When a party commits a breach of contract entitling the other party to terminate, the advice most often given is for the innocent party not to delay in the exercise of its rights. To do so may raise difficult questions as to whether the right has been waived and whether the late exercise of a right to terminate itself amounts to a repudiatory breach, which may gift the defaulting party an easy exit.

The recent decision of the English High Court in the “Hansa Murcia”[1] serves as a useful reminder that time may be an equally important consideration before the right to terminate arises.

Background

The buyers entered into a shipbuilding contract for the construction of a container vessel. Repayments of the instalments paid by the buyers under the contract were secured by a refund guarantee issued by the shipyard’s bank.

The refund guarantee was to remain in force until the earliest of: (i) the delivery of the vessel to the buyers; (ii) refund by the shipyard or the shipyard’s bank; or (iii) a fixed drop dead date. The refund guarantee also provided that if arbitration proceedings were commenced prior to the delivery of the vessel then the validity of the refund guarantee would be extended to 60 calendar days after the issue of the final arbitration award.

The construction of the vessel was delayed and the parties agreed a new delivery date, which was after the drop dead date in the refund guarantee. The shipyard undertook to arrange for the extension of the refund guarantee but failed to do so. Two days prior to the expiry of the guarantee the buyers terminated the shipbuilding contract. In their termination notice, the buyers alleged that the shipyard had failed to obtain an extension of the refund guarantee and that
this amounted to a repudiatory breach of the shipbuilding contract. The buyers served a notice of arbitration and on the same day the refund guarantee was extended by the shipyard’s bank.

Tribunal decision

The tribunal was asked to consider whether the buyers had validly terminated the shipbuilding contract. The arbitrators decided that although there was no express agreement as to when the extended refund guarantee had to be in place, it was reasonable time. A reasonable time was held to be no later than 14 days prior to the expiry date.

The arbitrators further decided that the shipyard’s failure to procure the extension until two days prior to expiry left the buyers with an unreasonably short time to consider what steps to take and, in particular, to decide whether to terminate the contract or to commence arbitration. The arbitrators took the view that the buyers were entitled to have absolute certainty that the extended refund guarantee was in place at least seven days before expiry. The buyers should not have had to wait until the last minute for the sellers to extend the refund guarantee. The shipyard was thus held to be in repudiatory breach and the buyers’ termination of the shipbuilding contract was found to be lawful.

What happened next?

The shipyard appealed the tribunal’s award, and their main argument was that no term could be implied into the agreement that any extension of the refund guarantee had to be procured within a reasonable time, because the expiry date of the refund guarantee was clearly stated in the guarantee itself.

The shipyard also argued that the wording of the refund guarantee was wide enough to trigger an automatic extension where arbitration proceedings had been commenced, even where proceedings were started after the expiry of the refund guarantee. Consequently, the shipyard argued there was never any danger that the buyers’ security would be imperilled.

Court’s decision

The court upheld the tribunal’s decision that there was an implied term that the extension of the refund guarantee had to be procured within a reasonable time. However, the court stated that as the implied term was only an inominate term this meant that in order to terminate the shipbuilding contract, the buyers had to demonstrate that the shipyard’s breach had substantially deprived them of the entire benefit of the shipbuilding contract.

The court did not agree with the tribunal that buyers’ security had been imperilled by the delay in extending the refund guarantee. The refund guarantee was still in place on the date when the shipbuilding contract was terminated, and the breach was capable of being remedied prior to the expiry date. The buyers could have waited until such expiry and then commenced arbitration proceedings against the shipyard. The start of these proceedings would have automatically triggered an extension of the refund guarantee and the resurrection of the security. The buyers would then have had adequate time to take advice, make decisions and implement any course of action in relation to arbitration, termination or calling on the refund guarantee. Since the breach by the shipyard did not substantially deprive the buyers of the benefit of the shipbuilding contract
the court concluded that the shipyard was not in repudiatory breach and the buyers were not entitled to terminate.

Reference was also made in the judgement to the tribunal’s observation that at no time prior to their termination had the buyers made time of the essence. In fact, in the two months after concluding the agreement on the extension, the buyers had done nothing at all in response to advice from the shipyard that efforts were being made to extend the refund guarantee.

One option that was available to the buyers was that they could have advised the shipyard that they were in default and also stated that unless the default was remedied within a certain period, then the shipbuilding contract would be terminated. In other words, the buyers needed to make time of the essence. The buyers’ failure to do so meant that they could not then suddenly terminate the shipbuilding contract without any prior warning to the shipyard.

Comment

The refund guarantee in the “Hansa Murcia” case is similar to a wording of many refund guarantees issued under shipbuilding contracts. The lessons of the case are clear and may have a wider application. Where contractual rights are breached, an innocent party cannot lie in wait choosing the moment to terminate.  Where a repudiatory breach has occurred the innocent party must act swiftly to protect its rights of termination. If the breach is not repudiatory or any right to terminate is not exercised immediately then, prior to exercising any rights of termination, the innocent party must consider whether time needs to be made of the essence so far as
concerns the performance of the outstanding contractual obligation.

[1] 1 Wuhan Ocean Economic & Technical Cooperation Company
Ltd and Nantong Huigang Shipbuilding Co Ltd –v- Schiffahrts – Gessellschaft
“Hansa Murcia” MBH & Co KG (Hansa Murcia) (2012) EWHC 3104 (Comm).