March 2005

Litigation Update

Repudiatory breach of contract: traps for the unwary

A repudiatory breach of contract is a breach which is sufficiently serious to entitle the innocent party to bring the contract to an end. However, identifying repudiatory breaches is not always easy and serious difficulties can arise if care is not taken. We see the issue appearing frequently in our cases and find that swift analysis of contractual conflicts can be vital to avoiding unwelcome consequences. In our experience, clients do not always spot potential problems.
The right to treat a contract as discharged for repudiatory breach is a common law right and often needs to be considered alongside express contractual termination rights. Sometimes contractual termination rights supplement common law rights. Sometimes they replace them. If a breach is repudiatory the innocent party usually has two options. It can either accept the repudiation and treat the contract as at an end or affirm the contract and insist on performance. Deciding whether a breach is sufficiently serious can be difficult where there is neither an outright refusal to perform in future nor a breach of "condition" but where the innocent party considers the breach or threatened breach to have significant commercial consequences. Sometimes the innocent party wishes to rely on the cumulative effect of numerous breaches as constituting repudiatory conduct - the "straw that broke the camel's back" approach - but would a court accept this? That depends very much on the facts. The situation can be even more complicated if the contractual terms are not in writing or if the obligations are unclear. And what if, instead of having a single contract, the parties have been operating under a series of related contracts? Does acceptance of a repudiatory breach under one discharge just that contract or are all bets off? Timing can be crucial. The innocent party usually needs to decide quickly what action to take. If you do nothing you risk affirming the contract, especially if the defaulting party is led to believe it's business as usual. You may be able to reserve your position but not for too long. What's more, if you are not clear about the basis on which you are reserving your position you may risk new contractual terms replacing or supplementing the original. What if you accept what you think is a repudiatory breach, but it turns out not to be repudiatory? There are cases that say that an unjustified termination of a contract does not always amount to a repudiation.1 In particular, a party who takes action in honest reliance on the terms of a contract, without showing an ulterior intention to abandon it, is not necessarily to be treated as repudiating it. To complicate matters, there are other cases of high authority where the defaulting party's honest misapprehension was no bar to a finding of repudiation given the immediacy and severity of its threatened breach. This can put the innocent party in a difficult position. How can it assess whether the terminating party is acting honestly? How immediate and severe must the consequences of a threatened breach be? If the innocent party decides to accept what it thinks is a repudiatory breach, but a court finds otherwise, that party may risk being held to have committed a repudiatory breach itself. The situation can be even more complicated if there are flow-on effects for other contracts. For example, suppose A terminating its contract with B obliges B to serve notices under its linked contracts with C and D. B may face considerable uncertainty because the validity of its notices may depend on a court's subsequent view of A's conduct. The question of damages can also be tricky for the unwary. If you accept a repudiatory breach at common law you are entitled to claim "loss of bargain" damages, that is, compensation for the loss of profit due to the contract not being performed in future. But if you exercise a contractual right to terminate when the breach in question would not also found a common law right to terminate, damages will probably be limited to loss suffered up to the date of termination unless the contract expressly provides otherwise. The difference can be considerable.

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Sometimes affirming the contract is the best tactic. If it is kept alive then sums due under the contract may give rise to a debt claim with no requirement to mitigate your loss. But there are practical limitations on the right to affirm which may suggest termination is the best option. In this regard you may need to consider whether a right to payment is conditional upon the prior or simultaneous performance of services or other contractual obligations.

You may also be faced with a charge by the defaulting party that you have no legitimate interest in pressing for performance rather than bringing the contract to a halt.
Note 1 See for example, Woodar Investment Development Ltd -v- Wimpey Construction UK Ltd [1980] 1 WLR 277.

Practical points
Watch out, on both sides of the contractual fence, for potential repudiatory breaches and breaches entitling termination under an express contractual termination clause. If you become aware of a significant breach, check your contract and be prepared to act quickly to preserve your options but remember you cannot safely reserve your position for too long. The greater the wait, the greater the risk. Equally, you cannot change your mind once you have elected to accept or affirm. Can you use the other party's default to your advantage, for example, to get out of an otherwise unprofitable contract or negotiate more favourable terms? Or should you affirm the contract and insist on performance? Analyse the probable outcomes and consider whether pressing for performance is commercially sound. Are there consequences for third parties, either with whom you have contracted or with whom the other side has contracted? Before exercising contractual termination rights, consider the remedies you may wish to pursue. If they include loss of bargain damages, consider the contract's remedies clause, if any, and whether a common law right to terminate co-exists. Be careful not to lose your rights and act consistently with your election. Give clear instructions to staff involved in the day-to-day implementation of the contract. Communications with the other party must be unequivocal. Think tactically. Explore your legal, commercial and strategic options, seeking early legal advice if appropriate.

Client training
If you would like to know more about the subject matter of this briefing, a client training presentation on contractual termination rights is now available. Other client training topics currently available from Ashurst's litigation team include: document management, freedom of information, dawn raids, arbitration, and privilege. For more information please contact Charlie Burgess at charlie.burgess@ashurst.com

Contacts
Michael Madden, partner Ben Tidswell, partner Carl Meyntjens, partner Jess Almoguera, partner Francesco Simoneschi, partner Karl Wach, partner Jean-Pierre Farges, partner London London Brussels Madrid Milan Munich Paris +44 (0)20 7859 1539 +44 (0)20 7859 1593 +32 (0)2 626 1900 +34 91 364 9800 +39 02 85 42 31 +49 (0)89 244 421 121 +33 (0)1 53 53 68 70 michael.madden@ashurst.com ben.tidswell@ashurst.com carl.meyntjens@ashurst.com jesus.almoguera@ashurst.com francesco.simoneschi@ashurst.com karl.wach@ashurst.com jean-pierre.farges@ashurst.com

This update is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to. Readers should take legal advice before applying the information contained in this publication to specific issues or transactions. For more information please contact us at Broadwalk House 5 Appold Street London EC2A 2HA Tel +44 (0)20 7638 1111 Fax +44 (0)20 7638 1112 www.ashurst.com 2005 Ashurst Ref:DTP/ 4011 Mar 05