THE OIL & GAS “CONTRACTING COMPASS”

3 – POINTING THE COMPASS TOWARD REMEDIES FOR BREACH

INTRODUCTION

Welcome to the third edition of the “Contracting Compass” seminar series – a Brodies’ oil and gas initiative offering insight on issues of English law relevant to oil and gas contracts. Where the landscape of the contract may be difficult to navigate, the “Contracting Compass” attempts to act as a guide – a roadmap of the law and a reference to points of best practice for drafting and applying contract language.

To reflect this goal, we have changed the directional points of the compass as follows:

The compass is labelled in this way because navigating the landscape of a contract requires knowledge of the law, an understanding of how language should be drafted in light of the law, and recognition of how that language will work in practice – whether it relates to contract performance, the ultimate commercial concern of payment or, if a breach has occurred, damages or other remedies.

For each seminar in the series, we will present a white paper dedicated to a single topic. This paper covers the topic of Breach of Contract and Remedies, divided in three parts:

• Part 1 – Breach;

• Part 2 – Damages and/or Termination; and

• Part 3 – Other Remedies.

We hope this third edition provides valuable insight and offers a practical guide. If you are interested in attending our accompanying seminar series, please don’t hesitate to contact us directly.

GREG MAY KEN MACDONALD PARTNER, OIL & GAS PARTNER, LITIGATION greg.may@brodies.com kenneth.macdonald@brodies.com 01224 392 255 01224 392 170

1

PART 1 – YOU’RE IN BREACH – SO WHAT?

One core principle of contract law is that all terms are not created equal. This principle is basic, and the black letter law can be stated succinctly as we have done in a few paragraphs below. However, as an in-house lawyer drafting a contract or a contracts manager negotiating terms, you will recognise that the landscape of the contract is textured – not merely black and white legal principles.

Acting as a commercial lawyer (whether in-house or external) or assuming any other role in an organisation at the sharp end of negotiating contract terms, you will recognise (almost intuitively) that any contractual relationship is not as simple as quid pro quo. A contract which constitutes the framework for a sophisticated commercial relationship will comprise a myriad of obligations and rights. It is, in essence, a bundle of benefits and burdens being exchanged between the parties.

At risk of being too abstract, there is a thread of yin/yang in any contractual relationship. Where one party receives a benefit the other party will bear a burden. The passing of benefits and burdens may not always be equal; but it is always the case that one will not occur without the other. There is a common thread that connects one party’s benefit with the other party’s burden.

Though the thread is common, it will not always run parallel between the parties. A contractual relationship will not always be balanced and the thread which ties benefits to burdens may, in varying degrees, be taught with tension. It is also the case that the threads will not always be confined to the four corners of the contract. They may be woven to create contractual frameworks (in some cases indemnity regimes) that extend to a wide range of entities - from affiliates, to contractors and subcontractors of multiple tiers, to genuine third parties.

These complexities are more apparent in the context of specific examples. Before turning to the law, we will therefore build a backdrop by looking at some common contract terms.

LOOKING AT THE CONTRACT

When looking at the law below, we have outlined the textbook legal position for classifying terms. The importance of a term is clear when viewed through the objective lens of the law. However, it is not so settled when considered from the competing perspectives of an operator and a contractor.

The Operator’s Perspective

When considering the whole of a contract and the broad spectrum of terms comprising the complete bundle of rights and obligations, the operator’s key contractual concerns will typically be focussed on performance, safety, and governance. An operator may demand that the contractor assume an absolute obligation to perform certain core obligations relating to performance – such as

(i) providing equipment and materials to a certain standard and maintaining them to that standard throughout the contract term;

(ii) rendering services to a certain standard;

(iii) complying with safety rules and requirements to a zero tolerance standard; and

(iv) conducting business in strict compliance with the law, as well as operator’s specified ethical standards.

2

The Contractor’s Perspective

The contractor will, of course, typically resist assuming an absolute obligation when circumstances beyond the contractor’s control may prevent the obligation being fulfilled. There may also be operational circumstances which are foreseeable and not typically related to contractor’s standard of performance. In such event, the contractor will again be unwilling to assume an absolute obligation.

There are various ways in which an absolute obligation can be qualified – e.g. “reasonable endeavours”, “subject to”, “to the extent reasonable practicable”. Whatever method or approach may be considered, the overriding concern should always be clarity and concern for how one provision of the contract will ultimately interplay with others.

In certain circumstances an operator may also require a warranty (as described below) in respect of the standard of service or condition of equipment. However, the type of service being rendered may lead a contractor to resist this type of obligation. For example, if a contractor is rendering day rate services under a drilling contract, the contractor may contend that warranty in respect of condition or functionality of the equipment which would, at law, give rise to claim in damages would be squarely inconsistent with provisions in the rate section which could contemplate a reduced or zero rate being applicable in lieu of damages.

LOOKING AT THE LAW

Classification of Provisions of the Contract

Terms of a contract can be classified as conditions, warranties or innominate terms: the classification applied by Courts to all manner of contracts.

• What is a condition?

A condition is a term which can be described as going “to the root of the contract”.

• What is a warranty?

A warranty is a term which is of less importance than a condition or is collateral to the main purpose of the contract. It can be an immaterial term.

• What is an innominate term?

A term is intermediate (or innominate) if the remedy for its breach depends on the effect of the breach at the time it happens. If the effect of the breach substantially deprives the innocent party of the whole of the benefit of the contract then it will be a serious, or fundamental, breach of the term and the remedy will be for breach of condition. That is, the innocent party can terminate the contract. If this is not the case, then the remedy will be for breach of warranty.

3

What is a Breach?

• How and when does a breach occur?

A breach of contract occurs when one party fails to fulfil or intimates that they do not intend to fulfil, without lawful excuse, an obligation under the contract. In most cases this will entitle the other party to a remedy intended to compensate them for the loss suffered as a result of the breach. The remedy sought will depend on the nature of the breach and the terms being breached as well as the consequences flowing therefrom. This will be considered in more detail in Part 2.

• Classification versus Consequences

We had mentioned at the beginning of Part 1 that all terms are not created equal. A corollary to the principle is that all breaches, and the consequences, are likewise not of equal importance. The classification of the term of a contract determines the consequences of a breach of that term.

Where a condition or material term of a contract is breached, the innocent party will be entitled to treat the breach as repudiatory, terminate further performance of the contract and sue for damages. The innocent party is not bound to terminate; they can elect to affirm the contract and hold the defaulting party to their contractual obligations.

Where a warranty or immaterial term of a contract is breached, the innocent party will be entitled to sue for damages but will not be entitled to terminate further performance of the contract.

Where an innominate term of a contract is breached, the innocent party will be entitled to a remedy based on the nature and effect of the breach at the time it happens.

Terms may be classified by statute (for example, under the Sale of Goods Act 1979). Alternatively, terms may be expressly designated in a contract and in those circumstances the courts will generally accept that designation and the consequences which flow from it except:

- Where statute or case law expressly provides that such a term should be designated differently;

- Where the contract makes provision for the consequences of breaching that term which are inconsistent with the designation; or

- Where the intention of the parties, as established from the surrounding circumstances, is inconsistent with the designation.

In circumstances where a term is not expressly designated in a contract the courts will look at:

- Statute or case law to identify an appropriate designation;

- The contract to see if breach of the term entitles the innocent party to terminate or not; and

- The surrounding circumstances to ascertain the intention of the parties in relation to the designation of that term.

4

It is worth noting that any express classification of a term is not conclusive i.e. whether a term is a condition or a warranty will depend on what the court concludes was the parties’ intention (L.Schuler A.G. v Wickman Machine Tool Sales Ltd HL 1974 AC 235).

Classification of terms provides the parties with a degree of certainty as to the consequences of a breach. However in more recent years, there has been a move in favour of the increased flexibility that comes from classifying a term as ‘innominate’ i.e. the modern approach of the courts is to look to the effect of the breach to ascertain whether the parties intended it to operate as a condition or a warranty. The leading case is Hong Kong Fir Shipping Co Ltd v Kawasaki Kisen Kaisha Ltd CA 1962 1All ER where the defendant charterers of a ship repudiated the charter alleging the ship was unseaworthy and that failure to provide a seaworthy ship was a breach of a “condition”. The claimants brought an action for wrongful repudiation arguing that the breach only entitled the defendants to claim damages i.e. the term which had been broken was correctly classified as a warranty. The question before the Court of Appeal was whether, looking at the consequences of the breach, the defendants had been deprived of the whole benefit of the contract. The Court of Appeal held that the breach was not such that it deprived the defendants of substantially the whole benefit of the contract and found for the claimants determining that the term was a warranty and not a condition.

5

PART 2 – THE BREACH HAS OCCURRED, THE DAMAGE IS DONE, BUT WHAT REMEDY IS RIGHT!?

We have described the many threads that form a complex web of contractual relationships in the offshore environment – all being interrelated and interdependent. In Part 1, we have also mentioned that any breach, as a matter of law, will not arise in isolation but in the context of a wider web.

Remedies must also be considered in this broader context. When looking at the law below we have described the various legal remedies for a breach in terms of fixed principles. Unfortunately, the facts and circumstances in a complex offshore environment will be variable and the consequences of a breach will often affect many commercial relationships beyond a single contract. Therefore a remedy must be carefully considered in this context and if possible a more flexible approach may be required to preserve a relationship rather than put the whole of the web of commercial relationships at risk. In Part 1, we built a backdrop of contract terms to put the complexities of breach in sharper focus. In Parts 2 and 3 we will build the same backdrop for damages, termination and other remedies.

LOOKING AT THE CONTRACT

When looking at the law below, we have outlined the textbook legal position for damages, termination and other remedies. Unfortunately, in the offshore environment, the law is not always fit for purpose either from the operator’s or contractor’s perspective.

The Operator’s Perspective

For any given project an operator may hold a vast number of contracts. The operator’s prime objective is getting the whole of the project to the finish line, on time and on budget. To meet that fundamental goal, the operator will require each contract to cover all contingencies – including what is going to happen when a particular contractor is not performing the contract as it should.

Remedies at law will not always be fit for that particular purpose. Where common law remedies are likely to fall short of an operator’s critical needs and key requirements for effective project management, it will be necessary to tailor remedies in the contract to meet those needs. Damages and termination are noteworthy examples of common law remedies falling short of an operator’s expectations and needs.

If an operator is managing a multi-billion pound project for a field development, a single contractor failing to perform may disrupt, delay or materially compromise the project – in whole or large part. In that event, an operator’s claim in damages against the culpable contractor will not likely be an adequate remedy. From the operator’s perspective, the better remedy will be a detailed and comprehensive contractual framework for identifying any defective performance and requiring the contractor’s re-performance within acceptable time constraints and to an acceptable standard. A properly formulated contractual regime for re-performance and cure will, from an operator’s perspective, also include a right to take over the work and effectively step-in to make alternative arrangements, if required. Step-in rights are usually coupled with a right to recover any associated additional costs (subject to any overall cap and any agreed indemnity for consequential loss). It can be a useful tool for the operator because it avoids delay. However, from the operator’s perspective, the whole

6

of the project will be best served by being able to take reasonably practicable steps within a well-constructed contractual regime to properly manage and hopefully maintain the relationship with the contractor.

If, however, the relationship cannot be maintained or does not, in the operator’s view, continue to serve the interests of the project, a right of termination at common law will also often not be an adequate remedy. In the same way an operator will typically incorporate a detailed and comprehensive contractual framework for correcting defective performance, it will include a similarly sophisticated contractual regime for termination. An operator’s right to terminate will be broadly expressed in two parts –

1. a right to terminate for convenience; and,

2. a right to terminate for cause.

From an operator’s perspective, termination for convenience is required because the scope and schedule of a significant scale project will comprise many moving parts. Flexibility in managing a contractor’s role or the absence of a role is therefore a core requirement.

From an operator’s perspective there may be causes, other than convenience, that must be anticipated as potentially requiring termination. The list of causes that an operator will consider necessary may include significant and/or repeated instances of poor performance, safety concerns, insolvency, force majeure or breach of business ethics. In certain circumstances, a right to terminate for cause will not be immediate. For example, a cause of poor performance, safety breach, or breach of business ethics may require the operator to serve notice of the nature of the breach and detail what is required by the contractor to cure the breach and in what period of time.

7

The Contractor’s Perspective

A contractor will, of course, have concerns about any contractual framework proposed by an operator which is tailored to create rights greater than those otherwise available at law. However, the contractor will not, of course, be in a position to reject outright any such regime – whether for defective performance or termination.

Where a defective performance framework is proposed, the contractor’s most critical concerns will be:–

(i) the right to establish that a relevant defect is attributable, or not to the contractor’s fault,

(ii) the right to remedy within an adequate time,

(iii) the right for any remedy to be made to an objective standard (or if to the satisfaction of the operator, such discretion not to be unreasonably exercised),

(iv) the right to take reasonable steps to avoid an operator having step-in rights to have the work re-performed by a substitute contractor, and

(v) the right to back-to-back remedies where defective performance may be attributable to a subcontractor.

Where a contractual regime for termination is proposed, the most critical concerns will be:–

(i) the cause of termination is attributable to contractor’s fault or circumstances within contractor’s control,

(ii) termination will not occur for non-compliance with a contractual term when the contractor has commenced to remedy and has continued thereafter to pursue the remedy (provided the cause is capable of being remedied);

(iii) the period for commencing to take steps to remedy is reasonable, and

(iv) if the cause is not capable of being remedied (i.e. breach of business ethics), the right to terminate will not arise until sufficient consultation has occurred at a management level to allow preliminary investigation to establish the veracity of an alleged breach and the existence of a good faith basis for termination in such event.

Cost and compensation will be a separate commercial concern of both parties. The contractor will, of course, maintain a right to recover the full value of the contract in the event of termination for convenience. In the event of termination for cause, the operator may assert that the obligation to pay should only apply to proper performance up to the date of termination. Moreover, the operator may contend it should be entitled to recover damages and losses directly attributable to the termination for cause. The contractor will, of course, have the competing concern that such losses may be grossly disproportionate to the original value of the contract and may argue that recovery of such losses would be inconsistent with the principle of consequential loss exclusion.

8

If any termination regime proposed by an operator should include breach of contract as a cause for termination, it is not uncommon for such language to be qualified with words such as “material” or “substantial” breach. As explained in the following “look at the law” section, these qualifying words should be carefully considered to ensure that unintended consequences will not result from a court’s interpretation.

LOOKING AT THE LAW

Termination as a Common Law Remedy

Hong Kong Fir Shipping Co Ltd v Kawasaki Kisen Kaisha Ltd CA 1962 1 All ER raises an important commercial consideration around terminating the contract as a remedy in itself for breach. To establish that a repudiatory breach has occurred, the injured party must show that the breach resulted in them being deprived of substantially the whole benefit of the contract. It follows that if the injured party wrongfully treats the contract as repudiated, the injured party actually ends up committing a repudiatory breach of contract and the innocent party will have a claim for wrongful termination.

Any party wishing to rely on a common law right to terminate for a breach of contract should carefully consider whether the breach has deprived them of substantially the whole benefit of the contract otherwise they risk a counter-claim for wrongful termination.

It is worth noting however that following the recent case of Vinergy International (PVT) v Richmond Mercantile Ltd FZC [2016] EWHC 525 (Comm) where a party is terminating for repudiatory breach the High Court has held that that party did not need to comply with a notice and cure period. The common law right to terminate was held not to have been affected by the restrictions in the contract which applied only to contractual rights to terminate.

Repudiation versus Rescission

Do not confuse the terms repudiation and rescission. Rescission is an equitable remedy available where misrepresentation has induced the contract and in the case of duress and undue influence. It is not a remedy that is comparable to a right to repudiate the contract. If a contract is rescinded both parties are restored to their original pre-contractual position i.e. the contract is void. A right to rescission can be lost where the innocent party does not rescind within a reasonable time or the innocent party affirms the contract.

Damages

We have looked at what constitutes a breach of contract and noted that any breach will give the innocent party the right to claim damages. Damages are therefore the most common remedy sought for breach of contract. The remedy arises as of right provided the innocent party can show that it has suffered loss or damage as a result of the defendant’s breach.

9

The general principle is that damages are intended to compensate the injured party so as to restore them to the position they were in but for the breach. They are not intended to be punitive. We revisit this in more detail when examining liquidated damages. The starting point is that a claimant can recover sums in respect of personal injury, damage to property, loss of profit and pure economic loss (i.e. loss that is not accompanied by any physical damage). In principle, the claimant will also be able to recover sums in respect of consequential loss.

Termination as a Contractual Remedy

A right to terminate for any breach is a draconian remedy even when coupled with a right to cure. It is commonplace that two sophisticated parties are free to agree contractual terms without interference from the court. However, absent clear unambiguous wording to the contrary, an interpretation of words in a contract which flouts business common sense must yield to business common sense.

In Rice (T/A The Garden Guardian) v Great Yarmouth Borough Council ([2000] All ER (D) 902)) the contract provided for a right to immediately terminate for breach of any of the contractor’s obligations. The Court of Appeal was unwilling to give literal effect to those words, favouring instead the “business common sense” argument and concluding that in order for a single breach to give rise to a right to terminate it had to constitute a repudiatory breach at common law. The court did however accept that although a contractual right to terminate may not arise in respect of a single breach which did not amount to a repudiatory breach, repeated breaches could give rise to such a right where the repeated breaches do amount to a repudiatory breach i.e. they substantially deprive the innocent party of the whole benefit of the contract.

It is not uncommon for a contract to qualify a right to terminate for breach with words such as “material” or “substantial”. Neither term has a well-established meaning at law and is rarely defined which could be a trap for the unwary. The contention that “material” is synonymous with “repudiatory”, as put forward by the claimants in National Power plc v United Gas Contractor Limited [1998] All ER (D) 321), did not succeed because the contractual termination provision included a right to cure the breach. This placed importance on curing defective performance such that “material” cannot have been intended to be synonymous with “repudiatory” because a repudiatory breach allows the innocent party to terminate without a cure period. Unhelpfully, this reasoning was not followed in Crane Co v Wittenborg A/S [1999] All ER (D) 1487 where the Court of Appeal held that “substantial” had no different meaning from “repudiatory” despite the existence of a right to cure. The Court expressed difficulty in distinguishing the terms because it would leave a question as to the meaning of “substantial”.

Elements of a Claim

• Causation

In order to establish that an award of damages should be made it must first be established that there is a causal connection between the breach and the loss which has occurred.

• Factual Causation

The question before a court will be “but for the defendant’s breach, would the claimant have suffered the loss”.

10

• Legal Causation – Foreseeability

Even where it can be proved that the loss suffered by the claimant was in fact caused by the breach of their counterparty, a claimant may only recover damages in circumstances where the breach is considered the dominant cause of the loss. If the chain of causation is broken by a novus actus interveniens (new intervening act) damages will not be recoverable. However, an intervening event which was foreseeable in the circumstances will not break the chain of causation. The test here is foreseeability.

In Hadley v. Baxendale (1854) 9 Ex 341, Asquith L.J. opined,

“The aggrieved party is only entitled to recover such part of the loss actually resulting as was at the time of the contract reasonably foreseeable as liable to result from breach.”

• Remoteness Rule – Hadley v Baxendale et al

The most significant common law restriction on any claim for damages is that embodied in the remoteness rule. Such rules exist in both contract and tort as a matter of policy because defendants being held liable for every loss flowing from their act or omission would produce absurd results. The remoteness rule in contract was established in the case of Hadley v Baxendale (1854) 9 Ex 341. This case concerned the late delivery of a mill shaft which resulted in a claim for loss of profits incurred during the period in which the mill was idle due to the delay. Alderson B laid down the test for remoteness of damage which was restated by the Court of Appeal in Victoria Laundry (Windsor) Ltd v Newman Industries Ltd, [1949] 2 KB 528 and ultimately discussed by the House of Lords in The Heron II, HL, [1969] 1 AC 350 such that it can now be expressed that a claimant may recover for:

(i) Loss arising naturally out of the breach i.e. in the ordinary course of things. As a reasonable person, the contract-breaking party is taken to know what this loss will be;

or

(ii) (in relation to special, abnormal or unusual loss) loss which could reasonably be supposed to have been within the contemplation of the parties, at the time of the contract, as the probable result of the breach.

It is well accepted that there are two limbs to the remoteness rule in contract.

The first limb is typically characterised as pertaining to direct losses i.e. what loss is within the parties’ reasonable contemplation is an objective test based on imputed knowledge.

The second limb is often characterised as indirect or consequential losses which will only be in the parties’ reasonable contemplation if the special circumstances which give rise to the loss are known to both parties at the time the contract is made i.e. the parties had actual knowledge of the special circumstances; the test is therefore subjective.

11

The link between time and knowledge is an important one because knowledge of special circumstances at the time the contract is made may affect the agreed terms and conditions i.e. any risk may be priced for and/or an exclusion clause may be agreed. Knowledge of special circumstances acquired by the defendant after the contract is formed will not satisfy the second limb rule and the loss will be considered too remote to be recoverable.

• Comparison with remoteness in tort

There is also a rule of remoteness in tort. The rules were discussed by the House of Lords in The Heron II [1969] 1 AC 350 holding that the test for remoteness in contract is narrower than it is in tort. Given that in practice the facts of many claims for breach of contract will also give rise to a cause of action for the failure to exercise reasonable skill and care i.e. the tort of negligence, an examination of what could be recovered as a result of a negligent act or omission bears consideration.

In tort, the purpose of the claim is to put the injured party in the position they would have been in had the tort not been committed (Livingstone v Raywards Coal Co (1880) 5 App Cas 25). Even though the negligent party is unaware of any special condition (i.e. the loss is unusual), he is nevertheless liable provided the loss was possible: likelihood is irrelevant (Overseas Tankship (UK) Ltd v Morts Dock and Engineering Co Ltd The Wagon Mound (No.1) [1961] 1 All ER 404). The wrongdoer takes their victim as they find them; that is to say whilst the loss is foreseeable the scale of the loss is particular to the claimant. This is known as the “eggshell skull” rule (Smith v Leech Brain [1962] QB 405), and is generally applied in personal injury cases. In a commercial context one can envisage circumstances, for example, whereby the defendant’s breach leads to financial distress or insolvency. The defendant would not have been aware of the claimant’s financial difficulties but this is irrelevant for the purposes of assessing remoteness in tort. In contract, the test has been interpreted more narrowly. As with tort, the loss must be possible but it must also be likely, that is to say, not unusual, and foreseeable at the date of contracting. The justification for the narrower test in contract is that the parties to a contract are known to each other and have had the opportunity to apportion their liabilities based on their knowledge of the risk (Lord Reid, The Heron II, [1969] 1 AC 350). For the law to then make a party liable for exceptional or unnatural risk would be odd given that said party would probably have attempted to protect himself for such risk if he had known such risk would result from his breach. In tort, the parties are unknown to each other and the injured party cannot protect himself in the same way as a party to a contract can (or can at least attempt to do so during negotiations). Tort does not distinguish between direct and indirect loss.

Thus on a particular set of facts where a party is faced with concurrent liability in contract and in tort it is important to establish which test applies as gives rise to different extents of liability for the loss suffered. Lord Reid’s justification for different tests is perhaps questionable given that the thrust of his argument is that the parties in tort are unknown to each other whereas in fact the claimant and defendant in a concurrent case i.e. one where the action may be brought in tort and contract are clearly not strangers and have contracted with each other. However, in the recent case of Wellesley Partners LLP v Withers LLP [2015] EWCA Civ 1146, the Court of Appeal held that in concurrent liability cases the narrower remoteness test in contract will apply, providing much needed certainty for contracting parties.

Where a claimant cannot show that its loss falls under one of the two limbs of the remoteness test originating in Hadley v Baxendale, the loss will be considered too remote to be recoverable.

12

• Date of assessment of damages

The general rule is that damages are to be assessed at the date of the breach of contract unless justice requires a departure from that date (Johnson v Agnew [1980] AC 367).

It is presumed that as at the date of the breach the innocent party can go to the market and obtain alternative performance from another party. This presumption intertwines with the duty to mitigate. The cost of the alternative performance is therefore relevant to the measure of the damage suffered.

There are certain circumstances in which the date of assessment will be later than the date of breach. Where alternative performance is not available at the date of the breach the date of assessment will usually be the date at which such alternative performance became available. In the case of latent defects where the innocent party could not have been aware of the breach at the time it occurred, the date of assessment of damages will usually be the date on which the innocent party discovered the breach or could, with reasonable diligence, have discovered the existence of the breach.

• Mitigation

Only losses that were reasonably incurred are recoverable. The innocent party, when faced with a breach, is not entitled to sit back, do nothing, and allow his losses to increase. Mitigation describes the obligations on the innocent party when faced with a breach – it is the other side of the coin face proclaiming only reasonable losses are recoverable.

It was established in British Westinghouse Electric and Manufacturing Co Ltd v. Underground Electric Railways Co of London Ltd [1912] AC 673 that a claimant must take reasonable steps to minimise the loss suffered as a result of a breach of contract. If a claimant fails to mitigate his loss then he cannot recover damages in respect of losses resulting from to his failure to mitigate.

There are two aspects to the “duty to mitigate”. Firstly, the claimant must not unreasonably increase the loss suffered as a result of the breach of contract. Secondly, the claimant must take all reasonable steps to minimise his loss.

• Damages that are difficult to quantify

It will not always to be straight forward for a court to award damages in respect of a breach where the damages are particularly difficult to assess and in some circumstances courts will be reluctant to award damages at all.

When considering damages for mental distress and disappointment, the Court, in Farley v Skinner [2001] UKHL 49, held that it was enough that an important object of the contract had been to give "pleasure, relaxation or peace of mind" and that breach of that object gave rise to damages being awarded. Only contracts of a personal nature will attract such damages.

Damages for non-pecuniary loss will rarely be awarded in commercial cases. As Lord Bingham explained in Johnson v Gore Wood & Co [2000] UKHL 65, “contract breaking is treated as an incident of commercial life which players in the game are expected to meet with mental fortitude.”

13

• Damages for loss of opportunity

Where the breach relates to a loss of opportunity for the injured party it will be inherently difficult for the court to assess the value of that opportunity. In Chaplin v Hicks [1911] 2 KB 786, the Court of Appeal held that where there is no recognised measure of damages, the claimant must be awarded a sum which is reasonable in all the circumstances.

• Limitation of liability

The parties may agree a cap on liability as an express term of the contract. This can be expressed in many ways as a percentage of the contract value or a set financial sum. It is also important to consider whether the cap should apply to liability arising from any breach of the contract or only to liability arising from breach of a specific provision(s).

A limitation of liability provision is a tool for balancing risk and reward. It is important to balance the competing tensions of both parties when drafting a cap on liability and to reflect other relevant provisions such as an indemnity regime (which is another way in which parties to an agreement allocate risk in a balanced and commercially sound way). It is generally accepted that where the parties have agree a knock-for knock indemnity regime, the re-allocation of liability should not be subject to any overall cap. Insurance provisions which define set levels for insurance should also be carved out to avoid any suggestion that the cap was also intended to apply to the levels of insurance required by the contract. Any conduct related carve-outs should also be considered (i.e. the cap may not apply in the event of the defaulting party’s wilful misconduct.)

A well-drafted limitation of liability provision should clearly set-out which provisions are caught by the cap and which provisions are not. Different limits may be appropriate at different stages of the contract (i.e. before and after completion).

Elements of a Defence

• Time bar

The Limitation Act 1980 provides for a six year limitation period for action in respect of breach of a contract and twelve years in respect of breach of an obligation in a deed. Such contractual limitation periods need to be carefully diarised.

It is possible in contracts governed by English law and subject to the jurisdiction of the English courts for parties to enter into a standstill agreement to ‘freeze’ the running of the limitation period.

Whilst compliance with pre-action protocols is important, when faced with an impending expiry of a limitation period it is more important to raise proceedings on time even if full compliance with pre-action protocols has not been achieved.

In considering a breach of contract it is important to consider the relevant limitation periods i.e. the period in which the claimant must commence a claim starting from when the cause of action accrues. If the limitation period has expired, it will provide the defendant with a complete defence to the claim which is said to be ‘time-barred’.

14

Standing the fact that the limitation period is likely to be either six or twelve years for any relevant breach of contract claim, it is not advisable to unnecessarily delay raising an action as the recall of witnesses and their ability to provide convincing testimony is likely to decrease substantially with the passage of time.

The relevant date for interrupting a limitation period is the date on which the court receives the claim form, not the day that it is issued. This is different to the position in Scotland whereby the period is only interrupted once the court action has been raised and served upon the defender.

In England, unlike Scotland, it is possible to extend the relevant limitation period by entering into a ‘standstill agreement’. This usually occurs in situations where a potential claimant has not yet issued a claim but wishes to protect its position to raise an action at a later stage. The potential defendant will usually only agree to this if it is in their interest to avoid unnecessary court costs at an early stage.

• Contributory negligence

At common law, contributory negligence is not a defence to an action for breach of contract. Contributory negligence used to operate as a complete defence to an action in tort no matter how slight the claimant’s failure to take reasonable care. The Law Reform (Contributory Negligence) Act 1945 was enacted to remedy the severity of the common law rule with the result that contributory negligence can reduce liability but not extinguish it. The purpose of this Act was to enable courts in tortious actions to apportion liability for the losses suffered by the claimant where both parties had been found to be at fault. Since the enactment of the Act, there has been considerable debate as to whether contributory negligence is now available as a defence in a breach of contract claim.

In a contract claim, the claimant’s damages can be reduced as a result of contributory negligence only where there has been a breach of duty to take care in contract and this breach of duty also constitutes a tort i.e. where there is concurrent liability.

Contributory negligence could be relevant, for example, where the defendant is liable in contract for breach of the term implied by s.13 Supply of Goods and Services Act 1982 (failing to provide a service with reasonable skill and care) and is also liable in tort in negligence. However, in situations where liability in contract in strict, i.e. there is no requirement to prove the defendant was at fault, the contributory negligence of the claimant will not reduce the damages awarded.

The unusual result of this is that in some circumstances (as was the case in Barclays Bank plc. v. Fairclough Building Ltd) [1995] 1 All ER 289) a defendant may argue that they are liable in tort so as to be able to advance the defence of contributory negligence whilst simultaneously a claimant may argue that the defendant is not liable in tort so as to avoid the application of this defence.

15

Types of Damages

• Expectation and reliance loss basis for unliquidated damages

Damages will normally be assessed on an expectation or reliance loss basis.

The aim of the court when assessing a damages claim and awarding damages on an expectation basis is to put the injured party in the position it would have been in had the contract been performed (Robinson v Harman (1848) 1 Ex 850). If the breach resulted in damaged goods, the prima facie rule is that damages will be the difference in value between the actual value and the value the goods would have had if not defective. In a contract for services, the prima facie rule is that damages will be the cost of putting the work right.

Damages awarded on a reliance basis are to put the innocent party in the position which he or she would have been in if the contract had never been made. Reliance loss would generally cover wasted expenditure (i.e. expenses incurred in performing the contract or preparing to do so). Reliance loss damages are likely to be the basis for award where damages claimed on an expectation loss basis are considered too speculative by the courts.

An example of a claim likely to be quantified on a reliance loss basis can be illustrated by way of considering a Front-End Engineering and Design (“FEED”) Agreement. This type of agreement may relate to a development of a specific field. In the event the agreement is breached it may be difficult to quantify damages based on what (if any) profit the field may one day have made and instead, a more appropriate basis may be to compensate the injured party for wasted expenditure up to the date of the breach.

A Court can look at the intention of the innocent party in order to determine reasonable loss. In Ruxley Electronics v Forsyth, 1995 UKHL 8, the defendant contracted for the construction of a swimming pool of a depth of 7’ 6”, but on completion the pool was only 6’ 9” deep. The court only awarded nominal damages for loss of amenity and was not prepared to award damages based on the costs of rebuilding the swimming pool to the correct dimensions as that was not reasonable and the court doubted the innocent party’s intent to rebuild.

• Liquidated damages

Parties may elect to remove the uncertainty that surrounds an award of damages by a court and specifically set out in the contract, the consequences of a breach in the form of a fixed amount of damages or a formula for their calculation. Clauses which quantify or liquidate the sum payable in the event of a breach are known as liquidated damages clauses.

This type of clause is legitimate and enforceable, so long as it is not considered to be a penalty.

Previously anything other than a genuine pre-estimate of loss would be considered a penalty.

16

The Supreme Court has now set down in Cavendish Square Holding BV v El Makdessi [2015] UKSC 67 that in determining whether a contractual provision is penal, the true test is whether it is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation.

In determining whether a clause imposes a detriment on the contract-breaker which is out of all proportion to any legitimate interest of the innocent party the courts consider whether the clause is designed to protect a legitimate interest and will look at this point in the wider commercial context. This re-statement (in Cavendish) provides more certainty to businesses as the courts are less likely to intervene and strike out a liquidated damages clause.

• Restitutionary damages

Restitutionary damages are intended to prevent unjust enrichment i.e. prevent the wrongdoer gaining from committing a wrong or a breach of contract. In cases of an award of restitutionary damages, the benefit derived by the wrongdoer is likely to exceed the detriment suffered by the injured party. Indeed, the injured party may have suffered no loss at all. It contrasts sharply with the concept that damages are generally intended to compensate the claimant with the focus instead being on reversing the unjust enrichment. It is only in a few exceptional cases that restitutionary damages have historically been awarded for a breach of contract.

17

• Wrotham Park damages

In a breach of contract claim, claimants are more likely to be able to recover damages in terms of the Wrotham Park principle than they could by means of restitutionary damages.

Developed in the case of Wrotham Park Estate Ltd v Parkside Homes Ltd [1974] 1 WLR 798, the principle behind Wrotham Park damages is that the claimant can recover such a sum as the defendant would have paid the claimant had the defendant, before breaching the contract, negotiated a release of its obligations by the claimant. The principle is rooted in property cases for breach of restrictive covenants as well as breach of confidence claims but is available in contract claims more generally. In Wrotham Park, the award of damages was actually in lieu of an injunction.

Although Wrotham Park damages are often referred to as a type of restitutionary damages they are essentially compensatory in nature although courts have repeatedly asserted that the claimant would not have earned the compensation but for the breach i.e. had the defendant come to the claimant for the aforementioned release the claimant may have waived the obligation instead of releasing the defendant in return for a sum. The principle requires the court to conduct a hypothetical negotiation to ascertain what the parties may have agreed.

Three features were identified in Experience Hendrix LLC v PPX Enterprises Inc [2003] EWCA Civ 323 as justifying Wrotham Park damages:

- The defendant's deliberate breach of its contractual obligations for its own reward.

- The claimant's difficulty in establishing resultant financial loss.

- The claimant's legitimate interest in preventing the defendant's profit-making activity in breach of contract.

These features were expressly approved in the more recent case of Morris-Garner and another v One Step (Support) Ltd [2016] EWCA Civ 180 where the Court of Appeal upheld a Wrotham Park damages award in a claim for breach of confidentiality, non-compete and non-solicitation covenants in a business sale. The decision made it clear that such awards are not restricted to cases where the claimant has suffered no “identifiable financial loss” nor must the case be exceptional. The correct test is whether Wrotham Park damages would be “the just response”. However on 2 August 2016, the Supreme Court granted leave to appeal the decision. It will be interesting to monitor the outcome of the appeal and whether the number of Wrotham Park awards increase as an alternative measure of loss.

18

PART 3 – THE BREACH MATTERS, BUT WHAT IF MONEY IS NOT ENOUGH!

LOOKING AT THE CONTRACT

The Operator’s Perspective

An operator will typically regard rights of set off at law as an inadequate remedy. The operator will therefore consistently take the position that a detailed framework should be included in the contract for withholding payment of all or any part of an invoice under the contract which is in dispute. The operator may also attempt to include a right to withhold from payment under the contract the amount arising from any other dispute it has with the contractor under any other agreement.

The operator will also have concerns about any liens that the contractor or any subcontractor may assert against the property of the contractor or any property at the worksite. The operator will, of course, be vigilant to any risk of potential interference with the continuous performance of operations. If such a lien is asserted, the operator may also require a right to withhold the value of any lien from any amount otherwise payable under the contract.

The Contractor’s Perspective

Where the operator does require a contractual framework for withholding payment, the contractor may assert that a separate provision should be added which entitles the contractor to interest on any amount disputed and withheld in the first instance but later resolved in favour of the contractor. The contractor may also object to the operator having the right to withhold amounts payable under the contract against amounts in dispute under any other contracts, whether or not connected.

Where the operator requires a right to withhold the value of any lien, the contractor may contend that such amount should not be withheld without the contractor having the opportunity to demonstrate that the lien is either unenforceable or is covered by the provisions of an enforceable policy of insurance.

LOOKING AT THE LAW

Other Legal Remedies for Breach of Contract

• Nominal damages

A claimant is generally entitled to nominal damages in circumstances where there has been a breach of contract, but no associated loss has been suffered, or the claimant fails to prove the amount of his loss.

Nominal damages are often described as a “mere peg on which to hang costs” because the general rule in litigation is that costs will be awarded in favour of the successful party.

19

• Self-help

- Retention and Liens

In certain circumstances, a person may elect to withhold performance of his/her own obligations under a contract. This is known as retention. For example, a tenant may be able to withhold rent until the landlord makes repairs to the building.

A lien is a particular type of retention whereby possession of another party’s goods is retained. For example, a solicitor may keep possession of client papers where the client refuses to pay the fees.

Where a person is employed to do work on the specific goods of another, they may exercise a special lien. For example, a garage may keep possession of a car until the repairs undertaken are paid for.

Retention and lien are useful bargaining tools as they allow parties to use their contractual leverage to force performance of the defaulting party without resorting to the courts.

- Set-off

Where two parties have financial claims against one another, the parties may agree to set-off the two amounts so that the party which is required to pay the larger amount simply has to pay the balance due.

Again this is a useful self-help tool which allows parties to balance their respective contractual rights and obligations in an efficient and fair manner. Additionally, set-off is usually operated as a defence to a non-payment claim, which would otherwise be deemed a breach of contract triggering termination or other default rights. Set-off arises through operation of law but can also be expressly excluded as a remedy under the Contract.

• Equitable remedies

- Specific performance

Specific performance has been described as ‘the remedy available in equity to compel a person actually to perform a contractual obligation’. Specific performance is therefore not appropriate to enforce negative obligations. Specific performance is a discretionary remedy. In contrast to the position in Scots law, there is no right to assert specific performance as there is to assert damages under common law.

In general, specific performance will only be available as a remedy where there is a valid enforceable contract and damages would not be an adequate remedy for the innocent party.

The first part of the test is that there is a validly constituted contract. Once that has been established the court has to consider whether damages would be an adequate remedy. Damages are usually only considered inadequate where the subject matter of the contract is so unique that there is no market equivalent available or where damages would be financially ineffective. The courts have tended to grant specific implement in contracts for the sale of land as the subject matter is considered so unique

20

that no market equivalent is available. Contracts for the sale of commercial goods is generally thought to give rise to damages for breach as a market equivalent can be sourced elsewhere. Specific performance may however be granted where the contract is for commercial goods which are particularly unique or specialised.

- Injunctions

There are two types of injunctions, namely, prohibitory and mandatory. A prohibitory injunction restrains a defendant from committing future breaches. A mandatory injunction either orders a defendant to undo a breach or to desist from a breach.

Generally injunctive relief is sought where a wrong has been committed and the innocent party seeks to protect itself from further wrongdoing. Injunction may be granted where a wrong is threated but has not yet been committed (a quia timet injunction).

Interim injunction can also be sought in cases of urgency before proceedings commence in order to preserve the “status quo”.

CONCLUSION

In summary, correct classification of contractual provisions forms the cornerstone for decisive exercise of parties’ rights when facing breach of contract. Critical analysis of the status of the provision in breach affords parties with the appropriate choice of response and avoids the pitfalls awaiting the careless or ill-advised.

Contractual remedies whilst clearly defined in law may not always be well suited to the evolving factual dynamic within which parties operate. The value of assessing the route map for achievement of commercial objectives, coupled with clinical understanding of both substantive rights and remedies under the contract cannot be overstated. Determining suitable remedies during the drafting and performance stages of the contract cycle best positions parties countering disappointment or adversity from counterparty breach.

The next seminar of the Contracting Compass will occur on 30 November 2016. We hope to see you again at Brodies House for this and other events.

21

OIL & GAS CONTACTS

CLARE MUNRO PARTNER, HEAD OF ENERGY & INFRASTRUCTURE clare.munro@brodies.com +44 (0) 1224 392 253

GREG MAY PARTNER, OIL & GAS greg.may@brodies.com +44 (0) 1224 392 255

SONIA LOVE PARTNER, OIL & GAS sonia.love@brodies.com +44 (0) 1224 392 287

KEN MACDONALD PARTNER, LITIGATION kenneth.macdonald@brodies.com +44 (0) 1224 392 170

MALCOLM MACKAY PARTNER, LITIGATION malcolm.mackay@brodies.com +44 (0) 1224 392 274