Breaches of the innocent

The recent case of MSC v Cottonex [2016] EWCA CIV 789 has clarified the law around repudiatory breaches of contracts, that which deprives the innocent party of substantially the whole benefit of the contract.

If a breach takes place, usually the innocent party may either: (i) treat the contract as having been terminated as a result of the breach, or (ii) affirm the contract (letting the contract continue) if it has a legitimate interest in doing so.

MSC owned containers that Cottonex used for shipping a quantity of raw cotton to Bangladesh. Under the contract, Cottonex agreed to return the containers by the end of a fixed period. If Cottonex failed to return the containers on time, it would be liable to pay MSC a demurrage fee.

The price of cotton fell drastically before the cotton arrived in port and the buyer refused to take delivery. Bangladeshi customs stopped any party from accessing the containers until the dispute was concluded, so Cottonex could not return the containers. MSC took action against Cottonex to claim the three years of demurrage fees that had accrued by the time the case came to court.

The High Court found MSC was only entitled to the fees for part of the period, as a repudiatory breach had taken place and because MSC had no legitimate interest in affirming the contract. The court also found that a decision by an innocent party to terminate a contract should be taken in good faith and not only in the commercial interests of the innocent party.

The Court of Appeal, on the other hand, found that MSC had not had the option to affirm the contract at all, regardless of any legitimate interest in doing so, on the basis that the contract had already ended. The court held that the purpose of the contract had been frustrated by the actions of Bangladeshi customs and that the demurrage fees were only recoverable until the time when it was acknowledged in correspondence by both parties (rather than just Cottonex) that Cottonex was unable to return the containers.

The appeal court rejected the High Court’s finding on good faith, although it agreed that, on the facts, had the contract not been frustrated and MSC been otherwise able to affirm it, MSC would still have lacked a legitimate interest for doing so, since it would have been entirely unreasonable for it to insist on further performance by Cottonex.

This is an important judgment as its effect appears to be that innocent parties will be unable to affirm a contract if a repudiatory breach takes place and it is impossible for the defaulting party to perform its contractual obligations.

In such a situation, it may be that the courts will prevent an innocent party from affirming a contract, even though it might be in the party’s legitimate interest to do so. This is a departure from the usual rule that a contract that has been repudiated does not terminate unless the breach is affirmed, although it is less of a departure than would have been the case had the Court of Appeal agreed with the High Court that good faith should be taken into account when an innocent party decides whether to affirm a contract.

Parties should also bear in mind, as ever, that the courts will look critically at liquidated damages clauses. Here, the court found it was entirely unreasonable for payments due to such a clause to accrue indefinitely where the defaulting party was unable to remedy the breach. While the Court of Appeal rejected the High Court’s finding about good faith, the judgment shows that a court may decide not to enforce such clauses if it feels they are not reasonable, with or without a general principle of good faith.

The case is also a reminder that parties to a contract should insist on robust force majeure clauses, drafted specifically to deal with events that might possibly prevent a party from performing its obligations under a particular contract. Of course, some situations are less foreseeable than others, but with such a clause in place, a party that finds itself unable to perform its obligations, due to matters beyond its control, may avoid having to pay potentially large sums in liquidated damages.

Henry Evans is a corporate and commercial solicitor at Gordon Dadds @GordonDadds www.gordondadds.com