The recent decision in MSC Mediterranean Shipping Co SA v Cottonex Anstalt (2015) has cast doubt on the ongoing recoverability of liquidated damages following a repudiatory breach of contract. The case has also extended the idea that contracting parties must act in good faith towards one another.
A contract contained a liquidated damages clause which provided for a daily rate to be paid for each day that a carrier's shipping containers were not returned following delivery.
The cargo was delivered to Bangladesh as agreed, but was never collected by the buyer despite ownership having transferred to the buyer. This meant that the seller, Cottonex, could not unpack the containers and consequently could not return them to the shipper, MSC. MSC began to charge Cottonex the daily rate of liquidated damages agreed under the terms of the contract.
Although MSC was suffering no financial loss, they were entitled under the terms of the contract to charge liquidated damages until the containers were returned empty.
Cottonex was powerless to force the buyer to collect the goods and bring the situation to an end, leaving them with a potentially open-ended liability for liquidated damages. The Judge considered this to be unfair.
The Judge held that a repudiatory breach had been committed when Cottonex informed MSC that it would be unable to return the containers. As MSC had no "legitimate interest" in keeping the contract alive after that date, the Judge held that MSC should be forced to accept the repudiatory breach and bring the contract to an end. This is a rare outcome as in most circumstances parties are not obliged to accept termination by repudiatory breach by the other side.
MSC's claim for liquidated damages was effectively capped on the date of the repudiatory breach.
What is the effect of this Judgment?
The decision whether to accept a repudiatory breach and terminate the contract, or to allow the contract to continue, would usually be for the innocent party to make, taking account of its own commercial interests.
This Judgment limits an innocent party's freedom to act in its own self-interest and says that the decision whether to terminate the contract or not should be made in "good faith". The idea that contracting parties should act in good faith towards one another is an emerging one which has been given different levels of support by different judges.
In addition the Judge also supported the decision, by finding that the liquidated damages clause would have been unenforceable as a penalty. This is another area of developing law – it is unclear whether the rule on penalties will survive 2015 in its current form due to Supreme Court caselaw expected this summer.
Why this matters for business
This Judgment casts doubt over your freedom to decide whether to continue with a contract after a repudiatory breach is committed by your counterparty.
You may no longer be able to act solely in your own commercial interests and may now have to consider a concept of good faith or fairness when deciding whether to bring a contract to an end.
Liquidated damages which have been negotiated and agreed between the parties at the outset may not be as secure as you think, if the Courts decide that recovering them would be unreasonable.
In any event it appears clear that the Courts will not let you claim an open-ended payment of liquidated damages even if the contract says you can. You must have some other legitimate interest to defend.