Cerno.Org Newsletter – To terminate? In good faith?

Deciding whether to terminate a contract is rarely easy. If you get it wrong and you may be in breach yourself; and it is quite common, at least in certain jurisdictions and quarters, for one party to call into question their counterpart’s termination.

Whilst the concept of good faith in English contract law is still developing, recent decisions have provided guidance on whether there exists a requirement to act in good faith when exercising termination rights, whether contractual or at common law.

Other than in a few well-established and restrictive categories, under English law there is no general duty to act in good faith towards your counterparty.

In the High Court case of Yam Seng Pte Limited v. International Trade Corporation Limited [2013] EWHC 111 (QB) the court held that a duty of good faith, or fair dealing, should be implied into the parties’ contract. Although His Honour Leggatt J gave a non-exhaustive list of examples, it remained unclear to what extent the courts would imply obligations of good faith in the future. Similarly, there was uncertainty as to the aspects of the parties’ relationship to which any implied duty of good faith would apply.

From this basis we must then ask, where there are express termination rights in the contract, are they subject to implied duties of good faith?

The recent case of Monde Petroleum SA v. Westernzagros Ltd [2016] EWHC 1472 considered this point. Where there is an express right to terminate a contract, is that right subject to an implied term that the party seeking to terminate must act in good faith?

Monde to provide consultancy services to Westernzagros (WZ) relating to negotiations for an oil exploration and production agreement (an ESPA) for work in Kurdistan. Monde received monthly payments and was to acquire a further interest in the project she the ESPA was signed.

After the ESPA was executed the Kurdistan authorities insisted on various amendments which had the effect of making the ESPA economically less attractive to WZ, who then sought to end its agreement with Monde in reliance upon the express right to terminate. Within its defence Monde argued that WZ was in breach of an implied term that WZ and Monde would act in good faith towards each other.

The court found two insurmountable obstacles to Monde’s case. Firstly, even though Monde argued the parties had intended their relationship to be long term and of a quasi-partnership nature, this did not automatically mean that an implied duty of good faith applied. (The Supreme Court decision in Marks & Spencer plc v. BNP Paribas Securities Services Trust Co (Jersey) Ltd [2015] UKSC 72 has reaffirmed that any term, to be implied, must be either necessary or obvious, and not inconsistent with the express terms.) Secondly, the court held that the implied term proposed by Monde would rarely, if ever, apply to restrict a contractual right to end the contract.

The court distinguished a term providing a right to terminate the contract from a contractual discretion. A discretion generally will be restricted by an implied term that the relevant party must exercise it in good faith, for the purposes for which it is given, and not in an arbitrary, capricious or irrational way; however, a discretion involves a range of options from which that party can choose whereas a right to terminate involves only a binary choice. The judge stated:

“A contractual right to terminate is a right which may be exercised irrespective of the exercising party’s reason for doing so. Provided that the contractual conditions (if any) for the exercise of such a right (for example, the occurrence of an Event of Default) have been satisfied, the party exercising such a right does not have to justify its actions.”

Can a general contractual duty to act in good faith restrict an express right to terminate? Sometimes the parties provide that they must act in good faith towards each other, or set out similar standards of conduct. Without clear language, will such a provision apply to a separate but express right to terminate?

This point did not arise in the Monde case, as the consultancy agreement contained no general good faith requirement but, in reviewing an earlier decision suggested that general good faith (or similar) wording is unlikely to restrict clear contractual rights to terminate. (TSG Building Services plc v. South Anglia Housing Ltd [2013] EWHC 1151 (TCC)).

Is a common law right to terminate for repudiatory breach subject to requirements of good faith? The innocent party can then elect to accept the breach and end the contract, or to affirm the agreement and keep alive the parties’ rights and obligations. Must it make that decision in good faith? This point arose in the Court of Appeal case of MSC Mediterranean Shipping Co SA v. Cottonex Anstalt [2016] EWCA 789.

The carrier under a contract for the international carriage of goods had the right to terminate for the shipper’s repudiatory breach. Due to a dispute between the shipper and consignee about who had title, the goods effectively remained embargoed at the port. The shipper was in repudiatory breach as it could not return the containers to the carrier. But the carrier elected to affirm and keep the contract alive, purely so it could claim liquidated damages in the form of demurrage. These payments were due at a daily rate, without limitation in time.

The Court of Appeal considered the facts of the case and decided the substantive issue on the basis that there was deadlock between the parties. The contract as agreed was no longer capable of performance, in effect it had become frustrated; the contract had terminated automatically at that point and with it the parties’ continuing rights. Addressing the good faith point, the Court of Appeal said it was neither “necessary [nor] desirable” to resort to that principle to decide the case.

The court suggested it was better for the law to develop along established lines and expressed the thought that the cases on express contractual discretions, and the implied good faith restrictions on their exercise, provided no help when considering the exercise of a right to terminate arising at common law.

What are the practical implications of these cases? When taken together these cases suggest the courts will rarely accede to an argument that a right to terminate has to be exercised in good faith, excepting circumstances where the parties have expressly provided for this. We suggest that this is logical; an express contractual right to terminate should not be subject to an implied requirement to exercise it in good faith, and that general good faith wording in the contract should not, properly interpreted, restrict such a right.

Care needs to be exercised when including in your contract a general requirement that the parties do act towards each other in good faith (or set a similar standard of conduct). It may be safer to state expressly if other specific rights are exceptions from such general duties rather than rely on the court’s interpretative powers.

MSC has provided useful clarification when considering whether to exercise a common law right to terminate; the decision whether to elect to end or affirm the contract is not comparable with the exercise of a contractual discretion and, therefore, is not generally subject to a requirement to act in good faith. Newsletter – I want my variations in writing! Sorry, that’s not going to be possible.

A contract can be formed orally or in writing. It is always preferable that terms are set out in the form of a written contract; it’s certainly easier to prove but this does not prevent oral agreements from being both legal and compellable. Likewise, where there is a written agreement it can be varied by agreement reached orally. But does this hold if your written agreement expressly states that any variation must be in writing?

The Court of Appeal of England & wales in MWB Business Exchange Centres Ltd v Rock Advertising Ltd [2016] EWCA Civ. 553, held that an oral agreement can vary a contract despite even where there is a clause requiring variations to be in writing and signed.

The issue was before the courts in two recent cases.

Anti-oral variation clauses are not unusual; the intent is to exclude any variations which are argued to have been concluded in discussions. There has been, however, uncertainty as whether those anti-oral variation clauses have the desired, legal effect. In United Bank v Asif [2000] the Court of Appeal upheld an anti-oral variation clause. Since then the courts have tended to the view that parties to a contract can unmake, remake, or otherwise change its terms. This is the freedom of contract principle.

The Court of Appeal in Globe Motors Inc v TRW Lucasvarity Electric Steering Ltd [2016] EWCA Civ 396 considered an contract that included a clause that the agreement could be amended only by a written document signed by both parties. In considering the earlier, conflicting decisions the Court made obiter comments that there was more authority to support the argument that parties were free to change the terms of an agreement even though there are clear problems in proving an oral agreement. Where an oral agreement was alleged, it would be for the court to decide.

The case of MWB Business Exchange Centres Ltd v Rock Advertising Ltd then followed, with the Court of Appeal holding that an oral agreement can vary a contract despite the existence of an anti-oral variation clause. The court stated that (citing the New York Court of Appeals in Alfred C Beatty v Guggenheim Exploration Company and others [1919]) ‘those who may make a contract may unmake it. The clause which forbids a change may be changed like any other. The prohibition of oral waiver may itself be waived. What is excluded by one act is restored by another. You may put it out by the door, it is back through the window. Whenever two men contract, no limitation self-imposed can destroy their power to contract again …’. 

This decision has potentially wide ranging effect. If the principle applies to oral versus written variations, can it apply also to oral notices of intention where the contract expressly requires written notices? As always the circumstances will dictate, but if there is shown to be acknowledgement of such a notice then it might yet be effective. in turn this could undermine other contractual provisions, including those perceived as a time bar to claims.
 Newsletter – Don’t start work without your (construction) contract!

Certainty is a great thing yet construction projects, large and small, are often performed without a formal contract in place. If a dispute ends up in legal proceedings, the courts may have to analyse what the parties have said, in the best way they can, no matter how vague or uncertain the exchanges were.

In the recent case of Goldsworthy (t/a Goldsworthy Builders) v Harrison [2016] EWHC 1589, which concerned a project for work on a residential, occupied property, Goldsworthy carried out works for the Harrisons. The Harrisons envisaged using a commonly adopted, standard form of contract; the Joint Contracts Tribunal (JCT) minor works contract form. Works began and it was more than a year before a copy of the contract was sent out for signing. Goldsworthy would not sign but subsequently took a dispute to adjudication, and obtained a favourable award. Goldsworthy then asked the court to enforce the award, but the Harrisons claimed that the minor works form did not apply.

In England and Wales adjudication is a statutory process applying, with limited exceptions, to all construction contracts. One such exception is in the case of residential occupiers – a category which would have covered the Harrisons and adjudication would not have applied but for the use of the JCT form.

The court noted that whether there is a binding contract, and what the terms of that contract are, depends on what the parties have agreed.

To achieve this a court will consider all communications between the two parties, whether in writing or oral, and their conduct to determine if, on an objective conclusion, all the terms which are considered essential in law to create a contract were agreed and there was an intention to create ‘legal relations’. A binding contractual relationship can be made even though the parties defer to a later date the agreement of other, important matters. Contracts can come into existence also asa result of conduct.

In the circumstances found in Goldsworthy v Harrison, without more complete evidence from the Parties, the judge found it impossible to say that there was no triable issue as to whether the parties had agreed to the application of the JCT minor works terms (with appropriate gaps). The result of this was that Goldsworthy’s application to enforce the adjudicator’s award by summary judgment failed.

The advice which must be drawn from this case, which is a situation all too commonly found, is that it is better to have the formal contract executed before any work is commenced. Newsletter – “Close of Business”: Not so obvious as you might think

In the recent case of Re. Elektron Holdings Limited (In Receivership), McCann v Halpin the Supreme Court of England and Wales considered the meaning of the stock phrase “Close of Business”.

The phrase “Close of Business” is a stock expression often used in business documents, with the assumption that it has an established meaning.

In the context of the noted case, which involved a banking institution, the Court, in upholding the decision of the lower court, that “close of business” should be interpreted as meaning the end of the banking business day ; the time at which banks have traditionally and normally closed their doors to customers.

The ordinary meaning of stock phrases are, however, dependent upon context. The phrase “close of business” is not a term of art; it is a flexible expression commonly used to describe the time at which a business might reasonably be expected to close its doors to its clients, or to the public. The meaning can change over time as business and social patterns change. Almost certainly the meanings will depend upon location also.

The lesson to be taken from this is it is wise to avoid the risk of ambiguity by avoiding stock phrases and by including definitions and explanation to put beyond doubt matters which may become controversial. Newsletter – Damages Clauses and Penalties

Makdessi & Parking Eye

The Supreme Court of England and Wales, in the consolidated appeals in the two cases of Cavendish Square Holding BV v Talal El Makdessi (Cavendishand Parking Eye Limited v Beavis (Parking Eye), perceived a more flexible test on whether a contract term is considered penal and thus unenforceable.

The traditional English law test on penalty clauses centred on whether a clause that takes effect on breach of contract is a “genuine pre-estimate of loss” and therefore compensatory or whether it is aimed at deterring a breach and therefore penal. In construction contracts this question arises often in relation to the provisions entitling an Employer to claim and deduct damages from the Contractor where the completion of the project has been delayed and there is no entitlement to an extension of the time for completion.

The origins of the penalty rule can be traced back as far as the 16th century. It originates in the concern of the Courts to prevent exploitation in an age when credit was scarce and borrowers were particularly vulnerable.

Essentially, a penalty is a payment of money stipulated in the contract and is unenforceable against the offending party if it is an exorbitant alternative to common law damages.

At the beginning of the 20th century, the judgment in the case of Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co. Ltd [1915] A.C. 847 (Dunlop) sought to restate the law on the penalty rule by providing four tests which were designed to be “helpful, or even conclusive” in determining whether or not a clause was an unenforceable penalty. The Dunlop judgment distinguished between penalty clauses (which are unenforceable) and “liquidated damages” clauses, which are enforceable provided that the specified sum is “a genuine pre-estimate of loss” – wording which has since appeared in many English law commercial contracts over the last 100 years.

In the present cases and in the words of Lord Sumption, the rule has become, “an ancient, haphazardly constructed edifice which [had] not weathered well”.

In Cavendish and Parking Eye, the Supreme Court restated the rule by introducing a more flexible test as to “whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation.” Following this decision, the question is no longer  “[is] the clause unconscionable or a genuine pre-estimate of loss”; instead, the innocent party’s wider interest will be taken into account when enforcing obligations.

Commentators have subsequently criticised this decision by highlighting the uncertainty of what will amount to a legitimate interest and the circumstances in which a clause will be considered out of proportion to that interest. This point is likely to be open to debate on a case-by-case basis. The new rule does, however, make way for greater freedom of contract; parties of equal bargaining power will be the best judges of what is a legitimate response to a breach of contract and commercially justified, even if, on the old test, this would be seen as a deterrent for breach. Newsletter – Retention of Title

Retention of Title

The Court of Appeal of England and Wales has ruled in the recent case of PST Energy 7 Shipping LLC Product Shipping & Trading S.A. v O.W. Bunker Malta Ltd and others [2015] EWCA Civ 1058 that a retention of title clause prevented a contract from being a sale of goods contract. Although the case was decided in the context of shipping, producing direct implications for ship owners, it is likely to have wider implications for retention of title clauses in the context of the supply of goods contracts.

In the PST Energy 7 Shipping case, the contract included a clause that, pending payment, the ship owner held the fuel as a baillee but was able to continue using the bunker.  This did not release the ship owners from their obligation to pay for the fuel.

Overall, as reported, this decision has implications for contracts for the supply of consumable goods where a retention of title clause provides ever diminishing security for payment. Newsletter – Belize v Belize Telecom Ltd clarified

Implying terms into contracts: the old rules revived

In Marks and Spencer plc v BNP Paribas Securities Services Trust Company (Jersey) Ltd [2015] UKSC 72, almost the same panel of Supreme Court judges as the one in Arnold v Britton clarified the law on when the courts can imply a term which the parties have not expressly included in their contract.

The Court unanimously endorsed the traditional, “officious bystander” approach that an implied term must either be so obvious as to go without saying or be necessary to give “business efficacy” to the contract to make it work properly.

Lord Neuberger commented that a term should not be implied into a detailed commercial contract merely because it appears fair, or because the court considers that the parties would have agreed it if it had been suggested to them.

A majority of the Court said that academics and judges had wrongly understood the decision in Attorney General of Belize v Belize Telecom Ltd [2009] UKPC 10 as meaning that a term may be implied just because it is reasonable to do so. This is not the case.

In addition, the Court found that some comments in Belize were misleading, because they suggested that implying terms is part of the process of interpreting a contract. The position to be adopted is that only once the express terms of the contract have been construed can the subsequent process of implying terms (which is subject to stricter controls) begin.

Belize should now be viewed as providing a helpful discussion, but not authoritative guidance, on the law of implied terms. Newsletter – Good Faith

Good faith duties are still narrowly construed in English law.

The debate about the extent of a good faith duty in English law continues to rumble on and in 2015 the courts continued to construe express good faith obligations narrowly.

In Portsmouth City Council v Ensign Highways Ltd [2015] EWHC 1969 (TCC), a case that considered a general good faith obligation in a long term, Private Finance Initiative (PFI) road maintenance contract, the judge found that the council was not subject to that duty when it came to its contractual obligation to assess the award of service points, which required the exercise of a discretion.

The Judge did find, however, that the council was subject to an implied obligation to make the contract work; namely that it would exercise its discretion by not acting in an arbitrary, irrational or capricious manner and also by acting honestly and on proper grounds.

It seems that the good faith clause was used to import into the implied term two extra, fact-specific duties. Contrary to the approach that was being taken in order to force Ensign to negotiate the original contract, which the council could no longer afford, the council could not simply award the maximum number of points for each contractor default.

(Note this case was heard before the case of Arnold v Britton was decided, the court followed Rainy Sky SA v Kookmin Bank [2011] UKSC 50 by interpreting the contract using commercial common sense.) Newsletter – When good sense doesn’t always prevail!

A contract’s plain meaning may override commercial good sense.

In the case of Arnold v Britton [2015] UKSC 36 the Supreme Court of England and Wales delivered a significant judgment on interpreting contracts, concluding that where the contractual wording is clear, the courts are reluctant to depart from its plain meaning to invoke considerations of commercial good sense.

This judgment reinforces a recent trend in which the courts have downplayed the importance of looking at whether or not a contract makes commercial common sense unless there is ambiguity or lack of clarity in the language used. The result is that where an event occurs that was not intended or contemplated by the parties, judging from the contract language used, the courts will only give effect to the parties’ intention when it is clear.

In the cited case the decision meant tenants had to pay a service charge much higher than they ever anticipated. Despite the harsh outcome, Lord Neuberger was clear that “there is no principle of interpretation which entitles a court to rewrite a contractual provision simply because the factor which the parties catered for does not seem to be developing in the way in which the parties may well have expected“. Newsletter – Don’t get (time) barred!

In the first of its newsletters for 2016 Cerno considers a recent case in the courts of the courts of Trinidad & Tobago, where a contractor’s case for payment was dismissed on the grounds of it having missed the statutory limitation period.

Cerno – Articles – Newssheet 2016-01

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