Type: Client Alerts
The decision has been long awaited. In its landmark unanimous ruling handed down on 1 July 2015, The Supreme Court laid down clear guidance on the assessment of damages arising out of a wrongful repudiation of a contract for the sale of goods. The Supreme Court also considered the interpretation of the standard GAFTA Default Clause. Reed Smith acted for the successful party, Bunge, in these proceedings.
The judgment is significant: it addresses the interpretation of express damages clauses (so called "default clauses”); it reinforces the law on the application of compensatory principles in the assessment of damages in the event of contract repudiation; and it clarifies other matters, including the law of mitigation when assessing damages in the case of contracts for the sale of goods.
Key Aspects of the Decision
- It is inherent in the use of an express damages clause that it may produce a different result from the common law. It cannot be presumed that the parties intended an express damages clause to produce the same measure of damages as the compensatory principle. Nor can it be presumed that damages clauses are ‘complete codes’ for the assessment of damages, so that they exhaustively cover the entire field of damages.
- The GAFTA Default Clause is not sufficiently comprehensive to be regarded as a complete code covering the entire field of damages. It neither provides nor assumes that assessment will depend only on the difference between contract price and market price; it simply provides that damages “shall be based on” that difference.
- Similarly, the GAFTA Default Clause does not preclude the operation of the common law principle on mitigation of loss.
- The Supreme Court removed all doubt by expressly stating that The Golden Victory (the compensatory principle) applies equally to ‘one-off’ sale contracts as it does to instalment contracts.
- Under the GAFTA Default Clause and similar express damages clauses, damages can be assessed as at the date when the injured party accepted the repudiation only when that party actually went into the market to fix a price at that date. If the injured party did nothing as a result of the termination and lost nothing, the arbitrators should not feel inhibited from saying so.
The Facts The dispute concerned the sale contract between sellers (Bunge) and buyers (Nidera) for 25,000 mt of Russian milling wheat, delivery FOB Novorossiysk in August 2010. In accordance with the contract terms, the parties narrowed the loading window to 23-30 August 2010. The contract incorporated the GAFTA 49 form.
On 5 August 2010, the Russian government introduced a temporary ban on the export of various commodities, including wheat, which was to run from 15 August to 31 December 2010 (therefore covering the contractual delivery period). On 9 August 2010, in reliance of the prohibition clause in GAFTA 49, sellers declared the contract cancelled. On 11 August 2010, buyers stated that sellers’ purported cancellation was a repudiation, which they accepted.
The following day, sellers offered to reinstate the contract on the same terms. Buyers did not agree. Buyers brought a claim for damages against sellers of US$3,062,500.
Notably, had the contract run its course, sellers would have cancelled the contract without liability in accordance with the prohibition clause in GAFTA 49, as, in the event, the export ban was maintained and so delivery would have been prohibited.
- Before the first tier GAFTA tribunal, buyers’ claim for damages failed. The first tier arbitrators found that although sellers were in anticipatory breach by sending their cancellation notice on 9 August 2010, the contract would have been cancelled in any event and thus had no value. Accordingly, buyers suffered no loss and were not entitled to any damages.
- Buyers appealed against the first tier tribunal’s findings on damages to the GAFTA Board of Appeal. The Board also found that sellers were in anticipatory breach by sending their cancellation notice on 9 August 2010. However, the Board went on to find that the purpose of the GAFTA Default Clause is to provide certainty – buyers were entitled to apply the contract versus market price test on the date of default (in accordance with Clause 20(c) of GAFTA 49) and so recover US$3,062,500 in damages.
- Sellers appealed against the Board of Appeal’s award to the High Court in relation to both issues of liability and damages, including mitigation. The High Court (Mr Justice Hamblen) upheld the Board of Appeal’s award.
- Sellers then appealed to the Court of Appeal. The sellers abandoned their arguments on mitigation. All Lord Justices (Mr Justice Moore-Bick, Mr Justice Floyd and Mr Justice Christopher-Clarke) unanimously affirmed the High Court decision and upheld the GAFTA Board of Appeal’s award.
- Sellers then obtained permission to appeal to The Supreme Court.
The Issues Before The Supreme Court The Supreme Court was asked to consider the construction of the GAFTA Default Clause and the application of the principle established in The Golden Victory. In particular, the following two issues were placed before The Supreme Court:
(a) Does the GAFTA Default Clause exclude the common law principles for the assessment of damages in the case of an anticipatory repudiatory breach of contract?
(b) If not, is the overriding compensatory principle established by The Golden Victory applicable to one-off sale contracts, such as in this case, as opposed to instalment contracts?
Interpretation of the GAFTA Default Clause The question before The Supreme Court was whether the GAFTA Default Clause was sufficiently clearly worded to confer a right to damages where no loss has been suffered by the buyers.
As sellers contended before The Supreme Court, in approaching the GAFTA Default Clause, it is objectively to be presumed that the parties and the GAFTA draftsman intended to contract by reference to the compensatory principle. This requires that the injured party is “so far as money can do it, to be placed in the same situation with respect to damages as if the contract had been performed”. The sellers said that the GAFTA Default Clause did not intend to give a right to damages for loss of the contractual benefit where the contractual benefit would never have accrued. (The question of whether the compensatory principle applies to one-off sale contracts was considered separately.)
The position on the construction of the GAFTA Default Clause was summarised by Lord Sumption as follows:
The clause applies, as its opening words declare, “in default of fulfilment of contract by either party”. Thus, the clause is concerned with non-performance. It does not matter whether the contract has not been performed, because it was repudiated in advance of the time for performance, or because it was simply not performed when that time arrived.
The clause gives, at sub-clause (a), the injured party the option, at its discretion, to sell or buy, as the case may be, against the defaulting party, in which case the sale or purchase price will be the ‘default price’.
Two alternative bases of assessment by the arbitral tribunal are provided at sub-clause (c): the first is the difference between the default price and the contract price and applies if a default price has been established but not accepted by the defaulting party; and the second is the difference between the contract price and the ‘actual or estimated value’ of the contract goods at the ‘date of default’.
The combined effect of these provisions is therefore to produce a measure of damages which differs in two main aspects from common law: the first is that the injured party is not required to mitigate its loss by going into the market to buy or sell against the defaulter, but has a discretion whether to do so; and the second is that if the injured party has not in fact gone into the market and made a substitute contract, the contract price falls to be compared not with the market price of the goods, but with their ‘actual or estimated value’.
According to Lord Sumption, the facts in this case give rise to two questions: (i) what is the relevant market price or value of the goods for the purpose of assessing damages? and (ii) in what, if any, circumstances will it be relevant to take account of contingencies, other than a change in the market price or value of the goods, which would have prevented the goods from being delivered whatever the market price or value, with the result that the buyer would have suffered the same loss in any event?
The Supreme Court effectively decided that the GAFTA Default Clause is concerned only with the first of these questions. Sub-clauses (a) to (c) constitute an elaborate and complete code for determining the market price or value of goods that either were actually purchased by way of mitigation, or might have been purchased under a notional substitute contract.
The clause, however, does not deal at all with the effect of subsequent events which would have resulted in the original contract not being performed in any event. As Lord Sumption characteristically said, the GAFTA Default Clause is not sufficiently comprehensive to be regarded as a complete code covering the entire field of damages. Likewise, in his opinion, it neither addresses nor excludes the consideration of supervening events (other than price movements), which reduce or extinguish the loss.
Application of The Golden Victory The issue before The Supreme Court relating to the construction of the GAFTA Default Clause and the correct understanding of the decision of the House of Lords in The Golden Victory are related. The Golden Victory, a case of wrongful repudiation of a time charter by the charterers, is one of the most academically criticised House of Lords judgments.
In that judgment, the House of Lords laid down the principle that where, after the date on which the market price is to be ascertained, a supervening event occurs which shows that neither the original contract (had it continued), nor the notional substitute contract at the market price, would ever have been performed, the innocent party has suffered no loss and so can recover no damages. The House of Lords held by a majority in that case that the overriding principle was the compensatory principle. Irrespective of the date at which the market price was ascertained, it was necessary to take account of contingencies known at the date of the arbitral tribunal’s or court’s assessment to have occurred, if their effect was that the contract would have been lawfully terminated at or before its contractual term.
The principle upheld in that case has faced a certain amount of academic criticism and judicial doubt, both of which are, to the minds of The Supreme Court, unjustified. Indeed, The Supreme Court upheld The Golden Victory principle in full force. Moreover, The Supreme Court made clear that The Golden Victory applies to both instalment contracts and one-off sale contracts and that there is no logical reasoning for distinguishing the two, as contended by the buyers.
The Supreme Court acknowledged that certainty is vital. They considered, however, that it was not important enough to justify a substantial damages award to someone who has suffered none. Hence, Lord Toulson held that the fundamental principle for the assessment of damages in cases of breach of contract is, within the limits set out in Hadley v Baxendale, to put the parties in their position had the contract been performed.
In the present case, sellers offered to buyers total restitution immediately upon the termination of the contract. There was no finding in the GAFTA appeal award that the offer was not genuine, and on the fundamental compensatory principle it provides a full answer to the buyers' claim.
Mitigation The application of the common law principle of mitigation of loss was not the subject of argument before The Supreme Court, but interestingly the Court rejected the argument that the GAFTA Default Clause precludes the operation of this principle.
In practice, where there is a renunciation of a contract and there exists an available market, the relevant market price for the purposes of assessing damages will generally be determined by the principle of mitigation: the innocent party is normally required to mitigate its loss by going into the market for a substitute contract as soon as is reasonable after the original contract was terminated. Damages will then be assessed by reference to the price which it obtained. If the innocent party chooses not to do so, damages will generally be assessed by reference to the mitigation principle at the time when it should have done.
As was held by Lord Sumption, although the GAFTA Default Clause deals with the innocent party’s duty to mitigate by going into the market to buy or sell against the defaulter, it does not deal with any other aspect of mitigation. It therefore leaves open the possibility that damages may be affected by a successful act of mitigation on the part of the innocent party or by an offer from the defaulter which would have been reasonable for the innocent party to accept.
What Does This Mean For You?
Clear and express words are required to exclude the compensatory principle so as to allow recovery of damages where no loss has been sustained.
Even where the contractual test for calculating damages results in damages being payable to the innocent party, the innocent party may not in fact recover any damages if it has suffered no loss.
These principles apply to one-off sale contracts as well as term/ instalment contracts.
Where the contractual test for calculating damages is based on the innocent party going into the market for a substitute contract, where the innocent party chooses not to, the normal mitigation principle may nonetheless apply. Again, clear and express words are required if a damages clause is to limit the innocent party’s duty to mitigate.
It is to be expected that damages issues debated in commodity arbitrations (and disclosure required) will become more complicated as a result of this decision, even when there is an express damages clause.
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Client Alert 2015-182