An innocent party is entitled to damages, even though performance of the contract is impossible

01 August 2019. Published by Geraldine Elliott, Partner and Eliot Henderson, Associate

The Court of Appeal considered the proper interpretation of exceptions or force majeure clauses and provided guidance on the correct application of the compensatory principle of damages in Classic Maritime v Limbungan.(1)

Quick facts and decision at first instance

A shipowner and a charterer entered into a long-term contract for the shipment of iron ore pellets from Brazil to Malaysia.  The charterer failed to make five cargoes available for shipment and claimed to be excused from its obligation to do so by the bursting of a dam in Brazil; this event fell under the "exceptions" clause in the contract.  The trial judge found that:

  • the burst dam made it impossible for the charterer to perform the contract; but
  • even if the dam had not burst, the charterer would have defaulted anyway (primarily due to a collapse in demand in the Malaysian markets).

The judge held that, in order to rely on the exceptions clause, the charterer was required to prove that "but for" the dam burst, it could and would have performed the contract in accordance with its terms.  In the light of the judge's finding that the charterer would have defaulted regardless of the burst dam, the charterer was unable to rely on the clause to excuse its failure to supply the cargoes.

The judge accepted that the applicable principle for assessing damages was the compensatory principle.  However, instead of a straightforward comparison between the position the shipowner was in as a result of the breach and the position it would have been in if the charterer had supplied the cargoes, the judge considered it relevant to take account of the reasons why the charterer was in breach of its obligations.  The judge therefore assessed damages by comparing the shipowner's position as a result of the breach with the position it would have been in had the charterer been able and willing, but for the dam burst, to supply the cargoes.  Since the charterer would not have been able and willing to supply the cargoes (regardless of the dam burst) the judge found that the shipowner was only entitled to nominal damages of US$1 per shipment.

This shipowner appealed the damages award and the charterer cross-appealed on liability.

The Court of Appeal decision

Interpretation of the exceptions clause

The Court of Appeal upheld the trial judge's interpretation of the exceptions clause and the judge's finding on liability.  In exploring the exceptions clause, the court found that if the parties had wished to agree a clause that excluded the "but for" test they could have done so.  Given that they did not, the clause in question did require such proof and the charterer was unable to provide it.

Compensatory principle of damages

The court found that the trial judge had misapplied the compensatory principle of damages.  The correct approach required a comparison in financial terms between
(i) the innocent party's actual position as a result of the breach and (ii) the position it would have been in if the contract had been performed.  The court held that its task was "simply to ascertain the value to the claimant of the
performance which the defendant should have rendered”, regardless of the reason(s) why the defendant did not perform the contract. 

This assessment of damages avoided the paradoxical conclusion reached by the trial judge that, even though the exemptions clause did not provide the charterer with a defence to liability, the charterer was not obliged to pay substantial damages for failing to perform its obligations under the contract.  The court found that the shipowner was in fact entitled to damages of almost US$20 million.

What does this mean for the drafting of exceptions or force majeure clauses?

This case provides yet another warning about the need for clarity in drafting contractual clauses and the implications of getting it wrong.

A clause may be drafted so as to relieve a party from liability in circumstances where it can prove that it would have been willing and able to perform the contract if a specified event had not occurred (as was the case here), or to relieve a party of obligations to perform in the future, regardless of its willingness and ability to perform the contract (which is more akin to a typical force majeure or frustration clause).  Either way, parties should consider what it is they wish such a clause to achieve, and draft the clause so as to make that intention explicit.  Relying on the clause heading to confer meaning to the clause will not suffice.

On the subject of clause headings, the court found that attempting to distinguish clauses on the basis of their labels (such as "exceptions", "contractual frustration" or "force majeure") was not particularly helpful.  What matters is the language of the clause: its meaning should simply be construed from that language. 

This decision is subject to appeal and we will report on the outcome of that application.

 

(1) Classic Maritime Inc v Limbungan Makmur SDN BHD & Anor [2019] EWCA Civ 1102