Out-Law News 2 min. read

How to terminate a contract safely: High Court gives guidance


Oil giant Shell lost the right to recover $15 million when another company breached a contract because Shell made the mistake of following the contract's termination procedure,  the High Court has ruled.

If a company does something so serious that it goes entirely against the thrust of a contract, the other party can assert that the contract has been 'repudiated'. That allows the second party to treat the contract, and its obligations under it, as terminated with immediate effect and to sue for damages for breach of contract.

However, if the second company does not terminate and instead behaves as if the contract is still in effect, that can 'affirm' the contract's continuing existence. Then, both companies continue to be bound to its terms and the second company's right to terminate for the repudiatory breach is lost.

When oil exploration company Centurion Petroleum Corporation, now Dana Gas Egypt, breached a contract with Shell such that the agreement was repudiated, Shell missed its chance to capitalise, the High Court said.

Instead of terminating the contract for repudiatory breach, and in doing so exercising a contractual right of rescission (i.e. treating the contract as void from the outset), Shell mistakenly terminated the contract in accordance with the termination procedure set out in the contract, giving 30 days' written notice to Centurion.

This act of termination pursuant to the contract affirmed the continuing existence of contract, the Court said, which had the effect of depriving Shell of the chance to claim for the return of its $15m investment. If Shell had terminated on the basis of repudiatory breach and exercised its right to rescind, it could have reclaimed that investment.

Centurion acquired drilling rights in the Nile Delta from the Egyptian government and brought Shell in as a partner in the oil and gas exploration project.

The contract that the two companies agreed contained clauses governing the circumstances under which Shell could end or extend its involvement in the project and, if that occurred, which company would owe the other what.

In some circumstances Shell would have to pay Centurion; in others Centurion would have to repay Shell; in others no payment would be made at all.

When Dana bought a holding company that owned Centurion in the middle of the project, Shell claimed that the company's failure to issue notices relating to its change of control constituted a repudiatory breach of the contract. The dispute went to arbitration. The arbitrators agreed with Shell, and found that Shell was also entitled under the contract to rescind it as the result of a separate breach.

Instead of informing Centurion of the breaches, and either terminating the contract at that moment or rescinding it from the outset, Shell wrote to Centurion terminating the contract on 30 days' written notice pursuant to the termination mechanism outlined in the contract's clause 3.1.8.

On appeal to the High Court, Mr Justice Tomlinson said that Shell's actions, in terminating under the contract, were clearly a mistake.

"When Shell sent the Termination Letter a mistake was made. Indeed it is obvious that Shell had made a mistake, and it must have been obvious to Centurion however surprising they may have found it," he said. 

However, he held that even if Centurion had realised that mistake, that did not "remove the essential thrust of the letter" which was that Shell wished to terminate the contract under clause 3.1.8.  Mr Justice Tomlinson therefore ruled that Shell's termination letter neither terminated the contract for repudiatory breach nor rescinded it.

The judge said that if Shell had not made that mistake it could have accepted that the contract had been repudiated by Centurion but also covered itself in case a court ruled after the fact that repudiation had not taken place.

"I can see no reason why Shell could not have served a notice which accepted the repudiatory breach as terminating the contract but, in the alternative, in case they were wrong in asserting that Centurion were in repudiatory breach, exercised the contractual right to terminate afforded by Clause 3.1.8," said Mr Justice Tomlinson.

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