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Termination options: General law or contractual right

29 May 2014

In Newland Shipping and Forwarding Ltd v Toba Trading FZC [2014] EWHC 661 (Comm), 12 March 2014, Leggatt J considered the interplay between express contractual rights to terminate an agreement and the rights to terminate that arise under the general law. A party which has a right to terminate both under a contract and the general law may exercise both of those rights provided there is no inconsistency in doing so. If it would be inconsistent to exercise both rights, the party must elect which right it wishes to exercise. The party seeking to terminate must clearly communicate which right is being exercised (or that both rights are being exercised), otherwise the communication may not be sufficiently certain for there to have been an effective termination. 

Background

Newland and Toba entered into a contract for the sale and carriage of gasoil. Clause 7 of the contract gave Newland the right to cancel the contract if Toba failed to pay for the goods within a set period and provided that Toba would be obliged to compensate Newland for all associated losses. Clause 12 sought to limit Newland and Toba's liability for loss or damages of any kind, except as expressly provided in the contract.

Newland duly shipped the goods and pressed for payment. An extension was agreed by the parties but Toba still failed to pay. Newland therefore served a notice purporting to terminate the contract and claimed Toba was liable to compensate Newland for losses connected with its failure to pay. Toba argued, inter alia, that Newland had failed to exercise a right to terminate pursuant to clause 7, but instead had purported to accept an alleged repudiatory breach of the contract. Toba further argued that if there had been a repudiatory breach of contract and Newland had accepted that breach, it was not liable to pay the sums claimed, as clause 12 operated to exclude liability for damages.
 
Leggatt J found that Newland had been entitled to terminate the contract under clause 7 and/or in accordance with its rights under the general law to terminate on account of Toba's repudiatory breach. A key issue was whether Newland's notice was effective to terminate the contract:

a. under clause 7;
b. by way of acceptance of a repudiatory breach; or
c. as a simultaneous exercise of both forms of termination right.

 

Inter-play between contractual right to terminate and termination under the common law

The judge observed that the "inter-play" between contractual termination rights and termination rights under the general law was "an area which is not free from difficulty". He noted that an express termination clause will not exclude the right to terminate under the general law unless the contract clearly says so. Leggatt J also confirmed that there is generally no inconsistency in opting to terminate both on the basis of an express contractual term and on the basis of a repudiatory breach. So, where both are available, a party can elect to exercise both at once. However, there may be an inconsistency in the exercise of these rights if the consequences of their exercise conflict. In the Dalkia case1, contractual termination and acceptance of a repudiation would have had "markedly different consequences" as the former allowed the defaulting party to retain possession of the energy plant in question (provided it paid a termination sum) whereas the latter would have entitled the innocent party to take it back. In these circumstances the judge in Dalkia found that the single termination notice could not be taken to have produced two "diametrically opposing consequences" and held that there had been a contractual termination only.

Therefore in cases where the consequences of exercising one termination right are inconsistent with the consequences of exercising the other, the party with the right to terminate cannot exercise both rights and must elect between them. Leggatt J, however, made a distinction between these cases and cases where the consequences of exercising the two rights are merely different, but not inconsistent. He also emphasised the fact that, if a party does need to make an election, for that election to be valid he must clearly communicate his choice to exercise one right rather than the other. In summary:
  • in cases where the consequences of contractual termination and termination under the general law are identical, termination will be valid even if the innocent party declines to specify which right he is exercising;
  • if the consequences of each termination right are different (but not inconsistent) termination will only be effective if the innocent party specifies which right is being exercised, or alternatively specifies that both rights are being exercised otherwise there is not sufficient certainty for the termination be effective;
  • where the consequences of exercising one termination right are inconsistent with the consequences of exercising the other, the innocent party must elect between the two rights and must clearly communicate his choice for termination to be effective.

Newland's termination – consequences were "different" but not inconsistent

If Newland had validly terminated under both clause 7 and the general law, then it would have a right to compensation under clause 7 and would (in principle) also be entitled to claim damages under the general law (subject to Clause 12). Leggatt J discussed the consequences of exercising each termination right and concluded that they were different. The sums that Toba would be obliged to pay under clause 7 were not the same as the sums that would be recoverable following termination for repudiatory breach, as clause 12 expressly excluded any damages that would be available under common law. In fact, the judge noted that termination for repudiatory breach would "add nothing of value. But that is no reason why it could not be done". The consequences of the exercise of the termination rights were therefore different, but in spite of this the judge still did not consider that they were necessarily inconsistent. Accordingly, Newland would have been permitted to exercise both termination rights simultaneously.

Which termination right(s) had Newland exercised?

To determine whether Newland had exercised its contractual termination right or its termination right under the general law (or both), the judge considered the mixed language of Newland's termination notice. In it, Newland stated that it recognised Toba's breach "as a repudiatory breach" entitling it to damages. At the same time the notice quoted the salient provisions of clause 7 and claimed compensation available pursuant to that clause. Unsurprisingly, Leggatt J held that the explicit references to "repudiatory breach" and "damages" were a clear exercise of Newland's right to terminate under the general law. The judge also held that having quoted the terms of clause 7 (and the specific recovery rights afforded by that clause), Newland's notice was also a clear exercise of its contractual termination right. Furthermore, Leggatt J noted that the notice had to be read against the background of earlier correspondence in which Newland had threatened to terminate in accordance with clause 7; Newland was only doing what it had previously threatened to do.
The judge noted that if, contrary to his view, it was not possible for Newland to exercise both termination rights concurrently, then by having failed to elect between the two rights Newland would have failed to validly exercise either. However, the judge noted that Toba's response to the notice did not treat the contract as having been terminated; on the contrary it asserted that there had been no breach and that the contracts remained valid. Moreover, to the extent that the contract had not already been validly terminated under both bases when the notice was served, Leggatt J found that a subsequent without prejudice e-mail sent by Newland (which was expressed to be "formal notice to terminate the contract as per contractual terms" if settlement was not forthcoming) was an "unequivocal election" to terminate under clause 7.
One way or the other, the judge therefore concluded that Newland had successfully exercised its termination right and was entitled to compensation in accordance with clause 7.

Comment:

Parties are reminded to take care when deciding whether to accept a repudiatory breach of contract or to use an available contractual termination mechanism. It is important to determine carefully which methods of termination can be relied upon and, if more than one is available, whether it is possible to exercise both consistently or whether an election must be made. Even in cases where there would be no inconsistency between the consequences of exercising each termination right, the way in which the rights are exercised must be carefully considered. It should always be borne in mind that if the consequences of exercising each right are different, unless both rights are clearly exercised a judge may well conclude that the innocent party has failed to terminate at all.
The method(s) of termination to be relied on should therefore be stated clearly and unambiguously in the termination notice. If there is any doubt as to which method(s) the innocent party is seeking to rely on then it seems that (in Leggatt J's view) prior conduct may be used as a guide.
Recipients of a notice to terminate should likewise carefully assess whether a notice of termination is an effective exercise of termination rights under the contract and/or the general law before responding to the notice or taking any other steps in relation to it.

Footnote:

1 Dalkia Utilities Services plc v Celtech International Ltd [2006] EWHC 63 (Comm).

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 20 3088 3710.