Facts
The Claimant, Dalkia Utilities Services Limited, a designer,
constructor and operator of energy plants, contracted with the
Defendant, Celtech International Limited, to supply energy services
by means of an energy plant for the Defendant's new paper mill.
Six Agreements were signed between the parties. The central
contract was known as the Principal Agreement and established that
the contractual relationship between the parties would last an
Initial Period of 15 years.
Payment was by way of "Charges" paid in 12 instalments per year
over the 15 year period. The Charge was split into 2 parts: a
Finance Element and an Operational Element. The Finance Element
represented the capital cost of the plant. The plant was initially
owned by the Claimant, but the objective was that by the tenth
anniversary of the agreements, the Finance Element of the Charge
would amortise the capital cost of the plant. Once the cost was
totally amortised, the plant would become the property of the
Defendant. The Operational Element made up the second part of the
Charge and related to the costs associated with running the
plant.
The agreements conferred on the Claimant a right to terminate
immediately if the Defendant was in material breach of its
obligation to pay the Charges (Clause 14.4). The Principal
Agreement also contained a Clause (Clause 15) which entitled the
Claimant to a Termination Sum if the contract came to an end
because of the Defendant's breach.
Upon payment of the Termination Sum, the Defendant would keep
the plant. Confusingly, the Principal Agreement was later amended
with the effect that the Termination Sum would be limited to any
interest outstanding on the "Charges" (Clause 9A.7) and in the
event that the Claimant became entitled to terminate, it would be
entitled to claim the full "Charges" due and payable (Clause 9A.8).
The Defendant sought to renegotiate further the Principal Agreement
and stopped making payments to the Claimant.
When the Defendant failed to pay 3 monthly instalments in
succession, the Claimant sought to terminate the agreements with
the Defendant by relying on Clause 14.4. In addition, the Claimant
claimed a Termination Sum from the Defendant pursuant to Clause
15. The Defendant argued that the breach of contract upon
which the Claimant was seeking to rely in its termination was not
"material". The Defendant argued that in circumstances where it had
failed to pay three out of 174 payments to the Claimant, and where
these non-payments were small (£390,000) in proportion to the total
amount payable under the agreements, the failure could not be
regarded as a material breach.
The consequence of termination would be that the Defendant was
to pay £3 million as the Termination Sum which was, in the
Defendant's eyes, a penalty. The Defendant referred back to other
occasions in which the Defendant had been similarly in breach of
its obligations where the Claimant had not sought to terminate. The
Claimant submitted that any breach that was more than trivial would
be material and that there was an obvious mistake in the drafting
of Clauses 9A.7 and 9A.8 and that these clauses were inherently
contradictory. The Claimant submitted that the termination clause
should be read as saying that upon termination the Claimant was
entitled to recover all the finance charges.
Judgment
Mr Justice Christopher Clarke found for the Claimant. The
Defendant, in failing to pay three monthly instalments, was in
material breach of its obligations to pay the "Charges". This was
because the three monthly instalments were neither trivial nor
minimal sums of money and the Defendant's failure to pay was
serious. The judge said
"In assessing the materiality of any breach it is relevant to
consider not only of what the breach consists but also the
circumstances in which the breach arises, including any explanation
given or apparent as to why it has occurred."
In the circumstances the Defendant had not paid the instalments
because it was not in a position to do so. The company was facing
insolvency and it was unlikely it would be able to pay in the near
future. The judge examined Clause 14.4 and stated that such a
provision was designed, in context, to protect the client where its
failure to pay was due to some mishap or administrative failure,
but if the failure was not due to this sort of reason, the clause
was designed to enable a supplier such as the Claimant to bring the
period over which it was extending credit to an end.
The factors taken into account by the judge included the fact
that the instalments missed were consecutive, that nothing
suggested that there was any better prospect of being paid and
that, although in the context of the whole project the missed
instalments were small, the payments represented a whole quarter's
payments and 8.5% of the total charges unpaid for the remainder of
the term.
There was, as the Claimant asserted, an obvious mistake in the
Amendment to the Agreement at Clauses 9A.7 & 9A.8. To construe
these clauses literally would have been commercially nonsensical
and contradictory, since the clauses stated that the "Charges"
would not be due on Termination, but only interest on the "Charges"
(Clause 9A.7); and that the Defendant was liable to pay the full
Charges which effectively meant that the Defendant was being asked
to pay operational charges that had not accrued at the time of
termination (Clause 9A.8). The judge concluded that the Claimant
would be entitled to a Termination Sum that excluded the
operational element of the "Charges". On payment of the Termination
Sum (and other sums that had accrued under the agreements which
were not in dispute) the plant would become the Defendant's.
The Defendant had asserted that the sums that the Claimant was
claiming amounted to a penalty. The judge stated that since the
Defendant was not being asked to pay the full charges (i.e. for
operational services that the Defendant had not received) and all
the Defendant was being asked to do was to repay early the capital
in effect advanced by the Claimant in return for which the
Defendant could keep the plant, the sum was not penal.
The Claimant submitted in the alternative that the Defendant's
failure to pay the instalments and in its indications about whether
it could pay or not amounted to a repudiation of the Principal
Agreement. These submissions were not accepted. Even if the
Defendant's behaviour could be considered repudiatory, the
Claimant's Termination Notice was not sufficient to amount to an
acceptance of repudiation as it did not refer to repudiation.
Commentary
The Dalkia decision may be added to a long line of authorities
dealing with contractual rights of termination, distinct from
repudiation, and it provides a good opportunity to recap on the
legal principles involved.
At common law a party may bring a contract to an end if the
other party's conduct is repudiatory. In Heyman v Darwins three
sets of conduct amounting to repudiation were set out:-
- where the party evinces an intention not to perform its
contractual obligations in some essential respect;
- where impossibility of performance arises as a result of the
party's act; and
- where there is total or partial failure of performance – if
partial, the failure must occur in a matter which goes to the root
of the question.
Contract draftsmen try to reserve contractual rights of
termination which allow a party to bring the contract to an end for
circumstances which are less than repudiatory. Some drafted clauses
are more effective than others. In "The Antaios" the Court
rejected the claimant's argument that because the contract provided
for termination in the event of
any breach, a party could terminate the agreement for any breach
whatsoever, however slight. In that case the complained of breach
was very small and the Court of Appeal disagreed with the
claimant's position, saying "if detailed semantic and
syntactical analysis of words in a commercial contract is going to
lead to a conclusion that flouts business common sense, it must
yield to business common sense." The Court found that the
breach had to constitute a repudiatory breach to allow termination,
which had not occurred in this case.
In National Power plc v United Gas Company the
termination clause provided for termination in the event a party
was in "material breach" and the party had not remedied the breach
within 7 days of notice to do so. Colman J found that this did
allow for termination in circumstances which were less than
repudiatory. Hence, the lesson was learnt, use the word "material"
and provide a remedy period, at least to cover the situation where
the breach is remediable.
The situation, however, was rather muddied by the case of
Crane Co v Wittenborg. The termination clause in that
contract provided for a remedy period but allowed termination in
the event of a "substantial" breach. Mance LJ construed this clause
in such a way to find that "substantial breach" was the same as
"repudiatory breach", and as such the draftsman had not reserved a
lower threshold for termination than that which would already be
offered by the common law.
More recently, in the leading case of Rice v Great
Yarmouth, where the contract allowed for termination in the
event the contractor committed any breach of its obligations, the
Court of Appeal upheld the decision in "The Antaios" and
found that any single breach of obligation did not give rise to
termination unless it was repudiatory. However, in this case the
additional argument was put forward that the totality of repeated
breaches could give rise to the right to terminate, even if each
breach on its own would not - the "death by a thousand cuts"
argument. The Court of Appeal accepted this and Hale LJ found that
in a contract of multiple, separate obligations, repeated breaches
would give rise to a right of termination if the breaches deprived
the innocent party of substantially the whole benefit of
substantially any aspect of the contract.
A lesser reported case is that of Phoenix Media v Cobweb
Information where again the termination clause referred to
material breach and allowed for a remedy period. Neuberger J
adopted an evaluative approach stating:
"materiality involves considering the
following: the actual breaches, the consequences of the breach to
[the innocent party], the [defaulting party's] explanation of the
breaches, the breaches in the context of the Agreement, the
consequences of holding the Agreement determined, and the
consequences of holding the Agreement continues."
Thus, the Court should evaluate all the circumstances, including
the consequences of finding the contract terminated or
enforceable.
And so we come to Dalkia. It is little wonder Celtech argued
that in the circumstances where it failed to pay 3 months'
instalments (totalling £390,000) in the context of a total of 174
payments to be made under the agreements, and where it would have
to pay £3 million as a Termination Sum, the non-payment should not
be regarded as material.
Whilst Clark J looked at the consequences for Celtech as a
result of the breach, he said that the main focus should be in the
nature of the breach not the consequences for thebreaching party if
the agreement is terminated. However, Clark J did lay significant
reliance on the fact that the breach had a significant impact on
Dalkia. Thus the Court has adopted a more limited evaluative
approach to that shown by Neuberger J, looking more particularly at
the consequences of the breach on the innocent party.
