EWCA Civ 75