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Court of Appeal sheds light on innocent party's right to affirm frustrated contract

08 November 2016. Published by Elizabeth Wiggin, Associate and Stuart Shepherd, Partner

It held that the innocent party could not affirm a contract once its commercial purpose had been frustrated in order to claim on-going damages.

Background

MSC Mediterranean Shipping Company S.A (MSC) had contracted with Cottonex Anstalt (Cottonex) to carry containers of Cottonex's cotton to Bangladesh. The various bills of lading specified that if MSC's containers were not returned within 14 days of discharge from the vessel, demurrage (in this context, liquidated damages for delayed return of the containers) became payable at a top rate of USD 24 per day per container. The running of demurrage was not subject to any express time limit and could, potentially, run indefinitely.

Cottonex sold and shipped the cotton between April and June 2011 but the buyer failed to collect it from the discharge port. The port authorities in Bangladesh refused to allow Cottonex to remove the cotton from the containers without the permission of the Court. No Court Order had been made and therefore the cotton remained at the port.

Demurrage began to run 14 days after discharge. On 27 September 2011 Cottonex notified MSC that it was unable to return the containers and thus perform its contractual obligations in terms of returning the containers as it did not possess legal title to the cotton anymore. On 2 February 2012, MSC offered to sell the containers to Cottonex. However, the negotiations did not come to fruition as Cottonex considered that the price offered was too high. MSC issued High Court proceedings to recover the demurrage which they said continued to accrue.

First Instance decision

Leggatt J., in the first instance Commercial Court judgment, ruled that Cottonex's notification on 27 September 2011 amounted to a statement that it would be unable to redeliver the containers within the foreseeable future, if at all. By this time, the Judge held that "the delay had become so prolonged as to frustrate the commercial purpose of the adventure and that [Cottonex] was therefore in repudiatory breach of all contracts of carriage".

The Judge ruled that MSC was entitled to recover the demurrage for the period between the expiry of the 14 days grace period and 27 September 2011 on which notification was given to MSC.

The judgment held that MSC could not affirm the contract as it did not have a legitimate interest in doing so (applying White & Carter (Councils) Ltd v McGregor [1962] AC 413). Indeed, MSC's only interest in affirming the contract was to claim demurrage indefinitely. The Judge ruled that it could not do so as there was no realistic prospect that Cottonex would be in a position to return the containers.

Court of Appeal decision

MSC appealed. The Court of Appeal agreed that MSC should only be allowed to recover demurrage up until the time by which Cottonex was in repudiatory breach. However, it disagreed with the High Court's ruling on the date at which Cottonex was in repudiatory breach.

a) When did the demurrage become payable

The judgment confirmed that once the 14 days grace period had expired, demurrage began to accrue by way of liquidated damages for the detention of the containers. That detention continued whether or not MSC had nominated a place for redelivery and until such time that Cottonex was able to return the containers.

b) Frustration of the commercial purpose of the contract

The judgment noted that it was surprising that the High Court had determined that the contract between MSC and Cottonex was repudiated on 27 September 2011. The Court of Appeal Judge commented:

"[…] in the absence of some special circumstances it is hard to see how such a relatively short delay can have been sufficient to frustrate the commercial purpose of the adventure. I can see a possibility that the uncertainty surrounding the future course of events and [Cottonex's] ability to redeliver the containers might lead to such a conclusion, but the judge did not base his decision on any assessment of that kind. With all respect to the judge, therefore, I do not think that his finding can stand".

Instead, the Court of Appeal held that the contracts were repudiated on 2 February 2012, when MSC offered to sell the containers to Cottonex. It also held that by this date the contracts were frustrated. The Court thus concluded that MSC was entitled to damages made up of (i) demurrage on the containers up until 2 February 2012, together with (ii) a sum representing the value of the containers as at that date.

c) Consequences of repudiation

The judgment noted that a repudiatory breach of contract does not automatically discharge the parties from further performance of the contract, but rather gives the innocent party the right to choose whether to treat it as having that effect.

Two questions arose following the frustration of the contract on 2 February 2012: (i) could MSC still insist on the performance of Cottonex's obligation to return the containers; and, if not, (ii) what damages flowed from the breach of that obligation?

In this connection, the Court commented that the accrued demurrage already considerably exceeded the value of the containers. Replacement containers were also readily available. The Court ruled that "it would have been wholly unreasonable for [MSC] to insist on further performance". However, the question of whether it was reasonable to affirm a contract and seek damages did not arise in circumstances in which the underlying contract has been frustrated, as in this case. The Court of Appeal held that the option to affirm the contract was not available to MSC as the contract had become frustrated since further performance was simply impossible, "just as it would if [Cottonex] or those for whom it was responsible had caused the containers to be destroyed". It was not that Cottonex would not return the containers, but rather it could not. The Court concluded that:

"[…] as from 2 February 2012 the contract in its agreed form was not capable of performance – further performance in the changed circumstances brought about by the delay would be radically different from that agreed […] In those circumstances, as it seems to me, the innocent party simply cannot treat the contract as subsisting because it is no longer capable of performance as agreed. There is no alternative to the conclusion that the contract has come to an end".

d) Good faith

Leggatt J. at first instance had commented, in the context of considering the limits on a party's rights to affirm a contract in the face of a repudiatory breach, on his perception of an increasing recognition for the need to imply obligations of good faith in contractual dealings. The Court of Appeal however, did not support the views expressed by Leggatt J. and commented that concepts of good faith were not "necessary or desirable to resort to it in order to decide the outcome of the present case". The Court observed that that there was a "real danger" that if a general principle of good faith were established, it could be equally invoked to undermine the terms agreed by contracting parties as well as to support them.

Comment

The Court of Appeal's judgment is interesting on two levels. Firstly, it highlights that in circumstances in which a contract has become frustrated one does not need to agonize about whether it would be reasonable for an innocent party facing a repudiatory breach to affirm the contract and claim damages; this is for the simple reason that once a contract has become frustrated it is at an end and thus impossible to affirm. Secondly, the judgment contains comments which are discouraging to those who believe that English law should be adopting, in the context of contractual dealings, a general duty of good faith.