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Case considers the right to affirm a frustrated contract

In the recent case of MSC Mediterranean Shipping Company SA v Cottonex Anstalt [2016], the Court of Appeal considered the question of whether an innocent party faced with a repudiatory breach could affirm a contract once its purpose had been frustrated.

The Court of Appeal held that the innocent party was not entitled to affirm the contract in order to claim liquidated damages. The Court of Appeal also elected to retreat from the High Court's view that there is an increasing need to imply obligations of good faith in contractual dealings and stated that the general principle of good faith was not necessary to decide the outcome of the case.

Background

The case concerned a written agreement between a cargo carrier, MSC Mediterranean (MSC) and a company operating within the textiles industry, Cottonex Anstalt (Cottonex), under which Cottonex engaged the services of MSC to ship 35 containers of raw cotton to Bangladesh. Upon arrival in Bangladesh, the cotton's market price had collapsed and the buyer refused to accept delivery of the 35 containers of cotton. As a result, the containers remained at the port under the control of the customs authorities.

Under the terms of the parties' contract, Cottonex had 14 days of free use of the containers before returning them to MSC. Cottonex notified MSC that it was unable to perform its contractual obligation to return the containers and pay a daily demurrage fee (a fee paid to owners where the discharge of cargo does not occur within an agreed period) as the cotton had been paid for and Cottonex no longer possessed legal title to it. MSC subsequently sought to sell the containers to Cottonex but negotiations did not come to fruition. As a result, it issued proceedings in the High Court to claim the demurrage.

The High Court determined that once Cottonex had informed MSC that it was unable to perform its obligations under the contract, the delay had become so prolonged as to frustrate the commercial purpose of the contract. As a result, MSC did not have a legitimate interest in keeping the contract alive and was entitled to demurrage only until the point it was notified that Cottonex was unable to return the containers.

Court of Appeal decision

The Court of Appeal arrived at the same outcome but its line of reasoning was somewhat different from the High Court's approach. While it agreed with the High Court that MSC should be entitled to demurrage until the repudiatory breach, it held that the breach occurred at a later date, when MSC offered to sell the containers to Cottonex. As a result, Cottonex was unable to perform its obligations stated in the contract and so MSC did not have the right to affirm the contract and recover demurrage indefinitely.

Good faith

The Court of Appeal also chose to retreat from the High Court's assertion that there is an increasing need for exercising the principle of good faith in contractual relations. It believed that there was no justification in applying the good faith principle when considering whether an innocent party had a legitimate interest in affirming a contract as a result of a repudiatory breach. Instead, it sought to develop the law in accordance with established principles, in this case, frustration.

Implications

Although the facts relating to this case are specific to shipping contracts, it is certainly possible that the issues raised could be relevant to other classes of contracts. The case establishes that where a repudiatory breach makes contractual obligations impossible to perform, the contract will be treated as frustrated and the innocent party will have no right to affirm it.

The case also suggests that there is no general organising principle of good faith (the requirement to 'play fair' and with one's 'cards face up') under English law, which would seem to curtail a developing line of authority.

This maintains an approach which has been upheld by the senior courts rigorously, and dashes the hopes of commentators who had been expecting a change.  Many jurisdictions, including the US, Australia and, to a lesser extent, Canada and New Zealand, impose a positive duty of good faith on contracting parties, but England and Wales will not, it seems, be joining them.

The court held that "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."

Instead, litigants will need to rely on well-established alternatives, such as the parties' intentions when entering into a contract, or a claim for irrationality.  In any case, the status quo, where good faith is concerned, continues.

Contributor: James Jaffa


This publication is intended for general guidance and represents our understanding of the relevant law and practice as at November 2016. Specific advice should be sought for specific cases. For more information see our terms & conditions.


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