Dalkia Utilities v Celtech

Out-Law Guide | 02 Nov 2007 | 8:31 am | 8 min. read

Can non-payment of invoices amount to material breach? The answer depends on a number of factors, the most important of which is the circumstances in which the breach arises. This case considered the point in the context of a long term agreement where the defendant failed to pay a contractor's invoices for three consecutive months. Despite the agreement being for a term of fifteen years, a failure to pay for three months was sufficient to constitute a material breach.

Dalkia Utilities Services plc v Celtech International Limited

  • Case No: 2004 Folio No. 311
  • PMCLR May 2007 [2006]

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Facts

The Claimant, Dalkia Utilities Services Limited, a designer, constructor and operator of energy plants, contracted with the Defendant, Celtech International Limited, to supply energy services by means of an energy plant for the Defendant's new paper mill.

Six Agreements were signed between the parties. The central contract was known as the Principal Agreement and established that the contractual relationship between the parties would last an Initial Period of 15 years.

Payment was by way of "Charges" paid in 12 instalments per year over the 15 year period. The Charge was split into 2 parts: a Finance Element and an Operational Element. The Finance Element represented the capital cost of the plant. The plant was initially owned by the Claimant, but the objective was that by the tenth anniversary of the agreements, the Finance Element of the Charge would amortise the capital cost of the plant. Once the cost was totally amortised, the plant would become the property of the Defendant. The Operational Element made up the second part of the Charge and related to the costs associated with running the plant.

The agreements conferred on the Claimant a right to terminate immediately if the Defendant was in material breach of its obligation to pay the Charges (Clause 14.4). The Principal Agreement also contained a Clause (Clause 15) which entitled the Claimant to a Termination Sum if the contract came to an end because of the Defendant's breach.

Upon payment of the Termination Sum, the Defendant would keep the plant. Confusingly, the Principal Agreement was later amended with the effect that the Termination Sum would be limited to any interest outstanding on the "Charges" (Clause 9A.7) and in the event that the Claimant became entitled to terminate, it would be entitled to claim the full "Charges" due and payable (Clause 9A.8). The Defendant sought to renegotiate further the Principal Agreement and stopped making payments to the Claimant.

When the Defendant failed to pay 3 monthly instalments in succession, the Claimant sought to terminate the agreements with the Defendant by relying on Clause 14.4. In addition, the Claimant claimed a Termination Sum from the Defendant pursuant to Clause 15.  The Defendant argued that the breach of contract upon which the Claimant was seeking to rely in its termination was not "material". The Defendant argued that in circumstances where it had failed to pay three out of 174 payments to the Claimant, and where these non-payments were small (£390,000) in proportion to the total amount payable under the agreements, the failure could not be regarded as a material breach.

The consequence of termination would be that the Defendant was to pay £3 million as the Termination Sum which was, in the Defendant's eyes, a penalty. The Defendant referred back to other occasions in which the Defendant had been similarly in breach of its obligations where the Claimant had not sought to terminate. The Claimant submitted that any breach that was more than trivial would be material and that there was an obvious mistake in the drafting of Clauses 9A.7 and 9A.8 and that these clauses were inherently contradictory. The Claimant submitted that the termination clause should be read as saying that upon termination the Claimant was entitled to recover all the finance charges.

Judgment

Mr Justice Christopher Clarke found for the Claimant. The Defendant, in failing to pay three monthly instalments, was in material breach of its obligations to pay the "Charges". This was because the three monthly instalments were neither trivial nor minimal sums of money and the Defendant's failure to pay was serious. The judge said

"In assessing the materiality of any breach it is relevant to consider not only of what the breach consists but also the circumstances in which the breach arises, including any explanation given or apparent as to why it has occurred."
In the circumstances the Defendant had not paid the instalments because it was not in a position to do so. The company was facing insolvency and it was unlikely it would be able to pay in the near future. The judge examined Clause 14.4 and stated that such a provision was designed, in context, to protect the client where its failure to pay was due to some mishap or administrative failure, but if the failure was not due to this sort of reason, the clause was designed to enable a supplier such as the Claimant to bring the period over which it was extending credit to an end.

The factors taken into account by the judge included the fact that the instalments missed were consecutive, that nothing suggested that there was any better prospect of being paid and that, although in the context of the whole project the missed instalments were small, the payments represented a whole quarter's payments and 8.5% of the total charges unpaid for the remainder of the term.

There was, as the Claimant asserted, an obvious mistake in the Amendment to the Agreement at Clauses 9A.7 & 9A.8. To construe these clauses literally would have been commercially nonsensical and contradictory, since the clauses stated that the "Charges" would not be due on Termination, but only interest on the "Charges" (Clause 9A.7); and that the Defendant was liable to pay the full Charges which effectively meant that the Defendant was being asked to pay operational charges that had not accrued at the time of termination (Clause 9A.8). The judge concluded that the Claimant would be entitled to a Termination Sum that excluded the operational element of the "Charges". On payment of the Termination Sum (and other sums that had accrued under the agreements which were not in dispute) the plant would become the Defendant's.

The Defendant had asserted that the sums that the Claimant was claiming amounted to a penalty. The judge stated that since the Defendant was not being asked to pay the full charges (i.e. for operational services that the Defendant had not received) and all the Defendant was being asked to do was to repay early the capital in effect advanced by the Claimant in return for which the Defendant could keep the plant, the sum was not penal.

The Claimant submitted in the alternative that the Defendant's failure to pay the instalments and in its indications about whether it could pay or not amounted to a repudiation of the Principal Agreement. These submissions were not accepted. Even if the Defendant's behaviour could be considered repudiatory, the Claimant's Termination Notice was not sufficient to amount to an acceptance of repudiation as it did not refer to repudiation.

Commentary

The Dalkia decision may be added to a long line of authorities dealing with contractual rights of termination, distinct from repudiation, and it provides a good opportunity to recap on the legal principles involved.

At common law a party may bring a contract to an end if the other party's conduct is repudiatory. In Heyman v Darwins three sets of conduct amounting to repudiation were set out:-

  • where the party evinces an intention not to perform its contractual obligations in some essential respect; 
  • where impossibility of performance arises as a result of the party's act; and
  • where there is total or partial failure of performance – if partial, the failure must occur in a matter which goes to the root of the question.

Contract draftsmen try to reserve contractual rights of termination which allow a party to bring the contract to an end for circumstances which are less than repudiatory. Some drafted clauses are more effective than others. In "The Antaios" the Court rejected the claimant's argument that because the contract provided for termination in the event of
any breach, a party could terminate the agreement for any breach whatsoever, however slight. In that case the complained of breach was very small and the Court of Appeal disagreed with the claimant's position, saying "if detailed semantic and syntactical analysis of words in a commercial contract is going to lead to a conclusion that flouts business common sense, it must yield to business common sense." The Court found that the breach had to constitute a repudiatory breach to allow termination, which had not occurred in this case.

In National Power plc v United Gas Company the termination clause provided for termination in the event a party was in "material breach" and the party had not remedied the breach within 7 days of notice to do so. Colman J found that this did allow for termination in circumstances which were less than repudiatory. Hence, the lesson was learnt, use the word "material" and provide a remedy period, at least to cover the situation where the breach is remediable.

The situation, however, was rather muddied by the case of Crane Co v Wittenborg. The termination clause in that contract provided for a remedy period but allowed termination in the event of a "substantial" breach. Mance LJ construed this clause in such a way to find that "substantial breach" was the same as "repudiatory breach", and as such the draftsman had not reserved a lower threshold for termination than that which would already be offered by the common law.

More recently, in the leading case of Rice v Great Yarmouth, where the contract allowed for termination in the event the contractor committed any breach of its obligations, the Court of Appeal upheld the decision in "The Antaios" and found that any single breach of obligation did not give rise to termination unless it was repudiatory. However, in this case the additional argument was put forward that the totality of repeated breaches could give rise to the right to terminate, even if each breach on its own would not - the "death by a thousand cuts" argument. The Court of Appeal accepted this and Hale LJ found that in a contract of multiple, separate obligations, repeated breaches would give rise to a right of termination if the breaches deprived the innocent party of substantially the whole benefit of substantially any aspect of the contract.

A lesser reported case is that of Phoenix Media v Cobweb Information where again the termination clause referred to material breach and allowed for a remedy period. Neuberger J adopted an evaluative approach stating:

"materiality involves considering the following: the actual breaches, the consequences of the breach to [the innocent party], the [defaulting party's] explanation of the breaches, the breaches in the context of the Agreement, the consequences of holding the Agreement determined, and the consequences of holding the Agreement continues."

Thus, the Court should evaluate all the circumstances, including the consequences of finding the contract terminated or enforceable.

And so we come to Dalkia. It is little wonder Celtech argued that in the circumstances where it failed to pay 3 months' instalments (totalling £390,000) in the context of a total of 174 payments to be made under the agreements, and where it would have to pay £3 million as a Termination Sum, the non-payment should not be regarded as material.

Whilst Clark J looked at the consequences for Celtech as a result of the breach, he said that the main focus should be in the nature of the breach not the consequences for thebreaching party if the agreement is terminated. However, Clark J did lay significant reliance on the fact that the breach had a significant impact on Dalkia. Thus the Court has adopted a more limited evaluative approach to that shown by Neuberger J, looking more particularly at the consequences of the breach on the innocent party.