Suppliers in breach of contract may face greater liability after Court of Appeal ruling

Out-Law News | 19 Feb 2009 | 5:26 pm | 3 min. read

A customer's decision to terminate a contract and then to use that contract's remedies to recover money did not prevent that company also suing for common law damages over a supplier's failure to fulfil the contract, the Court of Appeal has ruled.

Last week's ruling could make it easier for customers  to exercise both contractual and common law remedies on the termination of a supply contract, a legal expert has said.

Shipyard Stocznia Gdynia failed to build three ships as agreed with buyer Gearbulk Holdings so Gearbulk terminated the contract for each ship. It did so by exercising a right in the contracts that required Stocznia to repay any money already paid.

In its letter of termination, Gearbulk demanded the return of its prepaid instalments. Gearbulk then sought to recover common law damages for the shipyard's failure to fulfil the contract.

When a contract is breached so fundamentally that the other party is allowed to terminate that contract common law damages can be sought. Such damages are known as repudiatory damages. By failing to deliver the ships at all, Gearbulk said that Stocznia had acted in repudiatory breach of contract.

The shipyard argued, though, that Gearbulk could not treat the contracts as repudiated because it sought to rely on the refund provisions.

When a supplier fundamentally breaches the terms of a contract, the customer has a choice either to treat the contract as still in existence, which is called affirming the contract; or terminate and seek damages for repudiation at common law. Stocznia said that Gearbulk's exercise of the refund provision affirmed the contract.

If the shipyard's argument was upheld, i.e. if the contract had been affirmed, Gearbulk would not be able to then seek repudiatory damages.

The High Court said that there was affirmation, but the Court of Appeal disagreed. Overturning the earlier decision, it said that Gearbulk's exercise of its contractual right to terminate did not remove its right to claim damages under common law.

"[Stocznia's QC] Mr. Dunning sought to argue that Gearbulk had no right to recover damages for loss of bargain in this case because the effective cause of its loss was not the Yard's breach of contract but its own decision to exercise its contractual right of termination. I cannot accept that," wrote Lord Justice Moore-Bick. "I think it is clear that in this case the contract proceeds on the footing that if Gearbulk chose to exercise its right, the Yard's breach was to be viewed as the effective cause of the contract's termination."

"[Termination clause] Article 10 does not exclude Gearbulk's right to recover damages at common law for the loss of its bargain," he wrote. "I am quite unable to accept that the exercise by Gearbulk of its right to recover instalments of the contract price under Articles 5.9 and 10.7 involved an election on its part to affirm the contract."

"In the first place, Gearbulk's letters exercising its right to terminate the contracts … were wholly inconsistent with an election to affirm them, so there can be no doubt that the contract in each case was discharged," said Lord Justice Moore-Bick. "The right to recover the instalments of the price, together with the right to obtain payment under the bank guarantee, arose only on and by reason of the termination of the contract. I think it is clear, therefore, that the parties intended it to survive the termination of the contract, just as, for example, they intended the arbitration clause to survive. Reliance on that obligation could not, therefore, amount to an election to keep the contract in being."

Dispute resolution specialist Richard Twomey said that the ruling is good news for companies that are being let down on major contracts.

"Companies are sometimes wary to terminate the contract and seek to enforce the contractual remedies because they fear prejudicing their ability to claim damages at common law. The rights have always been rather uncertain," he said.

Twomey said that common law damages can be much higher than contractual remedies sometimes allow, so that is often a company's preferred claim.

"A party seeking repudiatory damages will be seeking a sum that puts it in the position that it would have been in had the contract been performed properly. That can be much more than, for example, the sums specifically recoverable under the contract," he said. "But this ruling will give companies confidence that they can make both contractual and common law claims."

As this case demonstrates, suppliers should consider addressing repudiatory damages in their contracts, according to Twomey.

"The ruling might have been different if the contract had provided that a claim under the contract would exclude any right to repudiatory damages," he said. "It would be worth suppliers trying to get such an exclusion or waiver into their contracts to reduce the range of remedies available to claimants like Gearbulk. 

Twomey said that a customer seeking to terminate an agreement should make clear in its letter of termination not just that it's claiming any benefits under the contract's termination provisions, but also that it reserves all rights, including the right to seek repudiatory damages. "This approach gives the terminating party maximum flexibility when it comes to enforcing its rights," said Twomey.