Last week's ruling could make it easier for customers to
exercise both contractual and common law remedies on the
termination of a supply contract, a legal expert has said.
Shipyard Stocznia Gdynia failed to build three ships as agreed
with buyer Gearbulk Holdings so Gearbulk terminated the contract
for each ship. It did so by exercising a right in the contracts
that required Stocznia to repay any money already paid.
In its letter of termination, Gearbulk demanded the return of
its prepaid instalments. Gearbulk then sought to recover common law
damages for the shipyard's failure to fulfil the contract.
When a contract is breached so fundamentally that the other
party is allowed to terminate that contract common law damages can
be sought. Such damages are known as repudiatory damages. By
failing to deliver the ships at all, Gearbulk said that Stocznia
had acted in repudiatory breach of contract.
The shipyard argued, though, that Gearbulk could not treat the
contracts as repudiated because it sought to rely on the refund
provisions.
When a supplier fundamentally breaches the terms of a contract,
the customer has a choice either to treat the contract as still in
existence, which is called affirming the contract; or terminate and
seek damages for repudiation at common law. Stocznia said that
Gearbulk's exercise of the refund provision affirmed the
contract.
If the shipyard's argument was upheld, i.e. if the contract had
been affirmed, Gearbulk would not be able to then seek repudiatory
damages.
The High Court said that there was affirmation, but the Court of
Appeal disagreed. Overturning the earlier decision, it said that
Gearbulk's exercise of its contractual right to terminate did not
remove its right to claim damages under common law.
"[Stocznia's QC] Mr. Dunning sought to argue that Gearbulk had
no right to recover damages for loss of bargain in this case
because the effective cause of its loss was not the Yard's breach
of contract but its own decision to exercise its contractual right
of termination. I cannot accept that," wrote Lord Justice
Moore-Bick. "I think it is clear that in this case the contract
proceeds on the footing that if Gearbulk chose to exercise its
right, the Yard's breach was to be viewed as the effective cause of
the contract's termination."
"[Termination clause] Article 10 does not exclude Gearbulk's
right to recover damages at common law for the loss of its
bargain," he wrote. "I am quite unable to accept that the exercise
by Gearbulk of its right to recover instalments of the contract
price under Articles 5.9 and 10.7 involved an election on its part
to affirm the contract."
"In the first place, Gearbulk's letters exercising its right to
terminate the contracts … were wholly inconsistent with an election
to affirm them, so there can be no doubt that the contract in each
case was discharged," said Lord Justice Moore-Bick. "The right to
recover the instalments of the price, together with the right to
obtain payment under the bank guarantee, arose only on and by
reason of the termination of the contract. I think it is clear,
therefore, that the parties intended it to survive the termination
of the contract, just as, for example, they intended the
arbitration clause to survive. Reliance on that obligation could
not, therefore, amount to an election to keep the contract in
being."
Dispute resolution specialist Richard Twomey said that the
ruling is good news for companies that are being let down on major
contracts.
"Companies are sometimes wary to terminate the contract and seek
to enforce the contractual remedies because they fear prejudicing
their ability to claim damages at common law. The rights have
always been rather uncertain," he said.
Twomey said that common law damages can be much higher than
contractual remedies sometimes allow, so that is often a company's
preferred claim.
"A party seeking repudiatory damages will be seeking a sum that
puts it in the position that it would have been in had the contract
been performed properly. That can be much more than, for example,
the sums specifically recoverable under the contract," he said.
"But this ruling will give companies confidence that they can make
both contractual and common law claims."
As this case demonstrates, suppliers should consider addressing
repudiatory damages in their contracts, according to Twomey.
"The ruling might have been different if the contract had
provided that a claim under the contract would exclude any right to
repudiatory damages," he said. "It would be worth suppliers trying
to get such an exclusion or waiver into their contracts to reduce
the range of remedies available to claimants like
Gearbulk.
Twomey said that a customer seeking to terminate an agreement
should make clear in its letter of termination not just that it's
claiming any benefits under the contract's termination provisions,
but also that it reserves all rights, including the right to seek
repudiatory damages. "This approach gives the terminating party
maximum flexibility when it comes to enforcing its rights," said
Twomey.
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