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Contractual termination and instalment payments: a cautionary tale

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Amy Edwards

Senior PSL - Litigation

London

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03 April 2013

In the case of Cadogan Petroleum Holdings Ltd v Global Process Systems LLC [2013] EWHC 214 (Comm) 15 February 2013, the termination of a sale contract for two gas plants resulted in the innocent party (the seller) keeping all the instalments paid by the buyer, the gas plants, and also entitled the seller to the remaining instalments. The case serves as a good reminder of how important it is to consider carefully how termination rights in a contract affect instalment payments.

This case involved a contract for the repurchase of two gas plants that had originally been manufactured and sold by the defendant (GPS) to the claimant (Cadogan). GPS agreed to buy back the plants and, as part of the contract, was already trying to find a buyer for them. Cadogan terminated the contract based on GPS's failure to pay two recent instalments. This failure to pay entitled Cadogan to terminate under the termination provisions of the contract. Seven instalments had already been paid totalling USD 7.5 million. The question for the court was whether Cadogan could keep the seven instalments, claim for all outstanding instalments which had accrued and were due and payable as at the date of termination (of USD 20 million) and also keep the gas plants, title to which did not pass to GPS, according to the contract, until all the instalments had been paid.

GPS argued that the instalments already paid were not meant to constitute forfeitable deposits and given that there was no rational basis for distinguishing the earlier payments from the later, it followed that none of the payments were a non-refundable deposit.

It was common ground that, as a result of GPS's non payment, Cadogan was entitled to exercise the right of "rescission" under the contract (the term "rescission" was used in the termination provisions). It was also common ground that the term "rescission" was not intended to refer to rescission ab initio but rather to contractual termination of the contract."

Rescission "without prejudice" to accrued rights

As a matter of construction of the contract, Eder J disagreed with GPS. Critically, the contract expressly provided that any rescission was without prejudice to any rights accrued to the seller. By the time of the termination, Cadogan had accrued rights to be paid all the outstanding instalments. GPS had not yet acquired the right to receive title to the gas plants. Eder J found the termination provisions to be consistent with this analysis, and also the recitals and general structure of the contract. There was no unconscionability in this bargain, and even if there was, it could be addressed by granting relief against forfeiture.

Penalty principle not applicable

GPS tried to argue, inter alia, that the penalty principle applied and that by Cadogan retaining the previously paid instalments, which were not a genuine pre-estimate of loss, this fell foul of the penalty principle.

By way of reminder, the penalty principle provides that a contractual provision which requires one party, in the event of his breach, to pay or forfeit a sum of money to the other is unlawful as being a penalty unless such a provision can be justified as being a payment of liquidated damages, being a genuine pre-estimate of the loss which the innocent party will incur by reason of the breach.

GPS relied on the Privy Council case of Workers Trust & Merchant Bank Ltd v Dojap Investments Ltd [1993] AC 573 as authority for showing that the penalty principle can apply to deposits which are subsequently kept on default.

Eder J rejected this analysis. Distinguishing the Workers Trust case, Eder J found that the penalty principle applies only to provisions which take effect on breach, not to sums which become payable on events other than breach, relying on, inter alia, Export Credits Guarantee v Universal Oil Products Co [1983] 1 WLR 399. GPS's obligation to pay the instalments was not triggered by breach, it preceded and was independent of the breach, and was thus not capable of being caught by the penalty principal.

No relief from forfeiture

Finally, Eder J considered whether GPS should be granted relief from forfeiture. GPS argued that Cadogan were, in effect, seeking to forfeit USD 27.5 million and that the court should grant relief against such forfeiture pending the sale of the gas plants. The power to do so depends on the exercise of the court's equitable jurisdiction having regard to the conditions existing when the relief is sought. Here, again, GPS failed. Eder J observed that it is likely to be very difficult to establish a case for such relief in a commercial context involving a freely negotiated contract. Eder J concluded that it would be unfair in this case to grant relief because Cadogan was contractually entitled to the instalments, the gas plants had not been sold and their present value was uncertain.

Eder J also rejected GPS's argument based on a total failure of consideration.

Comment

GPS ended up with no money and no gas plants. Cadogan ended up with the money and the gas plants. How can that be right? Clearly in this case there were some background factors that played a part, especially in the judge's consideration of whether relief from forfeiture should be granted. These included a history whereby Cadogan had originally purchased the gas plants, and then, following various disputes, GPS agreed to buy them back, with an element of the sale price being dependent on the price paid by a new buyer that GPS tried, but failed, to find. The judgment is not detailed in this respect, so it is difficult to know how much Cadogan had paid for the plants in the first place. However, given Eder J's reliance on the termination provisions in the contract when deciding how the instalments should be treated, the case is a perfect illustration of how careful parties must be when drafting contracts involving instalment payments. Consideration must be given to what is intended to happen both to already paid, and outstanding, instalments if the contract terminates before all instalments have been paid.

Further information

This case summary is part of the Allen & Overy Litigation Review, a monthly update on interesting new cases and legislation in commercial dispute resolution. For more information please contact Sarah Garvey sarah.garvey@allenovery.com, or tel +44 (0)20 3088 3710.