Court of Appeal finds innocent party could not affirm contract following repudiatory breach where defaulting party unable (not just unwilling) to perform

The Court of Appeal has upheld a decision that a party was not entitled to keep a contract alive for the purpose of claiming ongoing liquidated damages for delayed performance following its counterparty’s repudiatory breach: MSC Mediterranean Shipping Company S.A. v Cottonex Anstalt [2016] EWCA Civ 789.

The Court of Appeal did not however base its decision on whether the innocent party had a "legitimate interest" in affirming the contract, as the High Court had done (see our blog post on the first instance decision). Instead, the Court of Appeal found that it was not open to the innocent party to affirm the contract because the defaulting party was unable to perform its obligations, as the commercial purpose of the venture had become frustrated, rather than simply refusing to do so. The decision suggests that an innocent party's ability to affirm a contract following a counterparty's repudiatory breach will be fettered if performance is no longer possible.

The Court of Appeal also disagreed with the High Court's suggestion that "good faith" principles are relevant in considering whether an innocent party has a legitimate interest in affirming a contract. Its comments on this aspect suggest a reluctance on the part of the senior judiciary to broaden the application of "good faith" principles in matters of interpretation and contractual construction.

Gregg Rowan and Rob Javin-Fisher, a partner and senior associate in our dispute resolution team who commented on the High Court decision, consider the outcome of the appeal further below.

Background

The claimant (MSC) had contracted with the defendant (Cottonex) to supply and ship containers of the defendant’s raw cotton to a customer in Bangladesh. Under the bills of lading the containers were to be returned to the claimant within 14 days of discharge from the vessel, failing which a daily tariff (demurrage) for late delivery was to apply.

The customer never collected the cotton due to a collapse in the market price. The containers remained in Bangladesh, where the customs authorities would not allow them to be unpacked without a court order (due to legal action taken by the customer).

After the 14 day period elapsed, MSC sought to claim demurrage for each day that it was without use of the containers. Cottonex refused to pay, arguing that it no longer had title to the goods and was unable to empty the containers and return them to MSC.

High Court decision

The High Court (Mr Justice Leggatt) held that MSC was entitled to be paid demurrage after the 14 day period had elapsed, but only up to the point that Cottonex had repudiated the bill of lading contracts due to its inability to redeliver the containers to MSC, which he placed at 27 September 2011.

Although, as the innocent party, MSC would normally have a choice whether to accept the repudiation as terminating the contract or to affirm the contract, it was not open to MSC to affirm the contract for the purpose of claiming demurrage indefinitely unless it had a "legitimate interest" in doing so (applying White & Carter (Councils) Ltd v McGregor [1962] AC 413).

Leggatt J considered that, similar to the exercise of a contractual discretion, a decision to affirm a contract must be exercised in good faith. He held that MSC did not have a legitimate interest in affirming the contract; its only interest in keeping the contract in force was to claim demurrage in circumstances where there was no realistic prospect that Cottonex would be able to procure the return of the containers.

Court of Appeal decision

The Court of Appeal (Moore-Bick and Tomlinson LJJ and Keehan J) held that the contract had not been repudiated until 2 February 2012, rather than 27 September 2011 as the High Court had found.  It was at this point that it became apparent to a reasonable observer that the containers could not be redelivered within the foreseeable future, and so the commercial purpose of the venture was frustrated at that point.

The Court of Appeal agreed with the High Court that it was not open to MSC to affirm the contract, once it had been repudiated by Cottonex, but reached this conclusion on a different basis from the High Court's decision.

The consequences of repudiation

The judge rightly recognised that a repudiatory breach of contract does not inexorably lead to a termination of the contract, but rather  allows the innocent party to decide whether to treat it as having that effect or to affirm the contract.

On the question as to whether an innocent party must have a "legitimate interest" in affirming a contract, the Court of Appeal distinguished White & Carter, and the authorities following it, on the basis that they were concerned with situations where the party in breach was refusing to perform obligations that fell due for performance at a future date. In the present case, however, it was not open to MSC to affirm the contract because the commercial purpose of the venture had become frustrated and Cottonex was unable (rather than choosing not to) perform its remaining obligations. Accordingly, the question of whether there was a legitimate interest in affirming the contract, as per White & Carter, did not arise.

While the court concluded that MSC was unable to affirm the contract, Moore-Bick LJ noted, on an obiter basis, that, even if it was possible for MSC to affirm the contract, it would have had no legitimate interest in so doing on the basis that (a) by the time of the repudiatory breach the accrued demurrage greatly exceeded the value of the containers and (b) replacement containers were readily available. Accordingly, if it had simply been a case of Cottonex refusing to perform its obligations then the principle set by White & Carter would have applied.

Was there a duty of good faith?

At first instance, Leggatt J referred to the established rule of English law that a contractual discretion must be exercised in good faith and must not be exercised arbitrarily, capriciously or unreasonably, and extended that principle to a decision as to whether or not to affirm a contract following a repudiatory breach. The Court of Appeal however disagreed that there was any need to resort to "good faith" principles when considering whether any innocent party had a legitimate interest in affirming a contract following a repudiatory breach. Moore-Bick LJ observed that "[t]he recognition of a general duty of good faith would be a significant step in the development of our law of contract with potentially far-reaching consequences and I do not think it is necessary or desirable to resort to it in order to decide the outcome of the present case."

The passages that follow the above quote suggest that the Court of Appeal may be wary about the creep of the application of good faith principles into the English law of contract. In Moore-Bick LJ's view, there is a "real danger that if a general principle of good faith were established it would be invoked as often to undermine as to support the terms in which the parties have reached agreement."

Was the claimant required to mitigate?

While it was common ground between the parties that the principles of mitigation did not apply to the daily rate of demurrage, which was payable regardless of the amount of MSC's actual daily loss, Cottonex argued that there was nonetheless an obligation on MSC to minimise the duration of the period for which it claimed demurrage.

The Court of Appeal noted that, given its conclusion on the effect of the repudiation, it was not necessary to decide this issue. However, its provisional view was that the judge was right to conclude that there was no such obligation. If MSC had acquired further containers, that would only have increased MSC's stock and could not be regarded as true substitutes for those Cottonex continued to detain (and therefore could not amount to mitigating the loss).

Comment

The comments of Moore-Bick LJ, the Vice President of the Court of Appeal (Civil Division), indicate a reluctance on the part of the senior judiciary to create a "general organising principle" of good faith obligations. That is not to say that the Court of Appeal has closed the door to a recognition of "good faith" principles in English law, but the decision suggests that the senior courts do not wish to open the floodgates to "good faith" arguments being raised in a whole range of cases where they are not required.

The comments of Moore-Bick LJ on the effect of repudiation in circumstances where the party in breach is unable to perform its side of the bargain are also interesting. In White & Carter, the House of Lords referred to two limitations on the innocent party's right to affirm:

1. if the innocent party was unable able to perform its obligations under the contract without the other’s cooperation (unless it could get an order for specific performance to compel such cooperation); and
2. if the innocent party had “no legitimate interest" in performing the contract and claiming damages.

The present decision appears to establish a third, namely where further performance is impossible because the commercial purpose of the venture has been frustrated.