If the innocent party elects to affirm the contract after a repudiatory breach by the other party

Introduction

Can an innocent party affirm a contract following repudiation where performance by the party in breach is no longer possible? The Court of Appeal has considered this question in connection with a contract for the consignment of cotton.

The facts

Between April and June 2011, the claimant contracted with the defendant to carry 35 containers of raw cotton to the port of Chittagong in Bangladesh. The cargo was shipped in three consignments under five bills of lading. The defendant sold the cotton to a company in Bangladesh which was named as the consignee on the bills of landing; payment was to be made by letter of credit.

The bills of lading provided that the defendant was entitled to ‘free time’ of 14 days for the use of the containers after they were discharged at port. After this point, the defendant was obliged to return the empty containers to a place nominated to the claimant, otherwise demurrage accrued at a daily rate.

The containers were discharged at Chittagong between May and June 2011. However, a dispute arose between the consignee and the defendant; as a result, the consignee did not take delivery of the cotton and the containers remained at port. The claimant and defendant corresponded about resolving this issue; in the course of these discussions, the claimant requested payment of outstanding demurrage. On September 27, 2011, the defendant wrote to the claimant stating it did not have legal title to the cotton as it had received payment from the issuer of the letter of credit and suggested that the bank would pay the outstanding demurrage. However, the demurrage remained unpaid and the containers remained at port. On February 2, 2012, in a practical attempt to resolve the issue, the claimant offered to sell the containers to the defendant; the parties could not agree a price. In April 2013, the claimant issued proceedings against the defendant for accrued demurrage of US$577,184, alleged to be continuing to accrue at US$844 per day.

First instance judgment

At first instance, the judge concluded that the central issue was whether the defendant had repudiated the contracts of carriage. Drawing on authorities relating to charterparties, he found that delay will amount to a repudiatory breach of contract when it becomes so prolonged as to frustrate the commercial purpose of the venture. On the facts, the judge held that the defendant was in repudiatory breach of the contracts from September 27, 2011. He found that the claimant would have understood from the defendant’s message that there was no reasonable prospect of the defendant being able to arrange for the return of the containers and in any event, at this point, the delay in collecting the cotton was so prolonged as to frustrate the commercial purpose of the venture.

The judge noted that it was settled law that, upon a repudiatory breach of contract, the innocent party may elect to accept the repudiatory breach as terminating the contract or to treat the contract as continuing, i.e. “affirm” the contract. He went on to consider the “legitimate interest” principle (White v Carter), which indicates that an innocent party may not be able to affirm a contract “if it can be shown that a person has no legitimate interest, financial or otherwise, in performing the contract rather than claiming damages”. The judge remarked that the principle should be seen in the context of “increasing recognition in the common law world of the need for good faith in contractual dealings”. Applying the principle, the judge held that, by September 27, 2011, the claimant did not have a “legitimate interest” in keeping the contracts alive for the purposes of claiming demurrage.

Appeal judgment

The claimant appealed, including on the issue of whether the commercial purpose of the venture had been frustrated by September 27, 2011. The Court of Appeal held that the relevant test for whether the defendant’s failure to redeliver the containers amounted to repudiatory breach was in substance the same as for frustration: whether the delay was such as to render performance of the remaining obligations under the contracts radically different from those which the parties had originally undertaken. On the facts, this had occurred on February 2, 2012. The court relied both on timing and the parties’ actions. The delay by September 27, 2011 was relatively short; insufficient (without special circumstances) to justify a finding that the commercial purpose of the contracts had been frustrated. By February 2, 2012, the delay had continued for another four months. Further, the claimant’s offer to sell the containers to the defendant on February 2, 2012 was a clear indication that the commercial purpose of the contracts had been frustrated (sale would have discharged the defendant’s obligation to redeliver the containers).

The Court of Appeal also held that the legitimate interest principle did not arise. By February 2, 2012, the claimant could not elect to affirm the contract because the defendant was no longer capable of performing the contract as agreed, due to the frustration of the commercial purpose of the contracts. The court noted that the claimant had continued to press the defendant for performance beyond this date (requests for redelivery of the containers and payment of demurrage), but these were “acts in vain, unrelated to an existing contract”. Obiter, the Court suggested that had it been open to the claimant to affirm the contract, it would have been unreasonable to do so, given that the accrued demurrage exceeded the value of the containers by a considerable amount. Moore-Bick LJ also criticised the judge’s approach to good faith, distinguishing between the application of “broad concepts of fair dealing” to contractual construction and a general principle of good faith, which did not exist in English contract law. In his view, it was better for the law to develop along established lines rather than for judges to look for “some ‘general organising principle’ drawn from cases of disparate kinds.” He also pointed out that a general duty of good faith would risk undermining the terms agreed by the parties, in a similar way to an excessively liberal approach to contractual construction (noting the Supreme Court’s recent decision on that topic in Arnold v Britton).

As to damages, the Court of Appeal held that the claimant was entitled to demurrage up to February 1, 2012 and to damages for the loss of the containers (treated to have been lost on February 2, 2012), assessed as the replacement cost of the containers on that date.

Comment

This decision indicates that upon a repudiatory breach of contract the innocent party will not be able to affirm the contract if further performance by the defaulting party is not possible. This may arise where the repudiatory breach has the effect of frustrating the commercial purpose of the contract. These considerations may also be relevant to other cases where the contract provides for the accrual of liquidated damages. Contracting parties should be alive to these considerations, particularly when faced with a prolonged delay in the performance of the other’s obligations (for example in relation to contractual correspondence, which is likely to be relevant to the court’s approach to whether/when the commercial purpose of the contract was frustrated).

The Court of Appeal’s obiter comments regarding the legitimate interest principle also suggest that an innocent party will be unable to affirm a contract upon a repudiatory breach if it does not have a “legitimate interest” in keeping the contract alive, for example, where it would be affirming for the sole purpose of continuing claiming damages.

Finally, Moore-Bick LJ’s remarks suggest that the courts will be reluctant to recognise “good faith” as a principle of general application. His comments suggest that there are at least two overarching reasons for this: (i) lack of support in the authorities for a general duty of good faith; and (ii) the risk that importing principles of good faith into contractual construction would cause the Court to depart from the terms agreed between the parties. This suggests that, in a situation where there is no authority or express contractual wording for the application of “good faith” to the exercise of contractual discretion by a party, then for parties seeking to challenge the exercise of that discretion, the better approach may be to rely on concepts of “fairness” or “reasonableness”, rather than “good faith”.