LSE SUMMER SCHOOL
LL202 Commercial Law
Syllabus
Dates: 8th July – 26th July 2013
Lecturers: Professor Hugh Collins, Professor Michael Bridge, Dr Jo Braithwaite, Dr Jan
Kleinheisterkamp, Dr Solene Rowan.
Class teachers: Graeme Wood and Chris von Csefalvay.
Prequisites: Introduction to legal methods or equivalent
Course Aims: The course provides an introduction to English/common law commercial law
as a whole and focuses on some important aspects. It examines the basic common law
principles governing commercial contracts, including the topic of pre-contractual duties and
remedies for breach of contract. The course then considers particular types of transactions
in their commercial context including sales, credit and security, multi-party projects and
networks, long-term contracts such as franchises, and financial transactions including loans,
bonds, and derivatives. Aspects of litigation including international commercial arbitration
will also be considered. These examples are chosen to illustrate the commercial and
practical problems arising in different market sectors. A consideration of these paradigms
enables an exploration of a wide range of basic principles of law involving contract law, tort
law, restitution, and commercial law. The objectives of the course are that students will
become familiar with these basic principles of law, so that they can apply them to a wide
range of commercial transactions, in the light of the policy objectives which legal regulation
pursues, and with an understanding of the context of commercial transactions in which the
law operates
Core text: H. Beale, W. Bishop, M. Furmston, , Contract: Cases and Materials, 5th edn
(Oxford, OUP, 2007) (Abbreviation BBF)
Reference Texts: M. Chen-Wishart, Contract Law 3rd edn (OUP, 2010) (Abbreviation
Chen-Wishart)
R. Goode, Commercial Law, 4th edn. (London, Penguin, 2010) (Abbreviation: Goode)
Outline Syllabus 2013
Day 1 Introduction and Freedom of Contract HC 8/7
Day 2 Terms and their Interpretation SR 9/7
Day 3 Remedies for Breach of Contract JK 10/7
Day 4 International Commercial Contracts and Arbitration JK 11/7
Weekend break
Day 5 Pre-contractual Duties SR 15/7
Day 6 Sales Law HC 16/7
Day 7 Exclusion Clauses and Agreed Remedies SR 17/7
Day 8 Multi-party projects and networks
HC 18/7
Weekend break
Day 9 Long-term contracts and Franchises HC 22/7
Day 10 Credit and Security MB 23/7
Day 11 Financial law (1) Introduction and derivatives JB 24/7
Day 12 Financial law (2) Loans and bonds JB 25/7
Detailed Syllabus 2013
Day 1 Introduction and Freedom of Contract 8/7 HC
1.
Freedom of Contract
What policies and principles should predominate in the approach of the law towards
commercial contracts? Should contracts between businessmen be regarded as a field for
freedom of contract, so that, subject only to fraud and duress, they should be permitted to
make legally enforceable contracts with any content that they choose? Do arguments based
upon efficiency support such freedom of contract? Are there any valid policy reasons to limit
freedom of contract? Should the law be concerned about fairness? Should the law be
concerned about externalities? Is any interference with freedom of contract in commercial
contracts an example of unjustified paternalism?
(a)
Fairness – The Beguiling Heresy
Consider Union Eagle Ltd v Golden Achievement Ltd [1997] 2 All ER 215, PC (BBF 590). In
this case, the appellant entered a written contract to purchase a flat in Hong Kong for
$HK4.2 million, paying a 10% deposit. The contract provided that completion (ie payment of
the balance of the price) was to take place before 5.00pm on 30/9/91, that ‘time was of the
essence in every respect’, and that if the purchaser failed to comply with any of the terms of
the contract, the deposit was forfeited ‘as and for liquidated damages (and not a penalty).’ A
messenger carrying the payment arrived 10 minutes late at the vendor’s solicitor’s office, the
payment was refused, and the seller purported to rescind the contract and keep the deposit.
The purchaser sought specific performance, but was unsuccessful and appealed to the
Privy Council. Consider the following questions:
Should the Privy Council have forced the transfer of property (an order of specific
performance) or rejected the claim on the ground that the appellant had failed to produce
the money on time? Should the claimant be permitted to rely on an excuse that the
messenger was late without fault because the lifts were broken in the building where the
defendant’s office was located? What policy considerations should influence the court?
Speaking on behalf of the Privy Council, Lord Hoffmann concluded that the claimant was
seeking to rely on the ‘beguiling heresy’ that the courts enjoy an unlimited and unfettered
discretion to intervene to give relief from forfeiture of rights where it is unconscionable for the
respondent to insist on its contractual entitlements. Lord Hoffmann observed:
‘It is worth pausing to notice why it continues to beguile and why it is a heresy. It has
the obvious merit of allowing the court to impose what it considers to be a fair solution
in the individual case. The principle that equity will restrain the enforcement of legal
rights when it would be unconscionable to insist upon them has an attractive breadth.
But the reasons why the courts have rejected such generalisations are founded not
merely upon authority (see Lord Radcliffe in Campbell Discount Co. Ltd v. Bridge [1962]
AC 600, 626) but also upon practical considerations of business. These are, in
summary, that in many forms of transaction it is of great importance that if something
happens for which the contract has made express provision, the parties should know
with certainty that the terms of the contract will be enforced. The existence of an
undefined discretion to refuse to enforce the contract on the ground that this would be
"unconscionable" is sufficient to create uncertainty. Even if it is most unlikely that a
discretion to grant relief will be exercised, its mere existence enables litigation to be
employed as a negotiating tactic. The realities of commercial life are that this may
cause injustice which cannot be fully compensated by the ultimate decision in the case.’
In short, Lord Hoffmann argues that any power of the courts to intervene on grounds of fairness
threatens to undermine commercial life and therefore such powers should be rejected or at
least confined to narrow, certain exceptions.
If the appellant had merely asked for all (or some) of his deposit back, should he have got
it? If the contract had stated that in the event of any dispute between the parties, the dispute
should be determined by Professor Hugh Collins, in the light of business practice and
fairness, but in his absolute discretion, and he had awarded specific performance to the
appellant, (mostly because he had never received a Golden Achievement award from the
defendant but also because he felt sorry for the appellant who had missed the deadline
through no fault of his own), should a court enforce that order?
(b)
Externalities
(b) Externalities.
There are restrictions on freedom of contract in order to take account of (what economists
call) externalities. The parties to a commercial contract are likely to be concerned about
their own interests, but not those of third parties (eg. consumers). The law may need to
protect these third parties against the content of contracts.
In the context of commercial contracts, the two main examples are:
(1) Competition law:
Competition Act 1998 Section 2
(1)Subject to section 3, agreements between undertakings, decisions by associations of
undertakings or concerted practices which—.
(a)may affect trade within the United Kingdom, and.
(b)have as their object or effect the prevention, restriction or distortion of competition within
the United Kingdom,.
are prohibited unless they are exempt in accordance with the provisions of this Part.
(2)Subsection (1) applies, in particular, to agreements, decisions or practices which—.
(a)directly or indirectly fix purchase or selling prices or any other trading conditions;.
(b)limit or control production, markets, technical development or investment;.
(c)share markets or sources of supply;.
(d)apply dissimilar conditions to equivalent transactions with other trading parties, thereby
placing them at a competitive disadvantage;.
(e)make the conclusion of contracts subject to acceptance by the other parties of
supplementary obligations which, by their nature or according to commercial usage, have no
connection with the subject of such contracts..
(3)Subsection (1) applies only if the agreement, decision or practice is, or is intended to be,
implemented in the United Kingdom..
(4)Any agreement or decision which is prohibited by subsection (1) is void.
Prior to this legislation, the common law, through the restraint of trade doctrine, could also
invalidate contracts that were regarded as anti-competitive: e.g.
Esso Petroleum Co Ltd v Harper's Garage (Stourport) Ltd [1968] AC 269, HL.
(2) Insolvency law:
The ‘anti-deprivation’ principle says, in summary, there cannot be a valid contract that a
man’s property shall remain his until his bankruptcy, and on the happening of that event
shall go over to someone else, and be taken away from his creditors. The aim of this
principle is to protect the creditors in general of an insolvent company from terms of
contracts made by the company that have the effect of removing assets from the company
to a particular creditor, thereby ensuring that the creditors suffer equally (in pari passu, as
insolvency lawyers say).
For an example, see: Mayhew v King
http://www.bailii.org/ew/cases/EWHC/Ch/2010/1121.html
The scope of the anti-deprivation clause was recently considered in the Supreme Court in
Belmont Park Investments PTY Limited (Respondent) V BNY Corporate Trustee Services
Limited and Lehman Brothers Special Financing Inc (Appellant) [2011] UKSC 38, a crucial
decision following the collapse of Lehman Brothers.
http://www.supremecourt.gov.uk/decided-cases/index.html
The case is extremely complex, but you might want to look at the press release.
2. Formation of Contracts
For a binding contract to be formed in English common law, the parties must reach
‘agreement’ and the agreement must be supported by ‘consideration’.
(a) Agreement
Chen-Wishart, Chapter 3.
(1) Offer and Acceptance
As in most legal systems, the test of whether and when the parties have reached an
agreement is usually determined through an analysis of offer and acceptance. In Gibson,
the court insists on strict fidelity to the rules of offer and acceptance with the effect that even
though the parties were in agreement on the principal terms (price and subject matter), there
was no binding contract. Gibson v Manchester City Council [1978] 1 WLR. 520, [1978] 2 All
ER 583, CA; reversed, [1979] 1 WLR.294, [1979] 1 All ER 972, HL; BBF: 195. In the Court
of Appeal, Lord Denning said that ‘one ought to look at the correspondence as a whole and
at the conduct of the parties and see therefrom whether the parties have come to an
agreement on everything that was material’. Lord Diplock, in the HL, insisted on a
‘conventional’ approach of seeking in the written documents an ‘offer’ and an ‘acceptance’
on the same terms. Which approach best corresponds to the reasonable expectations of
businesses?
Although the common law does not permit acceptance by silence, it does permit acceptance
by the conduct of performing the contract. Brogden v. Metropolitan Railway Co (1877) 2
App Cas 666, HL; BBF: 208
(2) Battle of Forms
Businesses usually prefer to enter contracts on their standard terms of business. The parties
may believe or at least hope that they have reached an express agreement, but in fact the
inconsistency of the standard forms of business combined with the insistence of both parties
to have their own standard form govern the transaction raises a doubt whether agreement
on (significant) details was ever reached.
A court in the UK can decide (a) that no contract was agreed; or (b) the terms of one party’s
standard form governed the contract; or (c) that a contract was agreed but not on either
party’s standard form terms.
Butler Machine Tool Co Ltd v Ex-Cell-O Corpn (England) Ltd [1979] 1 All ER 965, CA (BBF
225)
Is there a last shot rule? If so, is it justified? Can the court apply such a rule without ignoring
some of the evidence that the parties had not yet reached agreement?
Are there any other possible options to resolve the issue?
UNIDROIT General Principles for International Commercial Contracts, Art.2.22 (BBF 229)
‘Where both parties use standard terms and reach agreement except on those
terms, a contract is concluded on the basis of the agreed terms and of any standard
terms which are common in substance unless one party clearly indicates in advance,
or later and without undue delay informs the other party, that it does not intend to be
bound by such a contract’.
Would this rule resolve the problem in Butler Machine Tool?
The empirical evidence is that battle of forms problems are frequent, that businesses know
that there is a problem of inconsistency, yet proceed with transactions nevertheless. Often
they are concerned to reach agreement on the ‘real deal’, but not necessarily on the
‘paperwork’. How might a business view an insistence by the other party on sorting out the
paperwork before any contract can be concluded?
(3)
Never Reaching an Agreement
In some cases, it is clear that the parties never reached an agreement and never supposed
that they had done so, yet despite the absence of an express contract, performance on the
contract may have started, or even have been completed. What are the rights of the parties
with respect to work performed and goods delivered in anticipation of a contract? In the
absence of a contract, what is the legal basis for a claim?
British Steel Corp v Cleveland Bridge and Engineering Co Ltd [1984] 1 All ER 604 (BBF 39)
What kind of remedy does this leave the seller to recover payment for the work and goods?
Breach of contract, tort, restitution? Which solution would the buyer prefer, and which the
seller? Why are contracts performed before a contractual agreement has been completed?
(4)
The Significance of the Formal Agreement
In some cases, the parties are agreed on pretty much everything, but they have not
completed the final step, such as an exchange of signed written contracts, as required under
the terms of their agreement, yet performance of the contract has commenced and perhaps
even been completed. Does the failure to complete the final step mean that there is no
contract?
*RTS Flexible Systems Ltd v Molkerei Alois Muller GmbH and Co KG [2010] UKSC 14,
[2010] 1 WLR 753
(b) Freedom Not to Make a Contract
Freedom of contract implies the freedom to decide not to agree to a contract or to continue
to negotiate until a contract can be agreed. The rules of offer and acceptance are designed
to ensure that there is no contract until there is complete agreement. In practice, however,
sometimes contracts are performed even in the absence of full and complete agreement.
How should the courts regard such a situation? Should they find that the parties did agree a
contract (since after all the contract has been performed), or should they find that no
complete agreement was reached, so there cannot be a contract.
RTS Flexible Systems Ltd v Molkerei Alois Muller GmbH and Co KG [2010] UKSC 14,
[2010] 1 WLR 753
"Schedule 1
48. COUNTERPARTS
48.1 This Contract may be executed in any number of counterparts provided that it shall not
become effective until each party has executed a counterpart and exchanged it with the
other."
"The general principles are not in doubt. Whether there is a binding contract between the
parties and, if so, upon what terms depends upon what they have agreed. It depends not
upon their subjective state of mind, but upon a consideration of what was communicated
between them by words or conduct, and whether that leads objectively to a conclusion that
they intended to create legal relations and had agreed upon all the terms which they
regarded or the law requires as essential for the formation of legally binding relations. Even
if certain terms of economic or other significance to the parties have not been finalised, an
objective appraisal of their words and conduct may lead to the conclusion that they did not
intend agreement of such terms to be a pre-condition to a concluded and legally binding
agreement." (Lord Clarke, para 45)
The Supreme Court makes clear in this case that a 'subject to contract' type of clause can
be waived by the conduct of the parties (usually by performing the contract).
(b) The Common Law Doctrine of Consideration
Chen-Wishart, Chapter 4
(1) Concept of consideration:
The idea of an exchange. The exclusion of donative promises.
Two concepts of consideration?
 Mutual requests
 Benefit and Burden
Requests and Conditional Promises: Shadwell v. Shadwell (1860) 9 CBNS 159, 142 ER 62;
BBF: 124
Unilateral Contracts: promise in return for requested action that is performed
Implied requests
Adequacy of consideration
Pre-existing Duty: Different types of duties:
general legal duties: eg promise not to hit someone
contractual duties owed to third parties: eg promise to perform a term of employment
modification of contracts: Williams v Roffey Bros & Nicholls (Contractors) Ltd [1991] 1
QB 1, [1990] 1 All ER 512, CA; BBF 111 Should consideration be a requirement for
modifications?
Is the doctrine of consideration a covert mechanism for testing the fairness of transactions?
Does the test of consideration conform to a test of efficiency (wealth-maximisation)?
(2) Intention to Create Legal Relations
The need for a qualification to the doctrine of consideration due to over-inclusiveness.
The origins of the doctrine of intention to create legal relations
(3) Equitable Estoppel
Is there a second substantive test of legal enforceability to deal with a problem of underinclusiveness in the doctrine of consideration? The reliance model suggests that
unrequested detrimental reliance upon a promise or undertaking should be protected by an
equitable remedy where the reliance was reasonable and where it would be unconscionable
to default on the promise or undertaking.
Proprietary estoppel: Crabb v. Arun District Council [1975] 3 All ER 865, CA; BBF: 155
Is this contract? A promise is enforced, but the remedy is equitable (order to grant right of
way), and no compensatory damages awarded (yet).
Questions for Class Discussion:
1. Assess the justice of the decision in Union Eagle Ltd v Golden Achievement Ltd .
2. Explain why there was consideration to support a contract in Brogden v. Metropolitan
Railway Co.
3. Does English law need a doctrine of consideration as a test for the enforceability of
contracts, or could it be safely abolished? What purposes does it serve?
4. Jim owns a small business, WFT, which manufactures replacement windows for old office
buildings. In March 2002 Jim receives a call from Chris, estates manager of the London
School of Commerce (LSC), asking for a quote for 10 replacement windows for an office
building. Jim faxes back a quotation using Chris’ measurements, including Jim’s standard
terms of business. These standard terms include (a) a specification of the kind of glass that
will be used, and (b) a discount of 5% on the price for payments within 10 days of delivery.
Chris faxes back a reply ‘accepting’ the quotation, but including the standard terms used by
Chris, one of which states that the contractor undertakes to comply with all current building
regulations. Jim sends a letter back headed ‘confirmation of order’, which includes Jim’s
standard form terms (again). Jim manufactures the windows, delivers them, and sends his
invoice for £5000. Chris pays the bill immediately, but a few days later is informed by the
local authority’s building regulations inspector that the glass in the windows does not comply
with the new Kyoto compliant standards of thermo-insulation for offices, so the windows
cannot be used. Chris telephones Jim saying that in view of the breach of LSC’s standard
terms, Chris is rejecting the windows and wants to recover his payment of £5000. Jim
replies that all that Chris is owed is £250 for the early payment discount, because the glass
conformed to Jim’s standard terms of business. Advise Chris.
Day 2 Express Terms, Implied Terms, and Interpretation
9/7 SR
When asked to advise on a dispute regarding a commercial contract, the first, and quite
possibly the last, thing an English lawyers will do is ask to read the express terms of the
written agreement and then apply them to the dispute at hand. This practice rests on the
assumptions that (a) the court will almost invariably enforce the express terms of the
contract because of their fidelity to the principle of freedom of contract, (b) that such terms
are readily discoverable, (c) that a court will not add additional obligations (implied terms),
and (d) that the meaning of the express terms is readily apparent. The following materials
investigate the plausibility of the assumptions in (b),(c), and (d).
Chen Wishart, Chapter 10
1.
Discovering the Express Terms
(a) Objective Test of Express Terms
'If, whatever a man's real intention may be, he so conducts himself that a reasonable
man would believe that he was assenting to the terms proposed by the other party,
and that other party upon that belief enters into the contract with him, the man thus
conducting himself would be equally bound as if he had intended to agree to the other
party's terms. (Blackburn J. Smith v Hughes (1871) LR 6 QB 597, BBF 303).
Rectification of inaccuracy in written agreement: Rose v. Pim [1953] 2 All ER 739, [1953] 2
All ER 739, CA BBF: 307
(b)
Standard Form Contracts and Incorporation
Signature binding: L'Estrange v F Graucob Ltd. [1934] 2 KB 394 (BBF 345)
Requirement to take reasonable steps to give notice of terms, and the more unusual and
onerous the terms, the more steps that are required:
Interfoto Picture Library Ltd. v Stilletto Visual Programmes Ltd [1988] 1 All ER 348, CA (BBF
336). Dillon LJ ‘if one condition in a set of printed conditions is particularly onerous or
unusual, the party seeking to enforce it must show that that particular condition was fairly
brought to the attention of the other party.’ Bingham LJ ‘the plaintiffs did not do what was
necessary to draw this unreasonable and extortionate clause fairly to their attention.’
AEG (UK) Ltd v LogicResource Ltd [1996] CLC 265, CA (BBF 339). Contract for sale of
cathode ray tubes on seller’s standard terms, but detailed terms not given to buyer but only
available on request. Clause 7.1 gave a warranty against defects caused by faulty materials
and bad workmanship, but in 7.7 otherwise excluded implied terms under SGA, and in 7.5.
required the purchaser to return goods at its own expense. CA found clause 7 contrary to
UCTA. Majority also found clause 7 not included as unusual or onerous; but Hobhouse LJ
dissented, saying this term was of the kind one expects to find in commercial contracts.
Would it make a difference if the contract had been signed by the buyer?
(b)
Forgetting the Form
What happens if the seller forgets to use the written form (containing the normal
disclaimers)? Does that mean that the form is not incorporated into the contract? Not
always:
(i)
course of dealing: Henry Kendall & Sons v William Lillico & Sons Ltd (The Hardwicke
Game Farm Case) [1969] 2 AC 31 (BBF 339);
(ii)
standard terms of trade: British Crane Hire Corporation Ltd v Ipswich Plant Hire Ltd
[1974] 1 All ER 1059, CA (BBF 340).
Would such arguments be accepted in contracts where the buyer is a consumer?
2.
Implied Terms
(a)
Sources of Implied Terms in the judge-made Common Law
There are several sources:
(i) unexpressed intention (officious bystander/business efficacy tests of intention);
(ii) importation of general legal obligations (eg duty to be careful in contracts for services
(ie the duty of care/negligence liability of Donoghue v Stevenson));
(iii) model or standard types of contracts, with standard incidents.
Liverpool City Council v Irwin [1977] AC 329, HL (BBF 415) (implied term that
landlord owed a duty to take reasonable care to keep in reasonable repair and
useability the common parts of the premises)
Mahmud and Malik v BCCI [1998] AC 20 (BBF 455)
(b)
Sources of Implied Terms in Statute: e.g. Sale of Goods Act 1979, s 14
(c)
General principle that implied terms cannot override express terms:
Johnstone v Bloomsbury Health Authority [1991] 2 All ER 293, CA (BBF 443)
Paragon Finance plc v Nash [2001] EWCA Civ; [2002] 1 WLR 685, CA
But by statute this may occur (ie compulsory terms) eg term of satisfactory quality in sales of
goods to consumers cannot be excluded.
(d)
Justification
What is the justification for implied terms (ie law’s insertion of additional obligations)? Save
on transaction costs? Fairness? Risk allocation? Efficiency?
3.
Interpretation
Chen-Wishart, Chapter 11
It is said that 99% of litigated cases concerning commercial contracts turn on questions of
interpretation, construction, or meaning of contracts. Why do written contracts cause such a
problem? Is the problem that the parties do not always say what they mean or do not always
mean what they say? Or is the problem that lawyers write the contracts and don’t know what
the parties mean? Or is the problem really one derived from the indeterminacy of language
in general? Or is the problem caused by the courts because they lack a consistent approach
to interpretation of the express terms of contracts? Or is the problem that the courts try to
secure a fair result regardless of what the contract says? Collins, 228-231
Thake v Maurice [1986] QB 644, [1986] 1 All ER 497, CA (BBF 330)
*Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 All ER 98
(Lord Hoffmann) (BBF 399)
Schuler AG v Wickman Machine Tools [1974] AC 235, HL (BBF 409, 599)
*Bank of Credit and Commerce International v Ali [2001] UKHL 8, [2002] 1 AC 251, HL (BBF
848)
There seem to be three possible basic approaches to the interpretation of written contracts:
(1)
(2)
(3)
A search for the actual intentions of the parties to the contract;
An application of the literal meaning of the words contained in the document;
An enquiry into what a reasonable person or reasonable promisee would have
understood to have been the meaning of the words.
The choice between these different approaches is usually guided by appeals to a variety of
policy considerations, including:





certainty;
fairness;
theories of the basis of contracts eg ‘will theory’, ‘reliance theory’;
promoting the utility of using written documents for business planning;
costs of litigation.
The approach in (1) (‘subjective intention’) seems to be condemned on various grounds:



actual intention is often hard for a court to establish;
the approach may merely reveal that the parties had different intentions;
the approach does not pay sufficient attention to the actual documents, because it
seems to open up the possibility of arguments that whatever the parties may have
agreed in writing their actual intentions were completely different so the court can
(and should) ignore the written contract.
The approach in (2) (‘literalism’ or ‘formalism’) is also condemned on various grounds:



the meaning of words is not fixed, but must be understood in the context in which it is
used;
literal meanings may lead to absurd results or at least commercially improbable
results in some circumstances;
it ignores the actual intentions of the parties’
The approach in (3) (‘objective promisee’) is also condemned on various grounds:


the courts may end up enforcing a contract that neither party actually wanted or
intended
it may sometimes allow the courts to ignore the literal meaning of the words
completely
Which approach is favoured by Sir Christopher Staughton, ‘How Do the Courts Interpret
Commercial Contracts?’ (1999) Cambridge Law Journal 303-313?
Rule 1: The task of the judge when interpreting a written contract is to find the common
intention of the parties, and the first (and possibly the last) place you look for the
intention of the parties is in the language which they themselves used.


The judge excludes evidence of actual (subjective) intention because (a) the
search is for common intention; (b) evidence of actual intention would be selfserving.
Exclusion of evidence of intention from previous negotiations is excluded
because it is unhelpful in discovering the common intentions.
Rule 2: The judge must consider surrounding circumstances where they must have been
known or were reasonably capable of being known to both parties at the time when the
contract was made – the facts which the parties must have had in mind when making the
contract.
Rule 3: ‘The fact that a particular construction leads to a very unreasonable result must be a
relevant consideration. The more unreasonable the result the more unlikely it is that the
parties can have intended it, and if they do intend it the more necessary it is that they should
make that intention abundantly clear’ (Lord Reid, Schuler v Wickman Machine Tools).
Staughton LJ cites as an example: Segovia v Pagnan & Fratelli, where in a charterparty the
charterers could order the vessel to any port in ‘The United States of America east of
Panama Canal’; ordered to New Orleans. Held that contract referred to any port which one
would approach from the Caribbean end of the canal.
Rule 4: The judge must take into account customs and usages of the trade that are
notorious, certain, and reasonable, which are in effect regarded as binding in the trade.
Which approach is favoured by Lord Hoffman? Investors Compensation Scheme ltd v West
Bromwich Building Society [1998] 1 All ER 98, HL (BBF 399):
(1)
Interpretation is the ascertainment of the meaning which the document would convey
to a reasonable person having all the background knowledge which would
reasonably have been available to the parties in the situation in which they were at
the time of the contract.
(2)
The background or ‘matrix of fact’ includes absolutely anything which would have
affected the way in which the language of the document would have been
understood by a reasonable man.
(3)
However, previous negotiations of the parties and their declarations of subjective
intent are excluded for practical policy.
(4)
The meaning which a document would convey to a reasonable man is not the same
thing as the literal meaning of its words as ascertained in dictionaries.
(5)
A judge may occasionally conclude that the parties have made a linguistic mistake if
the ordinary meaning of the words leads to a conclusion that flouts business
common sense or suggests an intention of the parties that they plainly could not
have had.
Lord Hoffmann’s restatement has been much cited and on some level is regarded as
authoritative. One important aspect of his approach is that he discards any precedents on
the interpretation of particular terms in contracts and any general principles for interpretation
other than those cited above. Lord Hoffmann asks: ‘If interpretation is the quest to discover
what a reasonable man would have understood specific parties to have meant by the use of
specific language in a specific situation at a specific time and place, how can that be
affected by authority?’ It is not clear that other judges accept this implication of his position:
eg BCCI v Ali.
Everyone seems to agree that ‘certainty’ is very important? Why? What does certainty mean
in this context? Is it the most important consideration? If not, what is? And which approach
achieves the greatest certainty?
It also seems to be agreed that the prior negotiations between the parties should not be
relevant to the question of the meaning of the contract: Chartbrook Ltd v Persimmon Homes
Ltd [2009] UKHL 38. Does that make sense? Do Staughton LJ and Lord Hoffman give a
good explanation of this exclusion? Everyone agrees that ‘rectification’ is a limited exception
to this rule. Also Lord Hoffmann would admit evidence of the background facts including the
use of ‘private language’ and the commercial purpose of the transaction, which may
indirectly involve reference to the negotiations, if not the precise negotiating positions.
It also seems to be agreed that subsequent conduct by the parties in the performance of the
contract should be irrelevant to the question of the meaning of the contract (see Schuler v
Wykman Tools ). Does that make sense? Goode comments: ‘Very often the record of
negotiations culminating in the contract is the best guide to the intention of the parties, as is
their behaviour subsequently’. He suggests that these legal restrictions are ‘widely ignored
in practice’ (though no evidence is cited).
Staughton LJ is very critical of the broad concept of ‘factual matrix’ in Lord Hoffmann’s
approach on the ground that it leads to very lengthy trials, but Lord Hoffmann insists that if it
is ‘relevant’ it must be considered.
Staughton LJ also warns that Lord Hoffmann’s fifth principle may go too far towards
rewriting the contract as opposed to interpreting it. But is it any different from Staughton LJ’s
Rule 3?
Questions for Class Discussion
1.
“The Applicant (Mr Naeem) agreed to accept the terms set out in the documents
attached in full and final settlement of all or any claims whether under statute,
Common law and in Equity of whatsoever nature that exist or may exist and in
particular, all or any claims rights or applications of whatsoever nature that the
Applicant has or may have or has made or could make in or to the Industrial
Tribunal, […]”. (Bank of Credit and Commerce International v Ali [2001] UKHL 8).
Read the statement above, which was signed by the Claimant in the BCCI v Ali case.
Based on the facts of the case, whose judgment would you agree with the most, and
why?
2.
In your view, which approach to the interpretation of contracts is best, and give
reasons for your opinion.
3.
What is the difference, if any, between the interpretation of contracts and the
implication of terms into contracts?
4.
Interpret the following contract terms:
5.
(a)
“I will paint your house in 7 days.” Does this include Saturday and Sunday?
(b)
A buyer is told “The goods will arrive in Reading on Friday.” They are left at the
post office for the buyer to collect. Is this a breach of contract by the seller?
Kim sees a pair of vintage 1960s boots for sale on an antique clothing company’s
website. They cost £50 including postage and packing. Kim isn’t worried about the
possibility that the boots might not fit because of a clear notice on the website saying
FULL REFUND IF THE GOODS ARE NOT SUITABLE. Kim submits her credit card
details and the boots arrive 2 weeks later. They don’t fit. Kim looks at the invoice in
order to work out where she should send the boots, and notices a small clause
saying “costs incurred in returning unsuitable goods must be met entirely by the
purchaser”. The boots are particularly heavy and Kim finds out from the post office
that returning them will cost £30. Advise Kim.
Day 3 Remedies for Breach of Contract 10/7 JK
I. The Aims of Remedies for Breach of Contract
Pacta sunt servanda ?



encourage keeping promises / deter breach
ensure that breach does not amount to ‘loss’
encourage settlement of disputes
II. Actions for Debt
(1) Claim for money owed - action for the agreed price:
Sales of Goods Act 1979 s 49(1) – Where, under a contract of sale, the property in the goods has passed
to the buyer and he wrongfully neglects or refuses to pay for the goods according to the terms of the
contract, the seller may maintain an action against him for the price of the goods.
(2) Simplified procedure, leading to a court order for the debtor’s assets to be seized and sold up to the
value of the debt.
(3) Debt must be ‘due’ – not if:
 already been paid
 the time for payment not reached
UTCCR – SI 1999/2083, Schedule 2
1. [Terms which may be regarded as unfair are those] which have the object or effect of- … (o) obliging the
consumer to fulfil all his obligations where the seller or supplier does not perform his.

performance not substantially fulfilled (eg SGA s 14(2))
When a contract provides for a specific sum to be paid on completion of specified work, the Courts lean
against a construction of the contract which would deprive the contractor of any payment at all simply
because there are some defects or omissions. The promise to complete the work is therefore construed as
a term of the contract, but not as a condition. … It is, of course, always open to the parties by express
words to make entire performance a condition precedent…
Hoenig v Isaacs [1952] 2 All ER 176, CA per Denning LJ
‘The present rule is that so long as there is a substantial performance the contractor is entitled o the
stipulated price, subject only to a cross-action or counterclaim [or set-off] for the omissions or defects in
execution... The converse, however, is equally correct – if there is not a substantial performance, the
contractor cannot recover. ... This rule does not work hardly upon a contractor if only he is prepared to
remedy the defects before seeking to resort to litigation to recover the lump sum.’
Bolton v Mahadeva [1972] 1 WLR 1009 per Sachs LJ
III. Termination for Breach of Contract
(1)
Not a ‘judicial’ remedy… but eventually subject to judicial control (‘was repudiation wrongful?’)
(2)
Rule: Termination is available if
‘the occurrence of the event deprive[s] the party who has further undertakings still to perform of
substantially the whole benefit which it was the intention of the parties as expressed in the contract that
he should obtain as the consideration for performing those undertakings’.
Hong Kong Fir Shipping Co Ltd v Kawasaki
[1962] 2 QB 26 per Diplock LJ
Situations:
 Repudiation
the other party treats the party as not existent or announces its total default (‘anticipatory
breach’)
 Express termination clauses
the parties defined what king of breach allows termination
 Breach of condition (↔ warranty)
the contract (implicitly) characterizes an obligation as such that its breach would deprive the
injured party of what is substantially deprived of what is entitled to.
→problems of interpretation
(e.g. Schuler v Wickman [1973] 2 All ER 39, HL)
(3)


Exception: loss of right to terminate
‘Affirmation of contract’
‘Waiver of breach’
IV. Agreed Remedies
(1) Freedom of Contract – some typical provisions about remedies for breach of contract
 Terms that fix the amount of compensation: ‘liquidated damages’
 Terms that provide for the forfeiture of a property right (charges) or a sum of money (deposits):
‘security rights’
 Terms that limit the amount of compensation payable: limitation of damages clauses;
 Terms that provide for a wealthy third party to pay outstanding debts: guarantees and
indemnities.
 Terms that limit the available avenues for redress: arbitration clauses.
(2) Control of Agreed Remedies

UCTA 1977 and especially UTCCR 1999: ‘reasonableness’ / ‘fairness’
Sched 1 (d) “[Terms which may be regarded as unfair are those:] permitting the seller or supplier to
retain sums paid by the consumer where the latter decides not to conclude or perform the contract,
without providing for the consumer to receive compensation of an equivalent amount from the seller or
supplier where the latter is the party cancelling the contract;”

Judicial control: prohibition of overcompensation through contractual ‘penalties’
‘The essence of a penalty is a payment of money stipulated as in terrorem of the offending party; the
essence of liquidated damages is a genuine covenanted pre-estimate of damages.’
Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd
[1915] AC 79, HL
(3) Deposits
Law of Property Act 1925 s. 49(2): Where the court refuses to grant specific performance of the
contract, or in any action for the return of a deposit, the court may, if it thinks fit, order the repayment of
any deposit.
‘The special treatment afforded to such a deposit [of 10%] derives from the ancient custom of providing
an earnest for the performance of a contract in the form of giving either some physical token of earnest
(such as a ring) or earnest money. The history of the law of deposits can be traced to the Roman law of
arra, and possibly further back still… In the event of completion of the contract the deposit is applicable
towards payment of the purchase price; in the event of the purchaser's failure to complete in accordance
with the terms of the contract, the deposit is forfeit, equity having no power to relieve against such
forfeiture.
However, the special treatment afforded to deposits is plainly capable of being abused if the parties to a
contract, by attaching the label “deposit” to any penalty, could escape the general rule which renders
penalties unenforceable.’
Workers Trust and Merchant Bank Ltd v. Dojap Investments Ltd
[1993] AC 573, 578-9 (PC)
(4) Repossession of Goods in Hire-Purchase
but Consumer Credit Act 1974 ss. 90, 91, 129.
[If the debtor has paid one third or more of the price, the creditor cannot recover possession of the goods
except by court order, and if the creditor does take the goods, the hire purchase agreement is
automatically terminated and the debtor is entitled to recover all his money back. A court can give extra
time to pay ‘if it appears to the court just to do so’.]
V. Compensatory Damages
(1) If there is no agreed remedy and the claim is not a simple one for a money debt, the primary remedy
offered by the courts is compensatory damages for ‘loss’.
(2) The notion of ‘loss’ can be described in various ways:
(a)
Reliance interest: putting the injured party back in the position as if there never had been a
contract;
(b)
Expectation interest: the position the injured party would have been in, if the contract had
been properly performed, in so far as money can achieve that, including loss of profits
(3) Two crucial qualifications:
(a)


Personal satisfaction/non-pecuniary losses/performance interest:
Jarvis v. Swans Tours [1973] 1 All ER 71, CA
Farley v Skinner [2001] UKHL 49 HL
‘If the cause is no more than disappointment that the contractual obligation has been broken, damages
are not recoverable even if the disappointment has led to a complete mental breakdown. But, if the cause
of the inconvenience or discomfort is a sensory (sight, touch, hearing, smell, etc) experience, damages
can, subject to the remoteness rules, be recovered.’
(b)
Remoteness of loss: Loss of profits incurred as a consequence of breach of contract sometimes
not recoverable under the doctrine of ‘remoteness of loss’
‘The damages recoverable for a breach of contract are such as may fairly and reasonably be considered as
arising naturally, ie, according to the usual course of things, from the breach of the contract itself, or such
as may be reasonably supposed to have been in the contemplation of both parties at the time they made
the contract as the probable result of the breach of it.’
Hadley v Baxendale (1854) 9 Exch 341
SGA ss.50/51: The measure of damages is the estimated loss directly and naturally resulting, in the
ordinary course of events, from the buyer’s/seller’s breach of contract.
But: (?)
‘Such a risk would be completely unquantifiable, because although the parties would regard it as likely
that the owners would at some time during the currency of the charter enter into a forward fixture, they
would have no idea when that would be done or what its length or other terms would be.’
Transfield Shipping v Mercator Shipping (The Achilleas)
[2008] UKHL 48 per Lord Hoffmann
Contrast:
‘The orthodox approach remains the general [Hadley v Baxendale] test of remoteness applicable in the
great majority of cases. However, there may be “unusual” cases, such as itself, in which the context,
surrounding circumstances or general understanding in the relevant market make it necessary
specifically to consider whether there has been an assumption of responsibility. This is most likely to be
in those relatively rare cases where the application of the general test leads or may lead to an
unquantifiable, unpredictable, uncontrollable or disproportionate liability or where there is clear
evidence that such a liability would be contrary to market understanding and expectations.’
Sylvia Shipping v Progress Bulk Carriers
[2010] EWHC 542 (Comm) per Hablen J.
VI. Specific Performance and Injunctions
(1) Specific performance is an order to perform the contract, and an injunction is an order to refrain
from breaching the contract. Failure to obey the order is a contempt of court, resulting in fines and
possibly imprisonment.
RSC Order 45
Rule 5(1) – Enforcement of judgment to do or abstain from doing any act
Where –
(a) a person required by a judgment or order to do an act within a time specified in the judgment or
order refuses or neglects to do it …; or
(b) a person disobeys a judgment or order requiring him to abstain from doing an act,
then, subject to the provisions of these rules, the judgment or order may be enforced by one or more
of the following means, that is to say –
(i) with the permission of the court, a writ of sequestration against the property of that person;
(ii) where that person is a body corporate, with the permission of the court, a writ of sequestration
against the property of any director or other officer of the body;
(iii) subject to the provisions of the Debtors Act 1869 and 1882, an order of committal against
that person or, where that person is a body corporate, against any such officer.
(2)
Equitable orders are awarded only exceptionally where:
(a) common law remedies (ie damages) would be ‘inadequate’ to meet the ‘justice’ of the case;
(b) they are ‘practicable’ and not force personal service; and
(c) it would not be unfair or oppressive to enforce the contract at the date of judgment (Patel v. Ali
[1984] Ch 283)
(3)
Orders for specific performance are very rarely granted in practice for breach of contracts (other
than for the transfer of interests in land)
‘No authority has been quoted to show that an injunction will be granted enjoining a person to carry on a
business, nor can I think that one ever would be, certainly where the business is a losing concern.’
A-G v Colchester Corporation
[1955] 2 QB 207, 217 per Lord Goddard CJ
‘The purpose of the law of contract is not to punish wrongdoing but to satisfy the expectations of the
party entitled to performance…. The exercise of the discretion as to whether or not to grant specific
performance starts from the fact that the covenant has been broken. Both landlord and tenant in this case
are large sophisticated commercial organisations and I have no doubt that both were perfectly aware that
the remedy for breach of the covenant was likely to be limited to an award of damages. The interests of
both were purely financial: there was no element of personal breach of faith… No doubt there was an
effect on the businesses of other traders in the Centre, but Argyll had made no promises to them and it is
not suggested that CIS warranted to other tenants that Argyll would remain. Their departure, with or
without the consent of CIS, was a commercial risk which the tenants were able to deploy in negotiations
for the next rent review.’
Co-operative Insurance Society Limited v. Argyll Stores
[1998] AC 1 per Lord Hoffman
Exceptional case:
Sky Petroleum v. V.I.P. Petroleum [1974] 1 All ER 954: Party suffering from breach would have to go
out of business if no specific performance were granted.
(4) Usual justification for absence of specific performance as normal remedy is efficient breach: if a
party to a contract can by breaking the contract and paying full compensation still be better off, then
breach maximises wealth.
UNIDROIT Principles (2004)
Article 7.2.2 (Performance of non-monetary obligation)
Where a party who owes an obligation other than one to pay money does not perform, the other
party may require performance, unless
(a) performance is impossible in law or in fact;
(b) performance or, where relevant, enforcement is unreasonably burdensome or expensive;
(c) the party entitled to performance may reasonably obtain performance from another
source;
(d) performance is of an exclusively personal character; or
(e) the party entitled to performance does not require performance within a reasonable
time after it has, or ought to have, become aware of the non-performance.
contrast:
Article 6.2.1 (Contract to be observed)
Where the performance of a contract becomes more onerous for one of the parties, that party is
nevertheless bound to perform its obligations subject to the following provisions on hardship.
Questions for Classes on
Topic 3 – Remedies for Breach
1. What are the primary and secondary remedies for breach of contract in English common
law and in equity? Why are English courts so reluctant to grant specific performance? Is the
principle of pacta sunt servanda nothing but an illusion in English law?
2. Tom and Jerry enter into a contract under which Tom promises to convey part of a tract of
land to Jerry and Jerry promises to pay £ 100,000 and to build a ‘first class theatre’ on it.
The underlying understanding of the parties, based on a report of an independent expert,
was that the building of the theatre would enhance the value of A’s remaining land at least
by 150%, maybe up to 250%. A conveys the land to B, who pays the price but eventually
refuses to build the theatre. What remedies are available to A?
3. Isn’t the right to right to refuse payment of money owed under the contract the same as the
right to terminate the contract?
4. Explain why Hadley v Baxendale is so important for the English law of damages? Doesn’t it
undermine the principle of full compensation?
5. In order to have the right to terminate the contract, the party suffering from a breach must
be able to show that it was essentially deprived of what it was entitled to expect under the
contract. In order to obtain specific performance, the party suffering from a breach must be
able to show that the common law remedies would be inadequate to meet the equity of the
case. Is there a common logic in the sense of ‘if money can fix it, money it is’?
Day 4 International Commercial Contracts and Arbitration 11/7 JK
A. Alternative Dispute Resolution in Commercial Law
I.
Origins of ADR

Self-government of medieval fairs and boroughs
▪ rules based on trade usages (law merchant, lex mercatoria)
applied by peers (merchant courts)
Lex Mercatoria from The Little Red Book of Bristol (circa 1280 AD)
‘In all market courts all judgments ought to be rendered by the merchants of that same Court and not by the
mayor or steward of the market… When a judgment is rendered in a market forum according to the law
merchant, execution is immediately demanded. This execution belongs first and principally to the lord of the
market or to the lord’s lieutenant in the market.’1
▪ in 17th century absorbed into common law (Holt CJ, Lord Mansfield)
II.

Privileges of foreign traders: right to use arbitration tribunals
(Carta mercatoria 1303, Treaty of Utrecht with Hanseatic League 1474)

Still today: peer dispute settlement mechanisms of trade associations for their members
→ amiable composition:
▪ no rigidity of procedural rules
▪ no application of the law but decisions ex aequo et bono
(cf. s 46(1)(b) Arbitration Act 1996)
▪ Examples:
- Grain & Feed Trade Association (GAFTA) London
- Financial Industry Regulatory Authority (FINRA) New York
Internal governance mechanisms

Parties can anticipate future disputes in contractual clauses
▪ contractual mechanisms: penalties, termination, exclusion, relief from forfeiture,
deposits / performance bonds, etc.
▪ architects certificates
▪ dispute management mechanisms:
negotiations, mediation, conciliation, adjudication, arbitration
= possibility to tailor mechanisms for individual contract
LCIA recommended clause for Mediation and Arbitration
‘In the event of a dispute arising out of or relating to this contract..., and if the dispute cannot be settled through
negotiation, the parties shall first seek settlement of that dispute by mediation in accordance with the [...]
Mediation Procedure...
If the dispute is not settled by mediation within [ ] days of the appointment of the mediator, or such further period
as the parties shall agree in writing, the dispute shall be referred to and finally resolved by arbitration under the
[...] Arbitration Rules...’
→ (partial or temporary) exclusion of interference by courts
= exception to rule of general jurisdiction (ius dicere) of state courts
Conditions for such derogation:
- either prior agreement of parties:
(partial / temporary) waiver of right to access to justice (cf. Art 6 EHRC)
1
Translated from Latin in P.R. Teetor, ‘England’s Earliest Treatise on the Law Merchant’ (1962) 6 American Journal of
Legal History 178, 195-196.
s 9 Arbitration Act 1996
(1) A party to an arbitration agreement against whom legal proceedings are brought … in respect of a matter
which under the agreement is to be referred to arbitration may… apply to the court in which the proceedings
have been brought to stay the proceedings as far as they concern that matter.
(4) On an application under this section the court shall grant a stay unless satisfied that the arbitration agreement
is null and void, inoperative or incapable of being performed.
- or statutory ADR: e.g. s 108 Housing Grants, Construction and Regeneration Act
1996:
‘(1) A party to a construction contract has the right to refer a dispute arising under the contract for adjudication
under a procedure complying with this section...
(3) The contract shall provide that the decision of the adjudicator is binding until the dispute is finally determined
by legal proceedings, by arbitration (if the contract provides for arbitration or the parties otherwise agree to
arbitration) or by agreement.
III.
Arbitration

The (myth of the) traditional advantages of arbitration
speediness: dedicated arbitrators, single instance, swift enforcement
▪ costs: deriving from speediness
▪ competence: possibility to choose specialists, including non-lawyers (engineers,
accountants)
▪ flexibility (see above II)
▪ confidentiality: award, existence of and material used in arbitration

Other reasons for opting for arbitration
▪ in England: avoiding barristers
▪ in the U.S.: avoiding jury trial

Especially at the international level:
an efficient regime of enforceability of arbitration agreements and awards in 146
countries
→ UN Convention on Recognition and Enforcement of Foreign Arbitral Awards (NY 1958)
▪ enforceability of arbitration agreements; Art II(1) and (3) NYC
▪ no double exequatur; cf. Arts III and V(1)(e) NYC
▪ presumption of validity upon presentation of agreement and award
→
burden of proof on award debtor for grounds for refusing enforcement
Art V(1) NYC
- lack of valid arbitration agreement or non-respect for its scope; (a)&(c)
- violation of due process or of procedure provided in agreement; (b)&(d)
- award not yet binding on parties or set aside in country of origin; (e)
▪ no review of the merits, although public policy exception; Art V(2)(b) NYC

importance of choice of place of arbitration
▪ default regime for many legal questions (cf. s 2 AA 1996)
▪ place of setting aside (cf. Art V(1)(e) NYC

importance of the place of enforcement; Art V(2) NYC

importance of institutional rules: e.g., compare s 69(1) Arbitration Act 1996 with Art 26(9)
LCIA Rules; or s 46(3) AA 1996 with Art 22(3) LCIA (see also below).
B. The Internationalisation of Commercial Law
I.
Co-ordinating legal diversity: Conflicts of Laws
1.
The impact of the international dimension
Unfair Contract Terms Act 1977
26 International supply contracts
(1) The limits imposed by this Act on the extent to which a person may exclude or restrict liability by
reference to a contract term do not apply to liability arising under such a contract as is described in
subsection (3) below.
(2) The terms of such a contract are not subject to any requirement of reasonableness under section
3 or 4: and nothing in Part II of this Act shall require the incorporation of the terms of such a contract
to be fair and reasonable for them to have effect.
(3) Subject to subsection (4), that description of contract is one whose characteristics are the
following—
(a) either it is a contract of sale of goods or it is one under or in pursuance of which the
possession or ownership of goods passes; and
(b) it is made by parties whose places of business (or, if they have none, habitual residences) are
in the territories of different States (the Channel Islands and the Isle of Man being treated for this
purpose as different States from the United Kingdom).
(4) A contract falls within subsection (3) above only if either—
(a) the goods in question are, at the time of the conclusion of the contract, in the course of
carriage, or will be carried, from the territory of one State to the territory of another; or
(b) the acts constituting the offer and acceptance have been done in the territories of different
States; or
(c) the contract provides for the goods to be delivered to the territory of a State other than that
within whose territory those acts were done.
2.
Choice of the applicable law
▪
Freedom of choice
Regulation (EC) No 593/2008 of 17 June 2008 on the law applicable to contractual obligations
(Rome I)
Article 3 – Freedom of Choice
1. A contract shall be governed by the law chosen by the parties. The choice shall be made expressly
or clearly demonstrated by the terms of the contract or the circumstances of the case. By their choice
the parties can select the law applicable to the whole or to part only of the contract.
▪
Limits of choice of law
Regulation (EC) No. 593/2008 (‘Rome I’)
Article 9 – Overriding mandatory provisions
1. Overriding mandatory provisions are provisions the respect for which is regarded as crucial by a
country for safeguarding its public interests, such as its political, social or economic organisation, to
such an extent that they are applicable to any situation falling within their scope, irrespective of the
law otherwise applicable to the contract under this Regulation.
2. Nothing in this Regulation shall restrict the application of the overriding mandatory provisions of the
law of the forum.
3. Effect may be given to the overriding mandatory provisions of the law of the country where the
obligations arising out of the contract have to be or have been performed, in so far as those
overriding mandatory provisions render the performance of the contract unlawful. In considering
whether to give effect to those provisions, regard shall be had to their nature and purpose and to the
consequences of their application or non-application.
Article 21 – Public policy of the forum
The application of a provision of the law of any country specified by this Regulation may be refused
only if such application is manifestly incompatible with the public policy (ordre public) of the forum.
2.
Choice of non-state law
▪
State Courts
Regulation (EC) No. 593/2008 (‘Rome I’)
Article 3 – Freedom of choice
1. A contract shall be governed by the law chosen by the parties...
2. The parties may also choose as the applicable law the principles and rules of the substantive law
of contract recognised internationally or in the Community.
However, questions relating to matters governed by such principles or rules which are not expressly
settled by them shall be governed by the general principles underlying them or, failing such principles,
in accordance with the law applicable in the absence of a choice under this Regulation. [original
proposal, COM(2005) 650 final]
▪
Arbitral Tribunals
Arbitration Act 1996
46 Rules applicable to substance of dispute
(1) The arbitral tribunal shall decide the dispute—
(a) in accordance with the law chosen by the parties as applicable to the substance of the
dispute, or
(b) if the parties so agree, in accordance with such other considerations as are agreed by them or
determined by the tribunal.
(2) For this purpose the choice of the laws of a country shall be understood to refer to the substantive
laws of that country and not its conflict of laws rules.
(3) If or to the extent that there is no such choice or agreement, the tribunal shall apply the law
determined by the conflict of laws rules which it considers applicable.
LCIA Arbitration Rules (1998)
Article 22 – Additional Powers of the Arbitral Tribunal
(3) The Arbitral Tribunal shall decide the parties’ dispute in accordance with the law(s) or rules of law
chosen by the parties as applicable to the merits of their dispute. If and to the extent that the Arbitral
Tribunal determines that the parties have made no such choice, the Arbitral Tribunal shall apply the
law(s) or rules of law which it considers appropriate.
(4) The Arbitral Tribunal shall only apply to the merits of the dispute principles deriving from “ex
aequo et bono”, “amiable composition” or “honourable engagement” where the parties have so
agreed expressly in writing.
II.
Overcoming legal diversity:
Harmonisation and Uniformisation of Commercial Laws
1.
Uniform Global Commercial Contract Law?
▪
International Treaties: e.g.
- Conventions on the Uniform Law of International Sales of Goods and Uniform
Law on the Formation of Contracts for the International Sales of Goods (1964)
→ Uniform Laws of Sales Act 1967 (c.45)
- UN Convention on the International Sale of Goods (Vienna 1980) [not ratified by
UK]
2.
▪
Model Laws: e.g.
- UNCITRAL Model Law on Cross-Border Insolvency (1997) [not adopted by UK]
- UNIDROIT Model Franchise Disclosure Law (2002) [not adopted by UK]
▪
Model Contract Clauses: e.g.
- Uniform Customs and Practices for Documentary Credits, UCP 600
- INCOTERMS
▪
General Principles of Contract Law (non-state law): e.g. UNIDROIT Principles
(2004)
Harmonisation of Commercial Contracts Laws in the EC
▪
Council Directive 86/653/EEC of 18 December 1986 on the coordination of the
laws of the Member States relating to self-employed commercial agents
▪
Directive 2000/35/EC of the European Parliament and the Council of 29 June
2000 on combating late payments in commercial transactions
▪
Towards a European Civil Code?
- Principles of European Contract Law
- Draft Common Frame of Reference:
http://video.google.com/videoplay?docid=852539341160949048
Questions for Class on
Topic 4 – ADR and Internationalisation
1.
Why can parties conclude contracts? Why can they choose the law applicable to their
contract? Why can they have their disputes decided by ‘private judges’? Can they actually
make their own law? Discuss the meaning of party autonomy in the light of global
transactions and in historic perspective.
2.
What are the differences between the various alternative dispute resolution mechanisms that
are at the parties’ disposal?
3.
When reaching the end of long negotiations of a complex joint venture contract for the
operation of an airport in Kuala Lumpur, your client, a multinational infrastructure and
logistics company, ask for your advice regarding the choice of law and the choice of a
dispute resolution mechanism. What would your preliminary advice be for considering the
different options?
4.
What does the English Arbitration Act 1996 (AA) mean in section 46 by ‘such other
considerations as are agreed by [the parties]’? How is section 46 (especially paragraph 3)
AA different from the equivalent provision in the LCIA Rules? How can they fit together?
5.
Do you think Europe needs a common civil code? What is happening in the meanwhile?
(If you have time, have a look at: http://www.youtube.com/watch?v=D0EEnUSyyd4)
Weekend Break
27
Day 5 Pre-contractual duties and the duty of good faith SR
15/7
Pre-contractual duties and the duty of good faith
1.
Introduction
Traditionally, the general principle of English law is that parties owe each other no
duties during the process of negotiation but with some exceptions (e.g.
misrepresentation, fraud).
The rationale of this general principle is that (a) parties are free during negotiations
to find the best deal the market has to offer, and (b) imposing obligations on parties
before they voluntarily assume them is an interference with liberty and freedom of
contract.
However this general principle is viewed today with some scepticism for reasons
which will be discussed. Accordingly, it has been suggested in recent years that
English law (a) should have or (b) does have a different underlying principle. The
most common formulation of that principle is the duty to bargain in good faith, a duty
recognised in some other legal systems in Europe (e.g. Germany’s principle of
‘culpa in contrahendo’). There are other possible formulations e.g. the duty to
bargain with care.
Would the recognition of a different underlying principle make any difference
in practice?
Would the adoption of such a general principle be too vague to be workable?
This topic requires that you know (a) the scope of the ‘exceptions’ to the traditional
principle of no obligations (b) have a view on whether the ‘exceptions’ already
comprise a different principle (c) if so, what that principle is, and (d) what difference
in practical results the (open) adoption of a different principle would make in English
law.
Reading (focus on starred items):
*Walford v. Miles [1992] 2 A.C. 128; BBF 271
28
*Esso Petroleum Co Ltd v. Mardon [1976] 2 All ER 5; BBF 328
East v. Maurer [1991] 2 All ER 733, CA; BBF 372
Misrepresentation Act 1967, s2(1); BBF 372, 377
*Petromec Inc v Petroleo Brasiliero SA Petrobas [2005] EWCA Civ 891, paras 120121
Multiplex Constructions UK Ltd v Cleveland Bridge Ltd [2006] EWHC 1341 (TCC)
(part of the extensive litigation over the Wembley Stadium: see para 15: Part 2 for
background facts. Reading should then focus on para 633 onwards: Part 14/Issue
9).
JSD Corp PTE v Al Waha Capital PJSC [2009] EWHC 3376 (Ch)
*Rt. Hon Lord Steyn, ‘Contract law: Fulfilling the Reasonable Expectations of
Honest Men’ (1997) 113 LQR 433
M. Bridge, ‘Doubting Good Faith’ (2005) 11 New Zealand Business Law Quarterly
426
R. Brownsword, Contract Law: Themes for the Twenty-First Century, Chapter 5;
BBF extracts pp 283-287
N. Cohen, ‘Pre-Contractual Duties: Two Freedoms and the Contract to Negotiate’ in
J. Beatson and D. Friedmann (ed.) Good Faith and Fault in Contract Law (1995,
Oxford: OUP), chapter 2
Goode, pp 95-6
2.
The general principle
The general principle in English law is that there is no obligation during the process
of negotiation owed by parties to each other. Traditionally the English courts are
reluctant to recognise a duty to negotiate in good faith. Walford v. Miles.
Considering the decision in more detail:
(a)
Did the purchaser receive damages despite the finding that the lock-out
agreement was unenforceable? What effects would upholding the lock-out
agreement have had in practice? Why was the lock-out agreement held to be
binding in JSD Corp PTE v Al Waha Capital PJSC [2009] EWHC 3376 (Ch)?
(b)
Compare the status of agreements to use ‘best endeavours’ (i) in the
performance of a contract, and (ii) in the negotiation of a contract? Little v
Courage Ltd (1995) 70 P. & C.R. 469; Multiplex Constructions UK Ltd v
29
Cleveland Bridge Ltd [2006] EWHC 1341 (TCC) (part of extensive litigation
over the Wembley Stadium).
(c)
What if there is an express agreement to negotiate in good faith? Petromec
Inc v Petroleo Brasiliero SA Petrobas [2005] EWCA Civ 891.
3.
What might the ‘exceptions’ to the general principle about parties’
negotiations be?
(a) Misrepresentation and misleading statements
(i) Equitable remedy of rescission.
(ii) Damages:
- fraud/deceit in tort. *East v. Maurer [1991] 2 All ER 733, CA; BBF
372
- negligent misstatement in tort under Hedley Byrne. *Esso Petroleum
Co Ltd v. Mardon [1976] 2 All ER 5; BBF 328, Box v. Midland Bank plc
[1979] 2 Lloyd’s Law Reports 391,
South Australian Asset
Management Corp. v. York Montague Ltd [1997] AC 191, [1996] 3 All
ER 365, BBF 384. (Note the SAAMCO case and others e.g. Nykredit
Mortgage Bank plc v. Edward Erdman Group Ltd [1997] 1 WLR 1627
arose from the property boom and crash of the early 1990s and there
may be similar issues in the cases which emerge from the credit
crunch and its fallout.)
- Misrepresentation Act 1967, s2(1); BBF 372, 377. There are
advantages for claimants in proceeding under the Act.
- Breach of collateral contract (collateral warranty). Esso Petroleum
Co Ltd v. Mardon.
- (not available for innocent misrep).
(b) Failure to disclose information
30
(i) Terms: Interfoto v. Stiletto [1998] 1 All ER 348 and see week 1’s lecture.
(ii) Facts: Contracts of utmost good faith/ uberimmae fidei e.g. insurance. In
practice this means that insurance contracts may be vulnerable to challenge
by insurers. Carter v Boehm (1766) 3 Burr. 1905
(c) Abuse of positions of trust
Duty of good faith owed to principal by agent/fiduciary. Goode p 177 onwards.
An example of a fiduciary relationship is business partners’ relationships to one
another (e.g. in law firms). It has recently been argued, unsuccessfully, that a
commercial banking relationship between an investment adviser and an allegedly
“unsophisticated investor” client gave rise to fiduciary duties: JPMorgan Chase v.
Springwell [2008] EWHC 1186 (Comm). (Fiduciary relations discussed at para. 572
onwards). (Appeal since dismissed by Court of Appeal).
(d) Misuse of confidential information
(i) Implied contract to use information only for authorised purposes.
(ii) Tort of disclosure or misuse of ‘confidential’ information.
(e) Misleading implied promises
(i) Collateral Contracts.
Walford v. Miles; Blackpool and Fylde Aero Club Ltd v. Blackpool Borough
Council [1990] 1 WLR 1195, [1990] 3 All ER 25, CA; BBF 244
(ii) Estoppel and restitution
Walton Stores (Interstate) Ltd v. Maher (1988) 164 CLR 387, High Ct. of
Australia;
BBF 158
Crabb v. Arun DC[1975] 3 All ER 865, CA; BBF 155
Hoffman v. Red Owl Stores Inc 26 Wis 2d 683, 133 NW 2d 267 (1965); BBF
281
Drennan v Star Paving Co 51 Cal 2d 409, 333 P 2d 757 (1958); BBF 249
British Steel Corp v. Cleveland Bridge & Engineering Co Ltd [1984] 1 All ER
504; BBF 39
31
Regalian Properties plc v. London Docklands Development Corp [1995] 1
WLR 212;
BBF 281
Do these ‘exceptions’ constitute a different principle?
If so, what is that principle?
4.
Traditionally the English courts are reluctant to recognise a duty to negotiate
in good faith. Why?
(a)
The courts are wary of over-broad principles not susceptible to clear and
concise application. Moreover, there is no consensus on what its content
would be or how to strike a balance between the interests of parties in
commercial negotiations.
(b)
The parties are free during negotiations to find the best deal the market has
to offer- i.e. this is part of the operation of the free market: “the legitimate
pursuit of self-interest” (Goode, p106)
(c)
Imposing obligations on parties before they voluntarily assume them is an
interference with liberty and freedom of contract.
(d)
Would the remedies in respect of this duty be impossible to assess? What, if
any, analogies may be drawn with other types of claims which are allowed
e.g. for loss of a chance? Would this additional means of redress add
anything to the existing remedies available?
5.
Contrast the position in English law with other legal systems.
A number of other legal systems have a requirement of good faith in negotiations,
including:
(a)
Principles of European Contract Law
Article 2.301- Negotiations Contrary to Good Faith
(1) A party is free to negotiate and is not liable for failure to reach an
agreement.
32
(2) However, a party who has negotiated or broken off contrary to
good faith is liable for the losses caused to the other party.
(3) It is contrary to good faith, in particular, for a party to enter into or
continue negotiations with no real intention of reaching an agreement
with the other party.
(b)
UNIDROIT
Article 2.1.15: Negotiations in bad faith
(1) A party is free to negotiate and is not liable for failure to reach an
agreement
(2) However, a party who negotiates or breaks off negotiations in bad
faith is liable for the losses caused to the other party.
(3) It is bad faith, in particular, for a party to enter into or continue
negotiations when intending not to reach an agreement with the other
party.
(c)
Civil law jurisdictions, e.g. Germany and other common law jurisdictions e.g.
US, Teachers Insurance and Annuity Association of America v Tribune
Company [1987] 670 F.Supp 491.
Are the situations covered by this requirement of good faith in these legal
systems resolved in a different way in this jurisdiction?
6.
What difference in practical results would the (open) adoption of a different
principle make in English law?
Would the recognition of a different underlying principle make any difference in
practice?
Would the adoption of such a general principle be too vague to be enforced?
How would it affect adversarial types of commercial relationship?
What other principles have been suggested in respect of this jurisdiction?
7.
Conclusion
33
JPMorgan Chase v. Springwell
[2008] EWHC 1186 (Comm) and Springwell
Navigation Corp v JPMorgan Chase and ors [2010] EWCA (Civ) 1221; Bankers
Trust International PLC v PT Dharmala Sakti Sejahtera [1995] HC, QBD Comm Ct.
In both cases investors sought to avoid liability and/or seek damages in relation to
investments which (in the first case) suffered heavy losses due to the Russian
financial crisis in 1998 and (in the second) had exposed the investor by way of a
swap to $65million losses because of a rise in interest rates. The cases are useful
to consider at the conclusion of this topic for two reasons. First, they show how
claimants in this jurisdiction deploy a wide range of the ‘exceptions’ discussed
above in order to attempt to make their case. For example, at first instance,
Springwell argued “breach of contract, negligence, breach of fiduciary duty,
negligent
mis-statement
and/or
misrepresentation
under
s.2
of
the
Misrepresentation Act 1967..” Secondly, these two cases offer interesting examples
of the courts’ approach to sophisticated investors in this position; in neither case
was the investor successful in its claims.
Questions for discussion in class.
Please prepare answers to the following questions, which your class tutors may use as the
basis for discussion in the class.
1.
The distinction has been made between legal relationships which are ‘essentially
adversarial’ and those which are ‘essentially cooperative’ (e.g. Goode,
p106).
Making reference to the cases discussed on the course so far, provide examples of
how each type of relationship may arise in practice and explain the implications for
pre-contract negotiations.
2.
X plc is a large UK-based manufacturing company. In each of the following
scenarios, advise X as to its obligations (if any) to its prospective counterparty.
(a) X is in negotiations with B, an insurance company. X’s
management is
concerned because its in-house weather forecasting unit has predicted a wet
summer, which is likely to hit sales of one of its core products, plastic garden
sunloungers. X is seeking insurance to cover this eventuality.
34
(b) X is in negotiations with C, the derivatives arm of a large investment bank. X
intends to protect its position as regards the possible wet summer by entering a
derivatives contract with C, where in return for a premium, C will pay X if certain
weather events occur.
(c) X is in negotiations with D, a company which supplies a range of materials to the
manufacturing industry. X and D have a long-term supply contract in place whereby
D supplies plastic pellets which X uses to make garden furniture (contract 1). X and
D are now 2 weeks into negotiating a separate, new contract for the supply of paint
by D (contract 2). Contract 1 was originally drafted by D’s City law firm and includes
a clause which states that X and D will use ‘best endeavours’ to agree to do more
business together in the future. It also states that if new negotiations do take place,
X will be banned from negotiating with D’s rivals for the first 3 weeks of any such
negotiations.
3.
The concept of a duty to carry on negotiations in good faith is inherently
repugnant to the adversarial position of the parties when involved in
negotiations. Each party to the negotiations is entitled to pursue his (or her)
own interest, so long as he avoids making representations.
Lord Ackner in Walford v Miles [1992] 2 A.C. 128, 138.
Why have the courts found that imposing a duty of good faith in this context would
be “repugnant”? Do you think that the general principle in Walford v Miles is due for
reconsideration?
35
Day 6 Sales Law HC 16/7
This part of the course studies problems arising in sales of goods between businesses. The
central problems arise from the buyer being dissatisfied with the product in some respect, usually
concerning its quality, and from the seller being concerned to receive payment.
1. Buyers’ Remedies
(a) Sale by Description.
In many sales of goods by reference to written documents, the seller provides a description of the
goods. This express term is legally binding like any other express term of the contract. But the
Sale of Goods Act 1979 s. 13 makes special provision about such terms.
*SGA s. 13 (1) Where there is a contract for the sale of goods by description, there is an implied
term that the goods will correspond with the description.
(1A) As regards England and Wales and Northern Ireland, the term implied by subsection (1)
above is a condition.
A sale of goods by description (under s.13) occurs where in the terms of the contract descriptive
words are used for the purpose of identifying or defining the goods and these terms are relied upon
by the buyer. The effect of the application of s.13 is that breach of a descriptive term of the
contract always triggers the buyer’s right to reject the goods (no matter how minor the breach) –
though that effect has now been modified by a new statutory provision SGA s.15A: BBF 594.
*Arcos Ltd v EA Ronaasen & Son [1933] AC 470; BBF: 428.
*Harlingdon & Leinster Enterprises Ltd v Christopher Hull Fine Art Ltd [1990] 1 All ER 737; BBF:
429.
Further reading: Goode: pp. 290-298.
(b) Implied Terms of Quality
(i) Common Law Principles
Collins 238-245.
M.G. Bridge, ‘The Evolution of Modern Sales Law’ [1991] Lloyds Maritime and Comparative LQ 52;
Peden, ‘Policy Concerns Behind Implication of Terms in Law’ (2001) 117 LQR 459.
(ii) Statutory Implied Terms
*Sale of Goods Act 1979, s.14 (as amended). BBF 427
s.14(2) ‘satisfactory quality’ and
s. 14(3) ‘fitness for buyer’s purpose’.
Sale of Goods Act 1979 s.14
(1) Except as provided by this section and section 15 below and subject to any other
enactment, there is no implied term about the quality or fitness for any particular purpose of
goods supplied under a contract of sale.
(2) Where the seller sells goods in the course of a business, there is an implied term
that the goods supplied under the contract are of satisfactory quality.
(2A) For the purposes of this Act, goods are of satisfactory quality if they meet the standard
that a reasonable person would regard as satisfactory, taking account of any description of the
goods, the price (if relevant) and all the other relevant circumstances.
(2B) For the purposes of this Act, the quality of the goods includes their state and condition and
the following (among others) are in appropriate cases aspects of the quality of the goods (a) fitness for all purposes for which goods of the kind in question are commonly supplied,
36
(b) appearance and finish,
(c) freedom from minor defects,
(d) safety, and
(e) durability.
2(C) The term implied by subsection (2) above does not extend to any matter making the
quality of goods unsatisfactory(a) which is specifically drawn to the buyer’s attention before the contract is made,
(b) where the buyer examines the goods before the contract is made, which that examination
ought to reveal, or
(c) in the case of a contract for sale by sample, which would have been apparent on a
reasonable examination of the sample.
(3) Where …the buyer, expressly or by implication, makes known…to the seller…any particular
purpose for which the goods are being bought, there is an implied condition that the goods
supplied under the contract are reasonably fit for that purpose…except where the
circumstances show that the buyer does not rely, or that it is unreasonable for him to rely, on
the skill or judgment of the seller.
(6)…the terms implied by subsections (2) and (3) are conditions.
*Slater v. Finning [1996] 3 All ER 398 [1997] AC 473, HL.
Goode, pp. 298- 323.
3 Exclusion Clauses
The SGA 1979 provides that in principle the parties can agree to exclude the statutory implied
terms, and the general principle of freedom of contract permits exclusion or limitation of liabilities
arising under other express terms. But these principles are all now subject to Unfair Contract
Terms Act 1977, ss. 6, 11, 12, Sched 2; BBF: 982, 983, 997, which in effect requires in a
commercial contract the exclusion clause to be ‘fair and reasonable’. E.g. George Mitchell
(Chesterhall) Ltd v Finney Lock Seeds Ltd [1983] 2 AC 803, [1983] 2 All ER 737, HL: BBF: 1000
4. Remedies for Breach of Quality Standards.
If the seller is in breach of the contract of sale by having supplied sub-standard goods, what
remedies are available to the buyer? Should the buyer be always entitled to 'reject' the goods, or
is that unfair to the seller in some (most?) instances? Should the parties to the contract be entitled
to determine the nature of the buyer's remedy for breach by the express terms of the contract? If
the buyer claims damages instead, how should the damages be calculated? In a commercial
context, should the damages always include 'loss of profits', or should some losses of this kind be
regarded as too remote? What is the purpose of the doctrine of 'remoteness in the law of
damages'? Do the legal sanctions for breach of contract in this context provide adequate
incentives for the seller to conform to the expected quality standard?
(a) General Common Law of Breach Permitting Termination
Chen-Wishart, Chapter 13
*Hong Kong Fir Shipping Co Ltd v Kawasaki Kisen Kaisha Ltd [1962] 2 QB 26, [1962] 1 All ER 474,
CA; BBF 563.
*Bunge Corp v Tradax Export SA [1981] 2 All ER 513, HL. BBF: 571
Schuler AG v Wickman Machine Tools [1974] AC 235, [1973] 2 All ER 39, HL. BBF: 409, 595.
Under the general law of contract, a party may only terminate a contract for a serious breach of
contract, sometimes called a fundamental breach or a repudiatory breach.
37
The general test for whether or not a breach is serious looks at the effects of the breach on the
injured party. The question is ‘does the occurrence of the event deprive the party who has further
undertakings still to perform of substantially the whole benefit which was the intention of the parties
as expressed in the contract that he should obtain as the consideration for performing those
undertakings?’ (Lord Diplock: Hong Kong Fir v KKK).
In their contract, however, the parties may specify that breach of a particular term should entitle the
other party to terminate the contract.
Certain phrases have conventionally been regarded as indicating that breach of a term amounts to
a fundamental breach eg ‘time of the essence’; ‘condition’. time clauses for delivery of goods in
Bunge v. Tradax, even though the breach may cause no loss whatsoever.
Should the courts always respect such terms? In Schuler v Wykman Tools the court treats breach
of a term labelled as a ‘condition’ as not giving a right to terminate. Does this destroy the one
possible beneficial use of the distinction between conditions and warranties (ie the saving of
transaction costs)?
(b) Rejection, and Conditions and Warranties under the Sale of Goods Act.
A buyer who terminates a contract for the seller’s breach is usually described as having ‘rejected’
the goods. The right to reject the goods arises normally either for breach of s.13 implied term (lack
of conformity with express terms of description) or s.14 implied terms. These implied terms are
described as ‘conditions’ and under the statutory scheme, breach of condition gives rise to the right
to rejection.
This statutory scheme sometimes creates the problem that the buyer rejects for breach of
condition when the effects of breach are not especially significant. Compare:
Arcos Ltd v EA Ronaasen & Son [1933] AC 470; BBF: 428.
*Cehave NV v Bremer Handelsgesellschaft mbH, The Hansa Nord [1975] 3 All ER 739, CA BBF:
566
* SGA 1979 s.15A: BBF 594. This provision states that a breach of condition under ss.13 and 14
will not be regarded as giving the right to reject the goods if ‘the breach is so slight that it would be
unreasonable’ for the buyer to reject.
But the buyer does not have to reject the good for breach of condition. Under the Sale of Goods
Act 1979 s. 11(2); BBF 560, the buyer may ‘elect to treat the breach of the condition as a breach of
warranty and not as a ground for treating the contract as repudiated.’
The buyer loses the right to reject the goods (but retains any right to compensation) by
‘acceptance’ of the goods. What amounts to acceptance? Sale of Goods Act ss. 34, 35, 35A;
BBF: 614
There are two main remedies envisaged by the Act for the buyer:
(1) reject the goods (in effect termination for serious breach), or
(2) accept the goods though claim damages for the poor quality/non-conformity.
(It is also sometimes possible to obtain specific performance of specific, ascertained, and ‘unique’
goods).
Under the Act the remedy of rejection is available if (and only if)
(1) the breach of contract is a breach of ‘condition’ (not a breach of ‘warranty’); and
(2) the goods have not been ‘accepted’.
(the buyer can always treat a breach of ‘condition’ as a breach of warranty by accepting the goods
and claiming compensatory damages instead SGA s.11).
The Sale of Goods Act specifies that the implied terms of conformity (s13), satisfactory quality and
fitness for notified purpose are ‘conditions’ (s.14(6)).
The courts traditionally interpreted the express terms of contracts of sale also within this
framework, so that some express terms are regarded as ‘conditions’, others as (mere) ‘warranties’.
This dual system of classification of terms seems to break down in the cases. Why does it break
down? Why is it necessary to create ‘intermediate terms’, where the effect of breach determines
whether or not there is a right to reject?
38
In the Hansa Nord the court plainly wants to deny a right of rejection (thus it has to find no breach
of warranty of merchantable/satisfactory condition), yet wants to award damages for breach of
quality. How is this result achieved?
Is the purpose of the distinction between conditions and warranties to determine when it is
reasonable to confine the buyer to a remedy in damages for breach of the quality standard in the
contract? By what criteria should we determine the reasonableness of the limitation on the remedy
available to the buyer. Should this depend on what the parties say in the contract? Should this
depend upon the effects of the breach on the buyer? What effect does the following reform have?
SGA s.15A (1) Where in the case of a contract of sale(a) the buyer would, apart from this subsection, have the right to reject goods by reason of
a breach on the part of the seller of a term implied by section 13, 14 or 15 above, but
(b) the breach is so slight that it would be unreasonable for him to reject them,
then, if the buyer does not deal as consumer, the breach is not to be treated as a breach of
condition but may be treated as a breach of warranty.
(a) Rejection and Acceptance
Rejection is special terminology in the sale of goods for termination of a contract by the buyer for
breach of contract. It is potentially a powerful, self-help remedy; the buyer does not have to return
the goods (s.36).
SGA s.35 (1) The buyer is deemed to have accepted the goods subject to subsection (2) below (a) when he intimates to the seller that he has accepted them, or
(b) when the goods have been delivered to him and he does any act in relation to them
which is inconsistent with the ownership of the seller.
(2)Where the goods are delivered to the buyer, and he has not previously examined them, he
is not deemed to have accepted them under subsection (1) above until he has had a
reasonable opportunity of examining them for the purpose(a) of ascertaining whether they are in conformity with the contract…
The right to reject the goods is typically lost by (a) doing something inconsistent with the
ownership of the seller (eg eating them, using them, selling them), or (b) lapse of reasonable
time. Asking for ‘repair of goods’ or reselling the goods, however, are not necessarily regarded
as ‘acceptance’ (s.35(6)). It is possible to accept the part of the goods which reach the quality
standard and reject the remainder, but all the satisfactory goods are then deemed to have been
accepted (s. 35A).
SGA s.30(1) Where the seller delivers to the buyer a quantity of goods less than he
contract to sell, the buyer may reject them, but if the buyer accepts the goods so delivered
he must pay for them at the contract rate.
(2A) A buyer who does not deal as consumer may not - (a) where the seller delivers a
quantity of goods less than he contracted to sell, reject the goods under subsection (1)
above …if the shortfall …is so slight that it would be unreasonable for him to do so.
(c) Damages
The buyer can claim damages for breach of the express or implied terms of the contract (in
addition to any rejection of the goods in some cases). What is the measure of compensation?
Sale of Goods Act 1979 s. 53.
*Slater v Hoyle & Smith Ltd [1920] 2 KB 11, CA. BBF 654
*Bence Graphics International Ltd v Fassson UK Ltd [1997] 1 All ER 979, CA, BBF 657.: restriction
on recovery for difference in value if no actual loss due to successful resales.
Lazenby Garages Ltd v Wright: lost throughput leading to lost profits.
What is the purpose/policy behind such restrictions on recovery? Are the restrictions about (a)
fairness between the parties? (b) protection of the practice of making contracts from deterrent
levels of damages? (c) incentives to disclose information? (d) incentives to take out insurance (e)
who should have taken out insurance (because this party could have done it at the least cost) (f)
risk allocation?
39
What measure of compensation for breach of contract did the contracting parties ask for and
expect in the Beale and Dugdale study? Why did they ask for so little (do you think)?
Does the law provide sufficient incentives to perform contracts and conform to quality standards in
sales? Is the law in fact aimed at encouraging efficient breach of quality standards?
2. Seller’s remedies
(a) Action for Price
SGA 1979 s. 49 BBF: 725.
(b) Action for Damages
Lazenby Garages Ltd v Wright [1976] 2 All ER 770, CA; BBF: 661
(c) Retention of Title
Under this quasi-security scheme, the seller parts with possession, but continues to assert legal
title of the goods until paid in full under express terms of the contract. The retention of legal title is
not a registrable charge, though it is likely to be regarded as such if it purports to retain or obtain a
proprietary interest in either (a) products made from the seller’s goods; or (b) the financial
proceeds of sub-sales by the buyers to third parties.
SGA s.19(1) Where there is a contract for the sale of specific goods…the seller may, by the terms
of the contract…, reserve the right of disposal of the goods until certain conditions are fulfilled; and
in such a case…the property I the goods does not pass to the buyer until the conditions imposed
by the seller are fulfilled.
For further discussion, see credit and security below.
Questions for Class Discussion
1. Ardos Ltd, a chain of garden shops, orders ‘five thousand, 2 metre by 20 centimetre
treated wooded fence posts’ from Hills Ltd at a cost of £2 per post. Ardos has placed many
orders with Hills before. In its shops, Ardos sells the posts together with metal cases that fit
in the ground. Hills acknowledges the order by post, including its standard form contract
that contains its usual terms: (a) all goods supplied comply with usual industry standards;
and (b) the supplier does not accept liability for consequential loss. Following delivery of the
posts, customers of Ardos begin to complain that the posts do not fit into the metal cases
easily. An investigation reveals that the posts are O.5 centimetre larger than 20. Hills
explain that the slightly larger posts comply with the new industry approved standards. The
posts can still be used with the metal cases after some trimming, but Ardos feels compelled
to permit customers to return the posts if they complain and to offer them a £10 token to
spend in their shops to compensate them for their inconvenience.
Advise Ardos, which wishes to return the remaining four thousand posts in its shops and to
claim £500 for the cost of the tokens given to customers.
2. Softees Ltd, a company that designs and installs software for businesses, enters a contract
with the London School of Ergonomics (LSE, a private college) to supply and install
software designed to handle the records for the admission process of the students in return
for a payment of £50,000. The software does not operate satisfactorily, so that as a result
many applicants only receive offers of admission in the Autumn, by which time they have
accepted a place at a rival college, Queens, and other applicants received rejections, when
they should have received offers, and go to Queens instead. As a result the number of
students admitted is reduced by half, with a commensurate reduction in fee income.
LSE wants to (a) claim their whole payment to Softees Ltd of £50,000 back; and (b) claim
damages for breach of contract. The fee income has declined by £250,000 from the
previous year.
40
Day 7 Exclusion Clauses and Agreed Remedies SR 17/7
Introduction
General Question. To what extent are the parties to a commercial contract free to select their
remedies for breach of contract? The short answer is that the parties generally have freedom of
contract. As ever, we concentrate on the scope of the exceptions.
Policy issues. On the one hand, freedom of contract has the advantage that the parties can plan
carefully in advance the consequences of any breach, take those potential costs into account when
pricing the deal, and bargain to protect any particular interests that they might have in relation to
the transaction. On the other hand, a remedy provided in a contract might prove to be either
oppressive in the sense that it effectively compels one party to perform a contract unwillingly or
unfair in the sense that the remedy provides protection that far exceeds any losses to the injured
party.
Scope of Question. There are a host of ways in which the parties can provide for remedies for
breach of contract, e.g.:
Security rights to ensure payment (considered elsewhere in this course)
Termination clauses
Exclusion of liability clauses
Limitation of damages clauses
Indemnity clauses
Guarantees.
We consider here some of these types of terms in contracts, with a special focus on those where it
is possible to challenge the validity or effectiveness of the clause.
Chen-Wishart Chapter 15.3 and Chapter 12 infra.
1.
Liquidated damages clauses: an agreement that in the event of breach of contract a
fixed sum (or a sum calculable by reference to fixed criteria) will be payable
These terms serve useful purposes: reduce uncertainties about the appropriate level of
compensation, offer the quick procedure of claims for an agreed sum, determine the scale of the
risk in advance, enable insurance arrangements or other kinds of guarantees/indemnities to be
comprehensive, avoid difficulties in proving speculative losses, and reduce delays in payment, and
encourage settlements.
But the courts have required liquidated damages clauses to specify a level of compensation which
is genuine pre-estimate of the loss, and if it is more, it will be dubbed a ‘penalty’ and be
unenforceable (though ordinary damages for breach of contract may still be claimed).
Unclear distinction between price terms and liquidated damages clauses: eg Interfoto v Stiletto, but
to be a penalty clause the payment must be triggered by breach of contract.
A fixed amount of damages may still be enforceable even if with hindsight it exceeds actual loss,
provided that at the time of formation of contract the fixed amount was the expected likely loss or at
least an average of expected likely losses: Dunlop v New Garage.
Many writers trained in economic analysis have questioned whether the courts should invalidate
penalty clauses. One argument (eg Rea) is that the price paid reflects the advantage obtained from
a penalty clause, so that by disallowing a penalty clause, the court upsets the balance of fairness
in the contract.
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*Dunlop Tyre v. New Garage [1915] AC 79 BBF 689
Lombard North Central plc v. Butterworth [1987] QB 527, CA BBF 605
Rea, ‘Efficiency Implication of Penalties and Liquidated Damages’ (1984) 13 Journal of
Legal Studies 147; BBF 696
Beale and Dugdale, ‘Contracts between Businessmen’ (1975) 2 British Journal of Law &
Society 45; BBF 223
H. Collins, ‘Fairness in Agreed Remedies’, in C. Willett, Aspects of Fairness in Contract
(London, Blackstone, 1996), ch.5
Compare the position in a civil law jurisdiction: O. Lando & H. Beale, Principles of
European Contract Law (London, 2000), 453
2.
Termination clauses
The general principles governing the right to terminate a contract for breach of contract are
considered in: Hong Kong Fir Shipping Co Ltd v Kawasaki Kisen Kaishs Ltd [1962] 2 QB 26, CA
(BBF 498); Cehave NV v Bremer Handelsgesellschaft mbH (The Hansa Nord) [1975] 3 All ER 739
(BBF 501). Under these principles, the courts are reluctant to permit termination for breaches that
have no or few adverse effects on the injured party, but nevertheless they recognise that by
convention and agreement even apparently trivial breaches can justify termination of a contract. In
other words, whether or not a particular breach should entitle one party to terminate the contract
depends ultimately on how the court interprets the contract and the significance it attaches to
breach of particular terms.
The language of condition and warranty is often used by the parties to signal that breach of a
particular term (a condition) will entitle the other party to terminate the contract. But this legal
convention is not always accepted by the courts: Schuler (L) AG v. Wickman Machine Tool Sales
Ltd [1973] 2 All ER 39, HL (BBF 527). The phrase that ‘time is of the essence’ is treated as a
special signal that lateness gives the right to terminate. In general in commercial contracts, where
the contract specifies a particular time for performance, a court will almost certainly treat this as a
condition.
But the parties can express the right to terminate in straightforward terms eg breach of clause X
will entitle the other party to terminate the contract, and provided that the term is clear, it will be
enforced by the courts. If there has been no breach of the relevant term yet a party purports to
terminate the contract for this reason, a court will regard this termination as a repudiatory breach of
contract itself. See Woodar Investment Development Ltd v Wimpey Construction (UK) Ltd [1980] 1
All ER 571, HL (BBF 585)
3.
Deposits: a fixed sum of money, payable in advance, which is forfeited by breach of
contract by the depositor
An earnest of future performance in the form of a sum of money which will be forfeited on breach is
a deposit. Deposits are excluded from the rule against penalties and are in general enforceable:
Union Eagle v Golden Achievements.
However, deposits can be challenged for being excessive. The test seems to be whether the
deposit is reasonable, which in turn depends upon the customs of the trade: Workers Trust v
Dojap. An unreasonable deposit has to be returned in full, though (presumably) ordinary damages
for breach of contract may still be claimed.
4.
Forfeiture of proprietary rights: the loss of a right to use property, either tangible (eg
land, goods) or intangible (e.g. a license to use a trade name)
There is an equitable jurisdiction to give relief from forfeiture of a proprietary interest. Its main
application is in relation to leases of real property; a court can defer repossession of property, thus
providing a tenant with more time to pay the rent, if the court believes that the tenant can come up
with the money soon.
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The question here is whether this equitable jurisdiction to defer repossession might apply to
commercial transactions in such a way as to prevent repossession of personal property (e.g. a ship
under time-charter: Scandanavian Trading Tanker v Flota Petrolera, The Scaptrade [1983] 2 AC
694, HL) or a licence to use intellectual property (eg a trade name: Sport International Bussum v.
Inter-Footwear Ltd [1984] 1 WLR 776, HL; and patent rights: BICC plc v. Burndy Corp [1985] Ch
232, CA).
The principles emerging from these cases may be that relief from forfeiture can only be given (1)
for rights conferring a proprietary interest, and (2) where that proprietary interest is added to the
contract by way of security for performance, and (3) where time is not of the essence for
performance.
Collins argues that the real issue should be whether the debtor has a significant commercial
interest in retaining possession and whether the forfeiture clause was merely a security against
payment (and time of payment is not of the essence).
On Demand Information plc v. Michael Gerson (Finance) plc [2002] UKHL 13
Smith, ‘Relief Against Forfeiture: A Restatement’ [2001] Camb LJ 178
If property is forfeited under a forfeiture clause, there is a risk of over-compensation for breach of
contract. The risk of over-compensation may be put forward as either:
(a) a defence: a court may refuse specific performance of the forfeiture clause in such
circumstances, though it will order full compensation to be paid, eg BICC v Burndy. See
also Lombard v Butterworth where the commercial lease provided for forfeiture of goods
and full payment of rent, and the court found the payment of rent to be a penalty clause.
(b) a claim for unjust enrichment: In Stockloser v Johnson a sale of machinery provided for
payment by instalments (ie credit arrangement). On default, the contract provided for
recovery of the machinery and retention of part payments. The majority (Denning) held that
if the retention of all the part payments led to unjust enrichment a claim for recovery of
some of them would be permitted. Romer LJ dissented – no interference with freedom of
contract.
5.
Performance Bonds
Cargill International SA v. Bangladesh Sugar and Food Industries Corp [1998] 2 All ER 406, CA
Solo Industries UK Ltd v Canara Bank [2001] 1 WLR 1800, CA
6. Exclusion Clauses
Collins, 256-264
*Unfair Contract Terms Act 1997; BBF 1004-13
*George Mitchell (Chesterhall) Ltd. v. Finney Lock Seeds Ltd. [1983] 2 AC 803, [1983] 2 All
ER 737, HL; BBF 1014
UCTA: Confined to exclusion clauses: s.13; not unfair terms generally. But extended concept of
exclusion: s.3: applies to express terms that apparently entitle one party to render performance
substantially different from that which was reasonably expected, or no performance at all with
respect to part or all of the his obligations. Question in Paragon Finance was: is power to vary
interest rate at bank’s discretion within s.3? No –because the term does not affect the bank’s
performance obligations, only those of the borrowers.
Includes contracts between businesses, but special rules for contracts where one party ‘deals as a
consumer’.
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Declares some exclusion clauses invalid, (eg. 2.(1) negligence liability for personal injury) but for
others grants a judicial discretion to determine whether a term is `fair and reasonable’.
S.11(1) `the term shall have been a fair and reasonable one to be included having regard to the
circumstances which were, or ought reasonably to have been, known to or in the contemplation of
the parties when the contract was made.’
Questions for Class Discussion
1.
Is the equitable control over ‘penalty clauses’ justifiable and consistent with other aspects of
judicial control over remedies agreed in the express terms of the contract?
2.
Peter a government minister, wants a large dome shaped building completed by 31st
January at 12 noon for a great public event on New Years Eve 1999/2000. Peter insists in
the specification for tenders that the works be completed on time and that there should be a
25% reduction of the price if the dome is not completed on time. Bob the builder bids
successfully for the job (£100 m). The building is completed one day late, and as a
consequence Peter suffers a nose dive in popularity ratings, threatening his chances of
being re-elected and leading to his sacking by the Prime Minister. Peter and the
government refuse to pay Bob more than £75m.
Advise Bob on his claim for £25 m.
3.
Under what conditions will a court provide relief from forfeiture of a proprietary interest
resulting from breach of a commercial contract?
4.
Explain why UCTA 1977 was inapplicable to the case of Paragon Finance plc v Nash
[2001] EWCA Civ, [2002] 1 WLR 685, CA.
5.
Was the disputed term in Interfoto Picture Library Ltd v Stilletto Visual Programmes Ltd
[1988] 1 All ER 348 (BBF 336) (see Week 2) a penalty clause? If so, and also if the term
had been incorporated into the contract, what would have been the outcome of the case?
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Day 8 Multi-Party Projects and Networks HC 18/7
Multi-party transactions, where there are chains or networks of contracts, create additional
complications. This session examines these, using the principal model of a construction project, in
which an owner or employer seeks to have work done using a main contractor, sub-contractors,
architects and other professionals.
Chen-Wishart, Chapter 16
1. Contractual Networks, Privity of Contract and Third Parties
The first part of this session will examine the limitations on the effectiveness of the contractual
arrangements between the parties, as a way of regulating the whole project. The doctrine of privity
of contract generally prevents contracting parties from either conferring rights or imposing burdens
on third parties to the contract. In the context of construction projects, this means, inter alia, that
parties who are working together on a project, such as two sub-contractors with no contract
between them, have no contractual rights or obligations towards each other. The session will
explore the general doctrine of the privity of contract; the range of actual/apparent ‘exceptions’ to
the doctrine: the legal mechanisms available to parties and/or the courts to ‘get around’ the limits
which the doctrine prima facie entails; and the basis and significance of the recent legislative
reform of the doctrine: the Contract (Rights of Third Parties) Act 1999.
(a) The general doctrine of privity of contract
*Scruttons Ltd v Midland Silicones Ltd [1962] AC 446 (HL) (BBF: 1154-1157)
Beswick v Beswick [1968] AC 58 (BBF: 1139-1142).
For the purpose of considering the legal rights and obligations of parties to a construction project, it is useful
to have the following schematic diagram in mind:
O
X1
M
X2
A
S
SS
In this diagram O is the owner/employer, who wants the building; M is the main contractor; S is the
subcontractor; SS is a sub-subcontractor; A is the architect/surveyor/engineer, employed by O to supervise
the work. The lines represent the normal contractual relations. X1 and X2 are exclusion or limitation clauses
that purport to restrict liability.
Doctrine of Privity of Contract: General Principle
Under the general doctrine of privity of contract, a person who is not a party to a contract cannot acquire
rights or be subject to obligations under the contract, and this is true even if the contract expressly or
impliedly says the opposite. This principle, though dubious in origin, was affirmed in Scruttons v Midland
Silicone so that it meant (in the above terminology) that S (the stevedores) could not obtain rights (ie X1)
contained in the 0-M contract (the bill of lading), and nor could O (the owner of the goods) have obligations
(X2, the limitation of the right to sue S) imposed by the M-O contract.
There are, however, lots of exceptions and qualifications to this principle, not least the possibilities of suing in
tort for negligence (which does not require the plaintiff and defendant to be parties to a contract, but does
require, of course, a duty of care). The Scruttons case was an example of a tort claim designed to overcome
the absence of a direct contractual claim.
The general principle was also affirmed in Beswick v Beswick (though a route around was found).
Agency.
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Not an exception to privity, since principal becomes a party to the contract, but a practical way around the
problem in some cases: M can contract both in his own right and as agent for S, thus in effect creating an OS contract, as in The Eurymedon. Why did this approach not apply in Scruttons?
An agent can make contracts on behalf of a principal within the scope of his (express and implied) authority;
but also an agent with ostensible or apparent authority to make a contract will also bind the principal, though
the principal will then have a claim against the agent for exceeding (express or implied) authority: Waugh v
Clifford.
Assignment
General principle that contractual rights (but not duties) can be assigned to a third party, who can then
enforce those rights as if he were the original contracting party – eg assignment of debts. That principle can
be excluded by a non-assignment clause in the original contract. The assignee of a contractual right takes
subject to ‘existing equities’, which means in general that the assignee should be in no stronger position than
the original contractual right-holder.
Burden in Networks
The problem here is whether in some circumstances the contract between M-S might limit the claims of O
against S. Scruttons says no, as a general principle, but Morris v Martin and the Pioneer Container say
there may be exception(s). How big is the exception?
It certainly applies in bailment (Pioneer): the terms on which the sub-bailee accepts the goods bind the
owner of the goods (bailor), if the bailor consented to the sub-bailment and the terms are such that the the
bailor has expressly or impliedly consented to them.
Why did this exception not apply in Scruttons?
Burdens can arise as incidents of ownership (ie third parties have rights in the property eg security rights).
Statutory reform:
Contract (Rights of Third Parties) Act 1999
s.1(1) Subject to the provisions of this Act, a person who is not a party to a contract (a “third party”) may in
his own right enforce a terms of the contract if (a) the contract expressly provides that he may, or
(b) subject to subsection (2), the term purports to confer a benefit on him.
(1) Subsection (1)(b) does not apply if on a proper construction of the contract it appears that the parties did
not intend the term to be enforceable by a third party.
(2) The third party must be expressly identified in the contract by name, as a member of a class or as
answering a particular description but need not be in existence when the contract is entered into.
Does the statutory reform change the result in: Beswick v Beswick; Scruttons v Midland Silicones ?
Examples of discussion of the statutory reform:
Nisshin Shipping Co Ltd v Cleaves & Co Ltd [2003] EWHC 2602, [2004] 1 Lloyd’s Rep 38
Laemthong International Lines Co Ltd v Artis, The Laemthong Glory (No 2) [2005] EWCA Civ 519
(CA)
Further reading:
Law Commission, Privity of Contract: Contracts for the Benefit of Third Parties (Report No 242
(1996)), esp pp 74-94 (http://www.lawcom.gov.uk/docs/lc242.pdf)
Stevens, ‘The Contract (Rights of Third Parties) Act 1999’ (2004) 120 LQR 292
Burrows, ‘Contracts (Rights of Third Parties) Act and its Implications for Commercial Contracts’
[2000] LMCLQ 540
2.
Tort Liability for Pure Economic Loss
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In the absence of direct contractual relations, the legal framework for the allocation of risks
between parties to multi-party transactions, such as construction projects, is provided by the law of
tort. The second part of this session therefore explores the incidence of liability in the tort of
negligence for property damage and pure economic loss. It is trite that courts are very willing to
allow recovery for the former, and relatively unwilling to allow recovery for the latter. What
constitutes ‘pure economic loss’? When have courts proved willing to allow recovery for such loss?
Do the cases in which recovery has been granted or denied fit any coherent pattern?
Lunney & Oliphant, Tort Law Text and Materials (3rd edn, 2007), chap 8
Deakin, Johnston & Markesinis, Tort Law (6th edn, 2008), pp 157-199
Boundaries of liability: central authorities
Spartan Steel and Alloys Ltd v Martin & Co (Contractors) Ltd [1973] QB 27 (CA)
Leigh and Sillivan Ltd v The Aliakmon Shipping Co Ltd, The Aliakmon [1986] AC 785 (HL)
Junior Books Ltd v The Veitchi Co [1983] 1 AC 520 (HL)
Greater Nottingham Co-op Society Ltd v Cementation Piling & Foundations Ltd [1989] QB 71 (CA)
D&F Estates Ltd v Church Commissioners [1989] AC 177 (HL)
Murphy v Brentwood District Council [1991] AC 398 (HL)
Hedley Byrne & Co Ltd v Heller & Partners Ltd [1964] AC 465 (HL)
Caparo Industries v Dickman [1990] 2 AC 605 (HL)
Henderson v Merrett Syndicates Ltd [1995] 2 AC 145 (HL)
White v Jones [1995] 2 AC 207 (HL)
Williams v Natural Life Health Foods Ltd [1998] 1 WLR 830 (HL)
Customs & Excise Commissioners v Barclays Bank plc [2006] 3 WLR 1 (HL)
Liability for Pure Economic Loss In Negligence
1. Why consider tort in a course on commercial contracts?
(a) Remember that the presence of a contract between claimant and defendant does not (ever?)
prevent a simultaneous claim in tort. Usually, however, there is no advantage to an additional
claim in tort because the result will be the same or worse for the claimant.
(b) It is also possible to make a claim against a defendant with whom the claimant does not have a
contract.
2. What is Pure Economic Loss?
(a) As a general rule, it is only possible to recover compensation in the tort of negligence for loss
due to personal injuries and damage to property. This loss includes economic loss (eg loss of
income) but it is consequent on the personal injury or the damage to property of the claimant.
(b) Pure economic loss is economic loss which occurs independently without being consequent
upon property damage or personal injury: eg. Hedley Byrne v Heller; Caparo Industries v
Dickman; White v Jones.
(c) It is not easy always, especially in cases involving construction disputes, to distinguish
between pure economic loss and economic loss consequent on damage to property belonging
to the claimant. Some loss was pure economic loss and some consequent on property
damage in Spartan Steel v Martin, and D&F Estates v Church Commissioners. Can you
explain how the distinction is drawn in those cases?
(d) And now for the test question: was the claim for pure economic loss in Junior Books v Veitchi?
3. Negligent Performance of Contracts
(a) Many, but not all, claims for pure economic loss are based upon an allegation of a negligent
performance of a contract: eg.
White v Jones: negligent performance of contract to draw up a will
Henderson v Merrett Syndicates: negligence performance of contract to give investment advice
Junior Books v Veitchi: negligent performance of contract to build a floor
Caparo v. Dickman: negligent performance of contract to audit a company
47
(b) But the claim is brought not by the other party to the contract, but a third party who has
suffered pure economic loss as a result of the negligence.
(c) If such claims were permitted, therefore, the doctrine of privity would have a major exception.
4. Policy Reasons for Rule Against Recovery for Pure Economic Loss
(a) Many reasons are put forward for the rule. Evaluate these reasons and consider whether in
particular they apply in the construction context.
(1) Indeterminate (unpredictable) amount of Liability
(2) Indeterminate (unpredictable) Number of Plaintiffs
(3) Upset the contractual allocation of risks.
(4) Provide an incentive to enter into direct contracts for the allocation of risks.
(5) Some losses are uninsurable (ie one cannot obtain insurance at any feasible cost).
(b) Do these reasons explain why there is a clear exception to the rule prohibiting recovery for pure
economic loss in cases involving negligent misstatements eg. Hedley Byrne v Heller; Caparo v
Dickman (notice here the careful use of proximity/assumption of responsibility criterion for duty of
care in order to deal with policy considerations in (a)(1)(2).)
Further reading
Stapleton, ‘Duty of Care and Economic Loss: A Wider Agenda’ (1991) 107 LQR 249
Stapleton, ‘Duty of Care: Peripheral Parties and Alternative Opportunities for Deterrence’ (1995)
111 LQR 301
Barker, ‘Unreliable Assumptions in the Modern Law of Negligence’ (1993) 109 LQR 461
O’Sullivan, ‘Suing in tort where no contractual claim will lie – a bird’s eye view’ (2007) 23 PN 165
Markesinis, ‘An Expanding Tort Law - The Price of a Rigid Contract Law’ (1987) 103 LQR 354
Cane, ‘Economic Loss in Tort: Is the Pendulum Out of Control?’ (1989) 52 MLR 200
3.
Risk Allocation in Multi-Party Transactions
The third and final part of this session considers the question risk allocation in multi-party
transactions. Perhaps the most difficult question, on which most attention will be focused, is the
relationship between the contractual arrangements for allocating risks of property damage and
pure economic loss, and the rules of negligence liability in tort. To what extent does, or should, the
allocation of risks reflected in the surrounding chain or network of contracts affect the tort liabilities
that participants may incur?
(a) The range of application of the contractual allocation of risk
Norwich City Council v Harvey [1989] 1 WLR 828 (CA)
Marc Rich & Co AG v Bishop Rock Marine Ltd, The Nicholas H [1996] AC 211 (HL)
Smith v Eric S Bush [1990] 1 AC 831 (HL)
Junior Books Co Ltd v Veitchi [1983] 1 AC 520 (HL)
1. Risk
(a) One of the important purposes of commercial contracts is to allocate risks in advance: the
planning function. The Beale and Dugdale study casts some doubt, however, on how
extensive such planning is in many commercial contracts. In major construction contracts,
however, there does seem to be a considerable degree of planning.
(b) Risk allocation affects the price charged for a service, and also whether and to what extent
insurance is taken out.
(c) Insurance arrangements are efficient when the person in the best position to be able to
estimate the probable loss takes out the insurance (eg owners of goods, owners of factories).
(d) But it may also be efficient to impose some liability on negligent performers of contracts in
order to deter that negligence; hence limitations rather than exclusions of liability may be
preferred.
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(e) For these reasons we should expect that parties to commercial contracts should be bound by
their agreed limitations of liability and that the courts would only rarely exercise their power
under UCTA s.3 to declare such exclusions/limitations in standard form contracts to be
unreasonable and unfair.
2. Exclusions and Third Parties
(a) Under the doctrine of privity of contract we have seen that 3rd parties cannot in principle take
the benefit of an exclusion clause in a contract to which they are not a party, nor have their
claims restricted in similar circumstances: Scruttons.
O
X1
M
X2
A
S
SS
In this diagram O is the owner/employer, who wants the building; M is the main contractor; S is the
subcontractor; SS is a sub-subcontractor; A is the architect/surveyor/engineer, employed by O to
supervise the work. The lines represent the normal contractual relations. X1 and X2 are exclusion
or limitation clauses that purport to restrict liability. Under the doctrine of privity, if O wants to sue
S for negligence, O’s claim cannot be restricted by either X1 or X2.
(b) Consider the implications of this rule for Junior Books. Let us assume that the contracts
contained X1 and X2 arrangements (which I believe they did). The effect of allowing O to sue
S successfully in tort in that case was to undermine the contractual allocation of risk. In
particular S would have priced the job according to the potential for liability, and would have
insured accordingly; those arrangements are undermined by the decision.
(c) How was this result avoided in Norwich City Council v Harvey, where O sues S? Why is there
not liability in tort for damage to property? Does the case abolish the doctrine of privity or
some aspect of it (surely not)?
(d) The Nicholas H raises the same problem in a different context: the owner O of the goods on
the ship has agreed with the carrier M to a limitation of liability clause; O sues S, the
certificator of seaworthiness, employed by M. The HofL denies liability of S to O, even though
this is clearly a damage to property case. This is very similar to the London Drugs case.
(e) Smith v Bush is slightly different in that although O sues S, and S relies upon an X2, S and M
had given notice to O of their disclaimer of responsibility/liability both before and at the time of
giving the advice. So the action by O in tort might be defeated by notice of the disclaimer (as in
Hedley Byrne), even if that notice was not part of a contract between O and S. The HofL
permits O’s claim in tort (was this property damage or pure economic loss?), but says that it is
defeated by the disclaimer unless the disclaimer was invalid under UCTA (which it was).
(f) Pacific Associates v Baxter is a case where M sues A in negligence for £45m. The CA refused
an action in tort because the O-M contract exempted A from liability, and also provided for
arbitration for such disputes about determinations by A.
3. Networks
(a) Is there a good argument for saying that where there is a network of contracts which allocates
risk, tort liability should not be permitted to upset those plans? If so, what counts as a
network?
(b) Can a network be regarded as a legal entity and be held liable to other parties?
(c) To what extent can risks be reallocated in chains of contracts?
Greaves & Co (Contractors) Ltd v Baynham Meikle & Partners [1975] 3 All ER 99 (CA)
Young & Marten Ltd v McManus Childs Ltd [1969] 1 AC 454 (HL)
Gloucestershire County Council v Richardson [1969] 1 AC 480 (HL)
Contractual Chains
(a) Under normal principles of the law of contract, each party may sue the party with which it has a
contract. Thus O may sue M, M may sue S, and S may sue SS. For each legal action, of
49
(b)
(c)
(d)
(e)
course, the claimant must establish breach of contract by the defendant and may be subject to
some limitation or exclusion clause.
Breach of contract may depend upon the question whether or not the liability is ‘strict’ or
requires proof of ‘negligence’ or ‘fault’ by the defendant. If the contract requires proof of fault,
some parties in the middle of the chain may not be liable if the fault originated further down the
chain.
Whether or not the contract imposes strict liability or fault liability depends ultimately on an
interpretation of the terms of the contract. There is no hard and fast rule. However, there is a
pattern that for the supply of goods the courts usually find strict liability, but for the performance
of a service the courts usually find a standard of negligence liability. This pattern is found in
the implied terms of the Sale of Goods Act and the Supply of Goods and Services Act 1982
s.13: ‘In a contract for the supply of a service where the supplier is acting in the course of a
business, there is an implied term that the supplier will carry out the service with reasonable
care and skill’. But one must be cautious in generalisations, as indicated by Greaves v
Baynham, where the CA holds the engineer to strict liability in connection with the design of a
building being fit for the purpose on the basis of the express terms of the contract. Also,
remember the cases of the hairy hand, and the vasectomy Thake v Maurice.
In Young and Marten Ltd v McManus the question was whether the contractor S was liable to
compensate M for defective roof tiles. S had engaged SS to perform the work, and SS had
purchased the tiles from the manufacturer, as instructed by M. The defects in the tiles could
not be discovered by reasonable inspection. The HL holds S strictly liable to M for the quality
of the tiles (not their fitness for purpose). In this case S had lost its action against SS down the
chain because the limitation period had expired.
The result would be different if the manufacturer had insisted upon supplying the goods with an
exclusion clause against latent defects and again M and S had no choice but to use that
manufacturer at the insistence of O: Gloucestershire v Richardson. The problem with this
decision was that if O could not sue M, there was no remedy at all for O. As a result the
standard form contract has been changed so that M may object to O’s choice of supplier, with
the result that M may be held liable to O for defective supplies of materials.
Insurance and insurers’ subrogation rights
Contribution rights
Civil Liability (Contribution) Act 1978
Co-operative Retail Services Ltd v Taylor Young Partnership [2002] 1 WLR 1419 (HL)
Royal Brompton NHS Trust v Hammond [2002] 1 WLR 1397 (HL)
Contribution
(a) The Civil Liability Contribution Act 1978 provides in s.1(1) that ‘any person liable in respect of
any damage suffered by another person may recover contribution from any other person liable in
respect of the same damage’ and goes on to explain that a ‘person liable’ may be liable in tort,
contract, or any other legal basis. In practice, a defendant is likely to join others as co-defendants
if the defendants believes that they may be liable for the same loss. The amount of contribution is
such that the court regards as just and equitable.
(b)Co-operative Retail Services Ltd v Taylor Young partnership [2002] UKHL 17: In a construction
contract with the usual parties (in the diagram above), liability for damage caused negligently
before completion was excluded in the main contract (X1 clause) but main contractors were
required to take out insurance in names of M,O,S and SS against such loss or damage. In the
main contract, payment for work to M to be made regardless of any such loss or damage, but M
was under a duty to reinstate and complete the works, the cost to be met by money from the
insurers and not otherwise. The same scheme applied to subcontracts. The building was
damaged by fire and M arranged for restoration. O claimed damages against A (the architects and
engineers) for negligence or breach of contract. A issued contribution proceedings against M and
S as persons liable to O for the loss caused by the fire. House of Lords held that the effect of the
50
contractual scheme was to eliminate the ordinary rules of contractual and tortious liability, so that O
could not claim compensation against M and S, but only ask them to reinstate the works using the
insurance money. Hence M and S were not persons liable under s,1(1) and could not be joined as
contributors. The effect is that A (or their insurers) may end up liable for all the losses of O (or
their insurers).
(c)Royal Brompton Hospital NHS Trust v Hammond [2002] UKHL 14. O claimed damages against
A for wrongly giving M extra time to complete works. O was not fully compensated in a claim
against M for delay because of A’s permissions for extra time. A was not permitted to join M as a
contributor, because not the ‘the same damage’: A was liable for negligent instructions and
permissions; M was liable for delays in completing the work.
Further reading
Stapleton, ‘Tort, Insurance and Ideology’ (1995) 58 MLR 820
Markesinis, ‘Eternal and Troublesome Triangles’ (1990) 106 LQR 556
Fleming, ‘Employer’s Tort in a Contractual Matrix: New Approaches in Canada’ (1993) 3 OJLS
430-439
Whittaker, Privity of Contract and the Tort of Negligence: Future Directions (1996) 16 OJLS 191
Eccles, ‘The Quasifirm in the Construction Industry’ (1981) 2 Journal of Economic Behaviour and
Organization 335
H. Collins (ed) Teubner, Networks as Connected Contracts (Hart Publishing, Oxford 2011).
51
Topics for Class Discussion On Multi party Projects and Networks
1. X, contracting with Y, wishes to ensure that a third party, Z, can sue to enforce Y’s
obligations, and/or can claim the benefit of a limitation clause in the contract with Y. Advise
X as to the various means by which this goal can be achieved.
2. What is the significance of the Contract (Rights of Third Parties) Act 1999? Was it a useful
and/or necessary reform of English contract law?
3. Sugar employs Warhol to build a bridge across the Thames. Warhol employs structural
engineers Dali to design the bridge’s stabilisers, and employs Bourgeois to install the
stabilisers. On completion, the bridge wobbles and costs Sugar £5m to correct. Warhol is
insolvent, but Sugar successfully claims £2.5m against Dali for negligent design and £2.5
against Bourgeois for negligent installation. Dali and Bourgeois both appeal to the CA on
the ground that neither owed Sugar a duty of care. Emmins LJ held…
Weekend break
52
Day 9 Long-term Contracts including Commercial Agency and
Franchises HC 22/7
Most commercial contracts occur within a long-term business relationship. In some instances, the
contracts may be discrete transactions, but form part of a continuing series of similar transactions.
In other instances, the parties enter into a long-term contract that tries to govern the performance
of the business relation over a lengthy period of time. Somewhere between these two
possibilities lies a third option of establishing a ‘framework agreement’ which sets the rules for the
business relation over a period of time, but this framework agreement may not be legally
enforceable itself.
1. Change of Circumstances
Legally enforceable long-term contracts encounter the problem that they may not provide
satisfactorily for future changes of circumstances. The contract may omit to deal with an
eventuality explicitly or precisely, or may deal with it rather crudely or coarsely so that one or both
parties are dissatisfied.
Under the common law, the general rule is that the original contract remains binding and
enforceable; there is no general power of the courts to relieve parties from transactions or to
rewrite the terms of the contract on the ground of change of circumstances. In exceptional, rare,
and extreme circumstances, the law may declare the contract unenforceable on the ground of
frustration.
BBF pp 881-898
(a) The parties themselves provide for changes in circumstances
May and Butcher Ltd v The King [1934] 2 KB 17n (HL) BBF 258
Staffordshire Area Health Authority v South Staffordshire Waterworks Co [1978] 1 WLR 1387,
[1978] 3 All ER 769 (CA) BBF 521
Paragon Finance plc v Nash [2001] EWCA Civ 1466, [2002] 1 WLR 685 (CA)
May and Butcher Ltd v The King —sale of old tentage; price to be agreed—so no binding contract.
However, if parties had simply left price unsettled, SGA s 8(2) would have filled the contracting
gap: if price not nominated (by some mechanism) then buyer must pay a reasonable price.
Staffordshire Area Health Authority v South Staffordshire Waterworks Co contract to govern ‘at all
times hereafter’, including pricing clause. 50 years later, in much changed market for water, CA
decided parties could terminate on reasonable notice, Lord Denning because rules of construction
would allow this if circumstances arose not contemplated by parties; majority because any contract
without express provision for termination could be terminated on reasonable notice, and the
relevant clause really meant ‘at all times hereafter [so long as there is a subsisting agreement]’
Paragon Finance plc v Nash —interest rate to be set by mortgage lender; CA implied a term that
power not to be exercised dishonestly, improperly, capriciously, arbitrarily or unreasonably, and
then decided that the mortgagee was not in breach of this implied term (mortgagees were in
financial difficulty). How did CA justify the implication?—rules re implied terms? Parties reasonable
expectations??? Public law analogies????
(b) The parties do not make provision, but the law regards the contract as frustrated
Chen-Wishart, Chapter 7
Law Reform (Frustrated Contracts) Act 1943 BBF 483
53
After contract formed, events occur which make performance impossible, illegal or radically
different from anything contemplated by parties. Consequences for the parties: contract
terminated automatically, henceforth, forthwith. Effects modified by Law Reform (Frustrated
Contracts) Act 1943 BBF 484
Davis Contractors Ltd v Fareham UDC [1956] AC 696 (HL) BBF 463
Blackburn Bobbin Co Ltd v TW Allen & Sons Ltd [1918] 2 KB 467, CA; BBF: 472
Krell v Henry [1903] 2 KB 740, [1900-03] All ER Rep 20, CA; BBF: 474 —hire of rooms to watch
coronation procession of King Edward VII. £75 rent, £25 deposit already paid. Consequences of
court decision? Alternative? Impact of statute had it been in force at the time?
Parties often include own force majeure or hardship clauses in the contract, rather than relying on
court.
2. Framework agreements, requirements contracts etc
In practice many sales between businesses are conducted within a continuing trading relation – a
supplier relationship. The purchaser orders goods at frequent intervals, according to requirements.
The parties to this business relation may treat each order separately, and produce a separate
contract for it. That atomized approach has its dangers, as for example when the standard form is
forgotten eg Henry Kendall & Sons v William Lillico & Sons Ltd (The Hardwicke Game Farm
Case) [1969] 2 AC 31; BBF: 339. But also that atomized approach, using discrete contracts, may
not represent the wish of the parties to have a continuing relationship, and may not provide the
buyer with the desired assurance that supplies of the correct quality and design will be readily
available when required.
In practice, the buyer will seek reassurances of this kind, which are often described these days as
‘supplier partnerships’. In such ‘supplier partnerships’ the buyer insists that the seller adopts
certain management practices, usually known as TQM (total quality management), co-operate on
design, and be in a position to deliver goods ordered ‘just in time’.
There is considerable theoretical interest in the nature of the relation because of the close
integration of the businesses without them forming a single firm. Is it appropriate in such contexts
to regard the firms as having opposing interests? If not, is it appropriate for the law to analyse their
relationship as a type of contract. The relationship is not so much a series of sales, but an almost
integrated production regime between two businesses. The relationship is not exactly a long-term
contract, but nor is it a single business organisation: hence it is sometimes described as a ‘hybrid’.
The central question we consider here is what is the legal nature of this continuing business
relationship. In particular, if the parties enter some kind of ‘framework agreement’ to govern their
long-term relationship, is it a binding contract, and if so what are its terms? The determination of
this question depends upon the application of the general principles for the formation of binding
contracts eg: did the parties reach an agreement? Was there consideration? Was there an
intention to create legal relations? Was the agreement sufficiently certain to be enforceable? If
there was no contract, did some other legal obligation arise, perhaps as a result of equitable
estoppel?
*Great Northern Railway Co Witham (1873) LR 9 CP 16, Common Pleas; BBF:116
*Rose & Frank Co v JR Crompton Bros [1924] All ER Rep 245, CA; [1925] AC 445, HL; BBF: 180.
Sale of Goods Act 1979, s.8; BBF: 258
*Hillas & Co Ltd Arcos Ltd (1932) 147 LT 503, HL; BBF: 259.
Brogden v Metropolitan Railway Co (1877) 2 App Cas 666, HL; BBF 208.
F & G Sykes (Wessex) Ltd v Fine Fare ltd [1967] 1 Lloyds Rep. 53 BBF: 267
Baird Textile Holdings Ltd v Marks & Spencer plc [2001] EWCA Civ 274, [2002] 1 All ER (Comm)
737, CA; BBF: 282
*S. Macaulay, ‘The Standardized Contracts of United States Automobile Manufacturers’, (1973) 7
International Encyclopedia of Comparative Law 3; BBF: 117 (Extracts).
Further reading:
54
Collins, H., ‘Quality Assurance in Subcontracting’, in Simon Deakin and Jonathan Mitchie (eds),
Contracts, Co-operation, and Competition (Oxford University Press, Oxford, 1997) 285.
3 possible analyses of the business relationship between buyer (supermarket) and supplier
(wholesaler):
Express long-term contract. But usually uncertainty about future needs (of the buyer) and about
market prices prevent any absolutely firm long-term contractual undertakings.
There may be an express agreement about the relationship, which may or may not be legally
enforceable (depending on its terms).
There may be an implied legally enforceable contract (somehow) – or something like it.
Express Agreements that May or May not be Legally Enforceable
The parties may expressly agree how the long-term supply relation should work. The supermarket
and the wholesaler may reach an agreement, for instance, about the supply of bananas. This
agreement, however, is not a sale of goods; it is rather an agreement about how the relationship
should work. The agreement may specify the ordering system (by the supermarket), how prices
and quantities will be determined, the quality of the goods (eg conformity to CE standard 4569 –
the straight bananas requirement?). Although extremely important commercially, the legal
status/.enforceability of such agreements is uncertain. There may be three obstacles to the legal
enforceability of such agreements as contracts.
(1) Consideration: depends upon the content of the agreement. Here are 3 main types of
agreement.
Type A: Master Agreement: a master agreement provides the detailed standard terms of trade
between the parties, so that whenever the parties to a master agreement enter into a lower level
transaction (a sale of goods), the terms of the master agreement become incorporated into the
transaction by implication. These master agreements are sometimes called ‘umbrella contracts’,
standard terms of business, framework agreements, or blanket order systems. But they are not
contracts in themselves, for neither party is obliged to do anything at all (ie no consideration).
Type B: Requirements Contracts: these arrangements contain a master agreement, but add to it a
promise by one party to meet all orders (or requirements) issued by the other party. The purchaser
(eg supermarket) thereby obtains a promise of a regular source of supply (eg of bananas). These
requirements contracts are, however, unlikely to be enforceable contracts owing to a lack of
consideration. Although the supplier has promised to meet all requirements (of the supermarket
for bananas), the purchaser has not agreed to do anything in return for this promise. In particular,
the purchaser has not agreed to buy anything at all (Yes, no bananas). At most, the requirements
contract of this type is a standing offer that cannot be revoked without notice (communication)
(rules of offer and acceptance).
Type C: Exclusive Dealing Requirements Contracts: these arrangements are the same as
requirements contracts, but add a promise by the purchaser to order all (or a certain proportion) of
requirements for supply of a particular product from the supplier in return for the promise to meet
all orders (eg supermarket promises to order all its requirements for bananas from a particular
wholesaler). This type of agreement is an enforceable contract, because the promise of exclusive
dealing represents the consideration for the promise to meet requirements.
Great Northern Railway Co v Witham is an example of a requirements contract (actually not a
contract -type B), but there was also an individual sale/order, which had not been performed.
Macaulay observes that a lot of requirements contracts are made, and that the businesses often
know that they are not legally enforceable for lack of consideration: so why make them?
Macaulay also demonstrates the one-sided nature of such requirements contracts in his discussion
of Auto Manufacturers: in their terms they impose many obligations on the suppliers, and none at
all on the buyers (themselves). Why do the suppliers agree to such terms?
(2) Certainty. Framework agreements may also be rather vague. They will leave quantity of goods
and timing of delivery to be determined later, and, crucially, also perhaps the price. The courts
have a doctrine, seldom used (eg Hillas v Arcos), which states that if a contract is too uncertain for
the court to know what it means, it will be void for uncertainty (ie the parties never really reached
an agreement at all). The absence of a determination of price is not fatal in individual sales due to
SGA s.8 (and (very) perhaps this applies to the framework agreement as well), but an express
55
agreement that the price needs to be settled by negotiation later (as opposed to being settled by a
mechanism such as an arbitrator) appears fatal (May v Butcher: see Scrutton LJs critical
comments in BBF p.271). The absence of a determination of quantity is also not fatal to a
requirements contract, at least if there is a provision for arbitration: F & G Sykes (Wessex) Ltd v
Fine Fare ltd [1967] 1 Lloyds Rep. 53
(3) No Intention to Enter Legal Relations: Rose & Frank v JR Crompton illustrates a long-term
supply contract (possibly a requirements contract) where the parties deliberately agreed that the
framework agreement would not be legally enforceable. Why make the agreement at all? Did it
affect the result in the case? Is the legal analysis that (a) the requirements contract is binding and
therefore prevents legal enforceability, or (b) that it is not a legally enforceable contract at all?
Implicit Contracts?
In the absence of any explicit framework agreement, do the parties owe any legal obligations
arising from a long-term supplier arrangement/partnership? Is it possible to infer a binding
framework contract or at least some kind of estoppel that prevents abrupt termination of the
economic relation? Baird Textile Holdings Ltd v Marks & Spencer plc suggests not.
Practical/policy questions:
Contrast classical contract law (discrete, requiring maximum ‘presentiation’ [Macneil]; clear
remedies) with neo-classical contract law (contract governs, but there are intended gaps, and
contractual governance structures for filling gaps), and with relational contracting (relationship is all
important, and variations are needed because the relationship has developed; no necessary
deference to original agreement—see Campbell and Harris and Daintith studies)
When do commercial contracts need to be flexible (ie able to be subjected to enforceable
modifications), and when do they need to be certain (and unalterable)? What features of the
arrangements between contracting parties suggest that their contract should belong in one
category rather than the other? (see Campbell and Harris (this week’s reading) and cf Bridge
(from week 3).
If a contract needs to be flexible, what sort of flexibility is usually considered necessary? (ie Which
terms might require alteration?). How can flexibility be built in? (settled standards—eg CPI; settled
process—eg engineer/architect/other third party to order/agree changes; settled renegotiation
process—arbitration; court in circumstances of UNIDROIT ‘hardship’ clauses—BBF p 887).
What advantages accrue to a party (or to both parties?) if the contract is flexible (and if it is not)?
What disadvantages exist?
How could the law reflect this assessment—ie what mechanisms does it have to assist in
necessary amendments and protect against potential disadvantages?
3. Agents, Distributorships and Franchises
This topic examines the legal regulation of three kinds of common commercial relations often used
in retailing products. What they share in common is a long-term commitment, sunk investments,
the need for co-operation between the parties in order to maximise profits, and the need for
provisions in the contract regarding termination. Statutory regulation (based on EC law) applies
only commercial agents; the other relationships are governed in the UK by the common law
(except for competition law issues).
(a)
Commercial Agents
The term “agent” is used in a wide variety of contexts; the law of agency is invoked in many areas
of the law. There are various ways that agency arises – contract (express or implied), but also
estoppel, ratification and operation of law. An agent acts for a principal, so that the contract
concluded by the agent is between principal and the third party (alone).
(i) Authority
See BBF 1128-32.
56
Actual authority: the authority to enter contracts on behalf of the principal expressly or impliedly
conferred by a contract.
Usual authority is the authority associated with a person in that position.
Apparent/ostensible authority is a possible extension of actual authority, or authority where there is
none, but it is reasonable for the promise to believe that there must be authority. The aim here is
to protect third parties against risk that agent exceeds its authority.
(ii) Agents Duties and Rights
These may be set out in a written contract. In any event agents are fiduciaries and as such have a
duty of care and a duty of good faith and must avoid conflicts of interest. They have a right of
indemnity against their principal.
Commercial agents
Council Directive 86/653/EEC of 18 December 1986, introduced into British law by Commercial
Agents (Council Directive) Regulations 1993, SI 1994, SI 1993 No. 3053.
*Lonsdale v Howard & Hallam Ltd [2007] UKHL 32
M. Bridge, ‘Compensation for Commercial Agents in the House of Lords’ (2008) 4(1) European
Review of Contract Law 31
Commercial agents are self-employed intermediaries who are given long-term authority to
negotiate the sale or purchase of goods on behalf of another business.
The normal rules of agency apply to these relations (ie duty of care and fiduciary relation).
The commercial agent is likely to invest time and effort in establishing a network of customers
(sunk investment).
These long-term contracts are also likely to have termination clauses.
Commercial Agents (Council Directive) Regulations 1993, SI 1993/3053, applies to most
commercial agents – the scope is defined as a self-employed intermediary who has continuing
authority to negotiate the sale or purchase of goods on behalf of the principal. The significance of
the Regulations is that they impose mandatory rules, which override freedom of contract.
Regulations 3 and 4 : duty of agent and principal to act dutifully and in good faith (this may or may
not be the same as the common law’s duties of care and fiduciary duties),
Where agent paid by commission (as they usually are) regulation 7(1) entitles agent to a
commission on transactions concluded with customers who he has acquired (even though the
particular transaction may not have been concluded by the agent). Reg 8 extends this posttermination.
Regulation 15 provides for a minimum period of notice for termination eg one month during the first
year, 2 months during the second year, and after that a minimum of 3 months.
Regulation 17 : indemnity (German law) if agreed, otherwise compensation (French law) on
termination of agency contract by principal, to take into account sunk investments of establishing
customer base and developing prospects;
17.—(1) This regulation has effect for the purpose of ensuring that the commercial agent is, after
termination of the agency contract, indemnified in accordance with paragraphs (3) to (5) below or
compensated for damage in accordance with paragraphs (6) and (7) below.
(2) Except where the agency contract otherwise provides, the commercial agent shall be
entitled to be compensated rather than indemnified.
(3) Subject to paragraph (9) and to regulation 18 below, the commercial agent shall be entitled
to an indemnity if and to the extent that—
(a) he has brought the principal new customers or has significantly increased the volume of
business with existing customers and the principal continues to derive substantial benefits from the
business with such customers; and
(b) the payment of this indemnity is equitable having regard to all the circumstances and, in
particular, the commission lost by the commercial agent on the business transacted with such
customers.
57
(4) The amount of the indemnity shall not exceed a figure equivalent to an indemnity for one
year calculated from the commercial agent's average annual remuneration over the preceding five
years and if the contract goes back less than five years the indemnity shall be calculated on the
average for the period in question.
(5) The grant of an indemnity as mentioned above shall not prevent the commercial agent from
seeking damages.
(6) Subject to paragraph (9) and to regulation 18 below, the commercial agent shall be entitled
to compensation for the damage he suffers as a result of the termination of his relations with his
principal.
(7) For the purpose of these Regulations such damage shall be deemed to occur particularly
when the termination takes place in either or both of the following circumstances, namely
circumstances which—
(a) deprive the commercial agent of the commission which proper performance of the agency
contract would have procured for him whilst providing his principal with substantial benefits linked
to the activities of the commercial agent; or
(b) have not enabled the commercial agent to amortize the costs and expenses that he had
incurred in the performance of the agency contract on the advice of his principal.
(8) Entitlement to the indemnity or compensation for damage as provided for under paragraphs
(2) to (7) above shall also arise where the agency contract is terminated as a result of the death of
the commercial agent.
common law would just give damages for loss – presumably on commissions earned and if not too
speculative future commissions, but subject to termination on reasonable notice (or express notice
term):
an indemnity is for the benefit that the principal continues to derive from more customers or greater
volume of sales after termination, taking into account value of lost commissions. Capped amount
of average of one year’s commission. Moore v Piretta PTA Ltd : for the purpose of calculating the
indemnity, the whole period of agency of 7 years, not just the most recent contractual period of one
year, should be taken into account. The purpose of the indemnity is to assess the value of the
‘goodwill’ not the lost commissions. Thus mitigation of loss is irrelevant. The goodwill is treated as
an asset of a quasi-partnership, to be shared between partners on dissolution.
Compensation is payable in particular where the commercial agent is deprived of the commission
which proper performance of the agency contract would have procured for him. Lonsdale v Hallam
considers the problem of termination on giving notice by a principal that goes out of business:
logically no loss of future commission and no benefit to principal of good will, therefore no
compensation at all. French law always gives 2 years commission, but HL rejects this rule on
ground of different commercial practice. It approves the logic of no compensation at all, but leaves
undisturbed trial judge minimal award of £5K.
Does the Directive “liken the commercial agent to an employee” or create a type of “quasipartnership”?
Do you think there are fewer “commercial agents” in Britain than in 1994?
Consider the issue of “sunk costs” in relation to termination.
(b)
Distributorship
58
Examples of distributorships are likely to be found in the sale of cars and other high value items
that require post-sale servicing. Closely analogous contracts govern the sale of petrol (‘solus
agreements’) (eg Esso v Mardon) and beer (‘tied houses’) (eg Courage v Creham).
They are long-term contracts, where the manufacturer of the product is concerned about its brand
name, and where co-operation is necessary for successful marketing.
The distributor obtains the advantage of the manufacturer’s support and (usually) an exclusive
territory in which to retail the product.
Distributorships also include a termination clause eg Schuler (L) AG v. Wickman Machine Tool
Sales Ltd: each visit stated to be a condition, but also contract contained termination by notice on
60 days for a ‘material breach’ which they have failed to remedy.
Compare with agency:
Agent
Supplier
Supplier
(c).
Customers
Distributor
Customers
Franchising
The basic transaction involves the license by the franchisor for the franchisee to use the brand
name in return for payment – a license of an intellectual property right. Business format franchises
are often found in shops and fast-food restaurants, but the arrangement applies in many different
contexts e.g. doorstep milk delivery, drain clearing. These agreements will typically be long-term
elaborate contracts.
The franchisor needs to protect its business name and ensure that it receives payment.
The franchisee needs to ensure that it receives real advantages of expertise and superior sales
from adopting the brand name, (Williams v Natural Life Foods) and that it receives an adequate
return on its (sunk) investment (Hoffman v Red owl Stores).
In practice the parties need to co-operate intensively during the life-time of the contract. The
payment mechanism usually contains a profit sharing mechanism in order to provide incentives.
Franchise agreements typically contain terms that entitle the franchisor to terminate the contract
and to withdraw the license to use the intellectual property right without compensation, though
perhaps with notice.
In Williams v. Natural Life Health Foods Ltd. [1998] UKHL: 17; [1998] 1 WLR 830; Lord Steyn
said:
“The underlying dispute arose in the context of a marketing system sometimes described as
business format franchising. It involves a contractual licence under which the franchisor permits a
franchisee to carry on business under a grade name belonging to the franchisor. The franchisor
provides advice and assistance to the franchisee about the manner in which the franchisee does
business and exercises some control over it. In return the franchisee pays stipulated fees to the
franchisor.”
See www.thebfa.org, the web-site of the British Franchise Association.
(b)
The contract
A franchise contract will normally include:
59
The right to use the trade name
The franchisee’s obligations
The franchisor’s obligations
The premises and the territory
Length of franchise contract
Financial aspects such as initial franchisee fee and ongoing royalties
Renewal terms
Control of standards
Rights of sale
Performance targets
Termination
Effects of termination.
In as much as the contract gives the franchisor a wide, discretionary power, to what extent will
English law restrict the exercise of the power? Recall Paragon Finance plc v. Nash & Staunton
[2001] EWCA Civ 1466; [2002] 1 WLR; BBF: 271
Opportunism.
H. Collins, Regulating Contracts, pp. 236-246.
(d)
Disputes
Note the arbitration and mediation schemes run by the British Franchise Association:
www.thebfa.org/arbscheme/index.asp. Do you think this explains the absence of litigation in
England?
(e) Termination Clauses
There is no equivalent protection for franchisees as that enjoyed by commercial agents.
What happens if one party exercises a right to terminate under the contract by mistake ie the facts
entitling it to terminate have not occurred? Woodar Investment Development Ltd v Wimpey
Construction (UK) Ltd says that the incorrect exercise of the contractual right to terminate, provided
not ‘totally abusive, or lacking in good faith’, is a kind of performance of the contract, not a
repudiation of it
(f) Theory of Quasi-Firms, Hybrids etc.
H. Collins, Regulating Contracts, pp. 246-254.
(a) Symbiotic contracts: why are franchises and distributorships so popular and successful as a
means of establishing retailing chains and networks? Or, to put the question another way, why not
have integrated ownership of the whole chain?
Principal and agent – where the agent uses its skill, know-how to further interests of principal, and
principal monitors and supervises performance.
Two crossed principal and agent relations, where both franchisor and franchisee are both principal
and agent.
Franchises may in practice be lop-sided in that franchisees lack adequate supervision and
monitoring of franchisors. Hence US laws: against termination in bad faith or without good cause.
No equivalent in UK.
But sunk investments and reputation issues on both sides may prevent opportunistic terminations
in practice far more than any legal constraints on termination clauses.
60
Long-Term Contracts and Franchises – Class material
1. Why do Long-term contracts present special problems and how should the law respond to
these problems?
2. Trashco Stores plc a large supermarket chain, wants to establish a regular supply of grade
1 turkeys for their shops all year round, but with significant increases in late November and
December. They enter into an agreement for five years with Providence Co, a turkey
breeding company, to supply Trashco’s requirements for grade 1 turkeys, which specifies in
clause 15 that “orders should be placed at least 4 weeks in advance of delivery date in
writing; no other orders will be accepted”; and in clause 17, that the price of each turkey will
be fixed by agreement at the time of the order, or in the absence of agreement, by an
arbitrator from the Poultry Farmers Association.
On November 1st, Hilary, a manager at Trashco realises that they have failed to order enough
turkeys for the new rush at Thanksgiving, on November 23rd, so she hastily telephones
Providence to ask if they can supply additional turkeys. Not wishing to lose their most value
customer, George, manager of Providence, agrees over the telephone to supply an additional
10,000 turkeys by November 20th. There is no discussion of price. But Providence co is unable
to feed up enough turkeys in time to be plump enough to count as grade 1 (owing to some of
the animal feed becoming mouldy in the hoppers). Providence co only supplies an additional
5,000 Grade 1 turkeys on November 20th.
On the day of delivery however, Hilary rejects the Turkeys on the grounds that there are too
few in numbers and some look too skinny to be grade 1 (though in fact they comply with the
requirement for grade 1 (which deals with oil/fat and weight only)). Providence has to destroy
the turkeys because they can find no other outlet for the 5000 birds (though George takes one
home for the family dinner).
Hilary then writes on behalf of Trashco to say that they are terminating their arrangement with
Providence for the supply of turkeys because of Providences’ inability to supply the turkeys for
Thanksgiving.
Advise Providence on any rights against Trashco.
61
Day 10 Credit and Security MB 23/7
It is a truth universally acknowledged that creditors who can take security for payment will do so.
Security can be resorted to when a debtor defaults, so that the creditor need not line up with
unsecured creditors for a small dividend when the debtor goes into (individual) bankruptcy or
(corporate) winding-up proceedings. Moreover, security can be enforced before formal insolvency
proceedings run their course or even commence.
Security can take broadly two forms. One is personal security, often a personal guarantee.
Directors of a company frequently give personal guarantees to a lending bank along with the
security over its assets given by the company itself. The other form of security is proprietary
security. Our concern in these two seminars lies with this latter form of security.
Proprietary security may be granted consensually or it may arise by operation of law (as in the
case of equitable and common law liens). These two seminars deal with consensual security.
Consensual security in English law takes one of three forms: the pledge, the charge and the
mortgage. The distinction between charges and mortgages is largely eliminated in practice. Both
are used to take non-possessory security, so that the debtor may continue dealing with its assets
in the normal course of business. Pledge, which we need to note only in passing, is a form of
possessory security and thus more suited to non-productive assets, like shares and bullion. (A
general reference below to security interest includes these three forms of security.)
Although it is not recognised in formal legal terms as security in England, the reservation of title by
an unpaid seller serves the same purpose in practical or economic terms. It commonly arises
where a seller of goods reserves the so-called right of disposal under section 19 of the Sale of
Goods Act 1979 until the buyer pays for the goods. Informal trade credit is frequently extended by
sellers to buyers on a 30-60 day credit cycle. The reservation of title clause in a contract of sale
gives the seller some protection if the buyer defaults or goes into insolvency proceedings.
(Reservation of title is also seen in asset financing, where a financial institution reserves title to
equipment and capital goods under conditional sale, hire purchase or similar transactions, pending
payment by instalments over a protracted period.)
Consensual, proprietary security and reservation of title are the subjects of these two seminars.
The central themes of these seminars are the following:
 (a) the avoidance of lending risk;
 (b) contractual certainty and autonomy;
 (c) the tension between individual contractual rights and collective rights;
 (d) the existence or not of a fair balance among creditors.
GENERAL REFERENCE
R M Goode, Legal Problems of Credit and Security (3rd ed 2003)
RM Goode, Commercial Law (3rd ed 2004), chs 22-23, 25
H Beale, M Bridge, L Gullifer and E Lomnicka, The Law of Personal Property Security (2007)
(particularly chapter 1)
For a global survey of English security law for a continental readership, see M Bridge, “The English
Law of Security” [2002] European Review of Private Law 483.
See also E Ferran, Company Law and Corporate Finance (Clarendon 1999), 488-512, 529-39
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1. Security, title reservation and insolvency
The key point about security and reservation of title upon insolvency is that they remove assets
from the debtor that would otherwise be distributed amongst all its creditors on a rateable, or pari
passu, basis. Only property belonging to the bankrupt vests in the trustee-in-bankruptcy. A
company liquidator (who will not normally need a vesting order) has powers to deal with the
company’s property. A seller reserving title to goods, and a creditor taking a security interest in the
debtor’s goods, therefore stand outside the formal insolvency processes administered by the
trustee and the liquidator. This is subject, however, to encroachments made on the rights of
secured creditors (and to a lesser extent those reserving title) in insolvency legislation (see below).
Insolvency Act 1986, ss 107, 145(1), 283(1)(a), Sch 4 para (6).
Oditah, “Assets and the Treatment of Claims in Insolvency” (1992) 108 LQR 459
2. Freedom of contract between debtor and secured creditor
It is a particularly marked feature of the law governing the creation of security in England that
debtor and creditor are free to arrive at their security bargain without considering the effect of this
bargain on third parties. A creditor, in fact, can sweep up in its security all of the debtor’s assets,
thus leaving nothing (apart from statutory intervention: see below) for distribution to unsecured
creditors in bankruptcy or corporate liquidation. Public policy is conventionally regarded as having
no part to play in English law in regulating the bargain struck between secured creditor and debtor.
Nevertheless, at various intervals in the law, although parties in their contract may strive for a
certain effect, their bargain may be recharacterised against their wishes. One such case concerns
attempts to avoid the creation of security in the formal legal sense (the reasons for this will appear
below). Another concerns the difference between fixed and floating charges (again, dealt with
below). English courts sometimes say they look beyond the form of an agreement to its substance,
but what do they mean by this? Is this public policy under another name?
Re Curtain Dream Plc [1990] BCLC 925
Welsh Development Agency v Exfinco [1992] BCLC 148
Did the draftsman of the documents in Re Curtain Dream commit a few slips of the pen which, if
avoided, would have led to a different result?
What was the draftsman trying to achieve in Welsh Development. Do you agree with the result?
3. Reservation of title
Under this head we shall examine the use of title reservation devices to protect the supplier of
goods from the risk of non-payment by the buyer. The device employed by sellers in this area is
the Romalpa clause, which builds upon the provisions of the Sale of Goods Act 1979. There is little
that is controversial about the reservation of title in the original goods: what has generated the real
difficulties has been the attempts by sellers, under extended reservation of title clauses, to
“reserve” title to the money proceeds of the goods supplied and to the goods manufactured from
the goods supplied as well as their money proceeds. After some initial success, the attempt to
characterise these extended title clauses as reservation clauses has foundered: they are now
consistently regarded by the courts as giving rise to registrable charges. It is quite an impracticable
proposition for the great majority of trade suppliers to comply with charge registration requirements
in the Companies Act 2006 (ss 860 et seq) so as to perfect their security against other creditors of
the buyer.
Title retention, though not formally recognised by the law as security in the proper sense of the
word, in fact functions as a security and, in those cases where it works, can be more effective than
a security interest. First of all, if a buyer (or a hirer under a hire purchase transaction or a lessee
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under a financial lease) receives goods the property in which has been retained by the unpaid
seller, then the seller's interest will always override any security claimed by a chargee (or
mortgagee) who has had dealings with the buyer in the latter's capacity as chargor. The chargee is
able to take security only over assets that the buyer has to charge, which excludes goods the
property in which has been retained by the seller. It does not matter that the mortgage might have
been given before the contract of sale was concluded. Secondly, title retention is cheap and easy
to accomplish. It requires no formality and the seller need not comply with registration
requirements laid down in the Companies Act 2006 (ss 860 et seq) (the Bills of Sale Act 1878
(Amendment) Act 1882 for individuals).
Clough Mill Ltd v Martin [1985] 1 WLR 111
Armour v Thyssen Edelstahlwerke AG [1991] 2 AC 339
Tatung (UK) Ltd v Galex Telesure Ltd [1989] BCC 325
Re Peachdart Ltd [1984] Ch 131
Sale of Goods Act 1979, ss 17, 18 Rule 5, 19
Do you agree with Robert Goff LJ in Clough Mill that a properly drafted clause will allow a seller to
“reserve” title to new goods manufactured with those supplied by the seller? How might it be done?
Do you also agree with him that a seller exercising its rights should, one way or another, have to
account for any surplus (over and above the price owed by the buyer) realised after the goods
have been repossessed and sold?
Apart from any extended reservation of title clause, do you think that sellers should have the right
to trace into the proceeds (new goods or money) deriving from the goods they supplied?
4. Types of consensual security
We shall deal with mortgages and charges. Unlike land, it is still possible to grant a mortgage over
personalty, so that title passes to the mortgagee subject to a cesser on redemption (that is, an
automatic reversion to the mortgagor) when the mortgage debt is repaid. The practical difference
between a mortgage and a charge is that, at law, a broader range of remedies is available for
mortgages than for charges. Drafting practice, however, has eliminated this distinction, as
chargees have successfully bargained for the further remedies of mortgagees. Even judges in the
House of Lords (Lord Hoffmann, for example) speak of mortgage and charge as though they were
the same thing and legislation also follows the same trend (Law of Property Act 1926, s 205(1)(xvi)
(mortgage includes a charge); Companies Act 2006, s 861(5) (charge includes a mortgage)).
Whereas a mortgage (of personalty) involves a defeasible transfer of ownership to the mortgagee,
a charge does not involve a transfer. Instead, it is an encumbrance affecting the property charged
until the charged debt has been repaid. A mortgage can be either a legal or an equitable mortgage,
but a charge exists only in equity. (Although the common recognised co-ownership, it did not
recognise undifferentiated rights in a bulk.)
The existence of a charge depends upon an intention to create a charge. When is that intention
present?
Swiss Bank Corpn v Lloyds Bank Ltd [1982] AC 584 (read the judgment of Buckley LJ in the Court
of Appeal)
Re Cosslett Contractors Ltd [1998] Ch 495
5. Fixed and floating charges
The modern bank debenture (loan instrument) typically recites a series of fixed charges over
identified types of property, before concluding with a floating charge that sweeps up all remaining
property. Very broadly, a fixed charge requires the specific consent of the chargee if the chargor is
to dispose of the charged property. A floating charge involves the grant of an authority by the
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chargee to the chargor to deal with, and even dispose of, the charged property in the ordinary
course of business.
The distinction between a fixed and a floating charge has been a battleground in recent years. At
stake, is the position of the chargee bank upon the chargor company’s liquidation. If a charge is a
floating charge, the chargee has been to a degree expropriated by legislation in favour of certain
creditors (preferential creditors) and unsecured creditors (to a limited financial extent). The battle
has centred on debts owed to the chargor company by its trading partners, which (like stock-intrade and work in progress) are part of a company’s circulating as opposed to fixed capital. For a
time, banks were able to take a fixed charge over the chargor’s debts but recent decisions of the
Privy Council and House of Lords mean that such attempts to take a fixed charge will be
recharacterised as a floating charge.
Evans v Rival Granite Quarries Ltd [1910] 2 KB 979
Agnew v Inland Revenue Commissioner [2001] 2 AC 710
Re Spectrum Plus Ltd [2005] 2 AC 680
Insolvency Act 1986, ss 29(2), 175, 386 and Sch 6 (as amended by the Enterprise Act 2002) and s
176A and Sched B1 para 65 (both as added by the Enterprise Act 2002)
RM Goode, Commercial Law (3rd ed 2004), ch 27
S Worthington, “Floating Charges: The Use and Abuse of Doctrinal Analysis”, in J Getzler and J
Payne, “Company Charges: Spectrum and Beyond” (Oxford University Press 2006), ch 3
What is “crystallisation” of a floating charge and why if at all is it significant?
6. Publicity (the Companies Act scheme)
The registration of company charges was introduced in England in 1900. A clear motivation behind
the duty to register from the outset was the belief that the concealment of secured credit was an
evil calculated to mislead those dealing with the company. Registration was designed for the
protection of those doing business with the company so that they might see how much of a
company’s assets would be available for distribution in an insolvent liquidation. Registration would
also do much to clarify the rights of secured creditors if the company debtor went into liquidation,
and the rights of those purchasing the company’s property, since it would avoid the evils of
backdated documents and provide the charge with a badge of authenticity. Registration has also
proved useful to those interested in the affairs of the company, such as financial analysts, credit
reference agencies and potential investors. Credit reference agencies, in particular, may be seen
as substitutes for unsecured creditors in the examination of a company charges register.
Companies Act 2006, ss 860-61, 869-70, 874, 894
National Provincial Bank and Union Bank of England v Charnley [1924] 1 KB 431
Should all company charges be registered? What about reservation of title clauses? How reliable is
the information available form Companies House about the state of a company’s affairs?
Does the Charnley decision subsidise carelessness?
7. Enforcing the security
A defining feature of the English law of security is the way that it permits secured creditors to
enforce their security without going to court and without having to await the outcome of insolvency
proceedings. Before changes wrought by the Enterprise Act 2002, this was done by means of the
ability, granted by contract, to appoint a so-called administrative receiver. (This right remains for
pre-2002 debentures and for designated capital markets and private finance initiative transactions.)
The debenture would grant the creditor an irrevocable power of attorney to appoint, in the name of
the debtor company, an administrative receiver who was the agent of the company chargor with
the primary task of paying down the debenture. (Technically, the company did it to itself.) This
same procedure, under another name (“administration” – extended in meaning under the 2002 Act)
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is still available, though subject to certain checks and balances in the cause of those modern
goals, transparency and accountability.
Insolvency Act 1986, s 29(2), Sched B1 (as added by the Enterprise Act 2002) (in outline).
Do you see why banks still need to take floating charges (apart from the recent decisions of the
Privy Council and House of Lords on fixed charges over debts)?
Should secured creditors have so much control over the enforcement of their security?
8. The Future
There have been numerous calls over the last 30-40 years for a thorough reform of the English law
of security. Most recently, the Law Commission has issued two consultative documents and a
report which, for all practical purposes, are defunct. At the heart of this intensive debate has been
the question whether English law should adopt the approach of Article 9 of the American Uniform
Commercial Code. The main features of Article 9, for present purposes, are the following. (1) It
adopts a functional, rather than a technical legal, definition of security. So reservation of title is
treated like security, which affects registration and remedies. (2) It bases priority among competing
security interests (this is a simplification) on the date of registration (“filing”, to use the technical
expression). (3) Only barebones details of a security interest are filed (“notice filing”), and there is
nothing corresponding to the (English) Registrar’s conclusive certificate. There are various
reasons for the rejection by the practising profession of these reform proposals, including a
sentimental attachment to the floating charge, a belief in the principle that something not broken
does not need to be fixed and a genuine concern that reform would have an upsetting effect on the
capital markets, where title-based transactions (such as so-called “repos”) are in common use. The
consultative documents and report are worth consulting to gain a fuller understanding of the
existing law. For those who are interested, here are the citations:
Registration of Company Charges: Property other than Land (Consultation Paper No 164, 2002)
Company Security Interests (Consultation Paper No 176, 2004)
Company Security Interests (Report No 296, Cm 6654, 2005)
RM Goode, “The Modernisation of Personal Property Security Law” (1984) 100 LQR 234
Credit and Security – Class material
1. Why and how does English law distinguish between fixed and floating charges?
2. Explain how crystallisation operates.
3. Should title reservation be treated as a security?
4. Is English law too tolerant of artificial transactions in the area of lending? Should it defined
security according to the form of a transaction or according to the function it served?
5. Is English law too favourable to secured creditors?
6. Does the registration of company charges serve a useful purpose?
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Day 11 Financial law (1) Introduction and derivatives JB 24/7
1.
Introduction
Financial law has been defined as ‘the law and regulation of insurance, derivatives,
commercial banking, capital markets and investment management sectors’ and as a subset
of commercial law (Benjamin, 2007: 4). The sources of financial law are market practice,
case law and legislation, though not always in that order. For example, there is little public
sector regulation of syndicated lending with the result that, in such deals, much turns on the
terms of the contracts which lenders and the borrowers negotiate for themselves. By
contrast, the capital markets are heavily regulated by European and domestic legislation
and individual investors will have little say about the terms and conditions of their securities.
The function of financial law is to translate risks of many kinds (for example, your house
burning down) into credit risk, and then to permit the circulation of units of risk among
market participants (Benjamin: 3). Valdez has described how in the financial markets ‘the
money goes round and round, just like a carousel on a fairground’ (Valdez, 2007: 3) but as
we will see, it is in fact more helpful for lawyers to think about the movement of risk, not
money.
The purpose of this lecture is to explore the importance of the contract law element of
English financial law. The positions which parties enter into may be economically complex
and sometimes bafflingly so, even for experts (certain derivatives which fuelled the ongoing
financial crisis have been called ‘the banking equivalent of space travel’ (Tett, 2009:7)) but
all may be understood in legal terms as contracts in one form or another. This perspective
affords a number of insights which we shall explore the first part of lecture, drawing on a
broad range of examples from across the markets and making reference to developments
since the financial crisis broke out in 2007.
The second part of the lecture will look in more depth at one part of financial law, that
relating to derivatives. While derivatives have long played an important role in the markets
for commodities and agricultural products, for example, certain innovative types of credit
derivatives grew at an exponential rate from the mid-1990s and played an important part in
the build-up to the financial crisis. Much attention is now being paid at national and
international levels to how this market should be reformed. Having outlined by way of
background some of the very different types of products involved in this category, we will
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discuss innovation, legal risk and current proposals for reform in this area, applying some of
our previous discussion to this particular, specialised context.
Reading
J. Benjamin, Financial Law (Oxford: OUP, 2007), chapter 1 and section 4.4
Lord Turner, The Turner Review (London: FSA, March 2009) pp. 27-28, 81- 83, 108- 110.
http://www.fsa.gov.uk/pubs/other/turner_review.pdf
Hazell v Hammersmith and Fulham LBC [1990] 2 QB 697, 739-741
Bankers Trust International plc v PT Dharmala Sakti Sejahtera (1995) 4 Bank LR
381(overview of highly complex facts only, but focus on the causes of action including
misrepresentation brought by the claimant).
BNP Paribas v Wockhardt EU Operations (Swiss) AG [2009] EWHC 3116 (Comm) (QBD)
The International Swaps and Derivatives Association’s website, at
http://www.isda.org/
Ed Murray "UK Financial Derivatives and Commodities Markets" in M. Blair and G. Walker
(eds) Financial Markets and Exchanges Law, (Oxford: OUP, 2007), chapter 6.
The following are not required for the course but may be of interest:
S. Valdez, An Introduction to Global Financial Markets (Basingstoke: Palgrave Macmillan,
2007)
S. Henderson, Derivatives, (London: LexisNexis UK, 2002)
G. Tett, Fool’s Gold (London: Little Brown, 2009)
2.
Understanding financial positions as contracts
Legally speaking, the positions which market participants enter into are contracts of one
form or another. These contracts may be analysed by thinking about how risk moves
between the parties.
For example:

Under a contract of insurance, the insurer assumes the insured’s risk of a particular
event happening. Funds move if and when the insured suffers loss. During the life
of the contract, the insured has a credit risk as regards the insurance company.
Prudential Insurance Co. v IRC [1904] 2 KB 658

Similarly under an indemnity, the surety assumes a liability to pay if and when the
principal debtor defaults. To this extent, the surety assumes the creditor’s risk of the
debtor defaulting but the creditor has a credit risk as regards the surety. ILG Capital
v Van Der Merwe [2008] EWCA Civ 542
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
In a syndicated loan, funds move at the outset of the transaction from a syndicate of
lenders to a borrower. During the life of the loan, the lenders assume the credit risk
of the borrower defaulting, which they may address, for example, through a
guarantee or an indemnity. Redwood Master Fund, Ltd and Others v TD Bank
Europe Limited and Others [2002] EWHC 2701 (Ch)

When Eurobonds are issued, funds move from investors (initially the managers) to
the issuer. Up to maturity, the bondholders assume the credit risk of the issuer
defaulting on the coupon (interest) and/or principal. Elektrim SA v Viviendi Holding
Corp; Law Debenture Trust Corp v Vivendi Holdings Corp [2008] EWCA Civ 1178
Across these different areas of financial law, market practice, case law and legislation are
all relevant but of differing levels of importance. For example, contrast how public sector
regulation protects of the following (if at all):

An investor buying bonds issued by a UK supermarket company, which are listed
on the London Stock Exchange.

An insurance company writing an insurance policy to protect an ice cream business
in the event of a wet summer.

A bank lending money to a start-up IT company in reliance on an indemnity from
one of the wealthy directors.

A bank lending money as part of a syndicated facility to a railway company which
will use it to buy new rolling stock.
How important, in these examples, are the other sources of financial law ?
In each case, which party is likely to have the most bargaining power and which
contracts do you think will be most heavily negotiated?
3.
Contract law as a tool for innovation in the financial markets
The financial markets based in London have long been a site of innovation,
for example
the first Eurobond issue was arranged here in July 1963 for an Italian national highways
authority. More recently certain innovative practices in the securitisation market have been
implicated in the build-up to the financial crisis. Indeed, Lord Turner’s 2009 review
described part of the cause of the crisis as ‘macro trends meet financial innovation’ (The
Turner Review, Chapter 1).
While some innovation turns on matters such as economics or tax law, other innovative
practices may be understood as contract law-based responses to various problems which
presented themselves in the financial markets. For example:
69

Markets facilitated by the standardisation of contracts.
Issue: Privately negotiated contracts, sometimes entered into in high volumes and
at speed by traders, which have to address the full range of legal issues as well as
the economic terms, expose parties to cost, delay and risk.
Response: Standardisation of contracts driven by trade associations. e.g. ISDA’s
Master Agreement for the ‘over-the-counter’ derivatives market and LMA’s Facility
Agreement for the syndicated loans.

Contractual credit risk mitigation.
Issue: Borrowers under syndicated loan facility agreements have no disclosure
obligations (either on signing or during the life of the loan); the usual rule of caveat
emptor applies.
Response: Sophisticated contractual drafting, which is now market standard,
enables the providers of capital to flush out information on signing and to monitor
the borrower closely during the life of the loan. These ‘representations’, ‘repeating
representations’ and ‘covenants’ are drafted to impose a significant disclosure
burden on the borrower. This gives the lender early warning of any problems which
the borrower might be facing so they can take pre-emptive action as provided for in
the ‘events of default’ section of the agreement. ‘Cross-default’ provisions mean that
the lenders can also benefit from the protections enjoyed by other creditors of the
borrower under their agreements. This is a particularly useful device if the market
has become less ‘lender friendly’ over time.

Secondary market in loans
Issue: For various reasons, lenders may wish to sell their participation in a loan to a
third party, for example if the loan has many years to run and the bank wishes to
free up capital for new deals. Legal techniques for the transfer of property such as
novation, assignment, sub-participation, risk participation can be onerous for
lenders in practice, e.g. in terms of serving notice (s. 136 Law of Property Act 1925)
or obtaining consents (novation). Shopping around for a transferee may also breach
a bank’s duty of confidentiality to its client. Tournier v National Provincial and Union
Bank of England [1924] 1 KB 461
Response: Transfer Certificates were developed in the 1980s and it is now
standard to find them schedule to the facility agreement. Taking advantage of the
concept of the unilateral offer, they simply require that lenders sign and deliver the
certificate to the Agent for the loan participation to be transferred to a new lender.
This has facilitated the market in secondary loans, making these positions much
70
more liquid. This also means that new types of participants, such as hedge funds,
have become involved in the loan market as transferees.
As to confidentiality, standard drafting in the LMA Agreement gives the borrower’s
consent to lenders making disclosures to potential transferees, though the borrower
may require confidentiality agreements to be signed.
4.
Common causes of action in the financial markets.
When borrowers become insolvent or transactions lead to losses not profit, parties may be
inclined to sue either their counterparty or a third party. It is common for claimants in this
position to launch multiple causes of action, some of which may be based on contract law.
For example:
Misrepresentation, breach of contract, breach of collateral contract claims. When
parties which suffer heavy losses in the financial markets they sometimes seek remedies
on the basis that they were induced into the contracts by false statements or that
contractual terms were breached. For example: JPMorgan Chase v. Springwell [2008]
EWHC 1186 (Comm) and Springwell Navigation Corp v JPMorgan Chase and ors [2010]
EWCA (Civ) 1221; Bankers Trust International PLC v PT Dharmala Sakti Sejahtera [1995]
HC, QBD Comm Ct. In both of these cases investors sought to avoid liability and/or seek
damages in relation to investments which (in the first case) suffered heavy losses due to
the Russian financial crisis in 1998 and (in the second) were extremely complex and had
exposed the investor by way of a swap to $65million losses because of a rise in interest
rates. Both cases saw several different causes of action pleaded. In the first case,
Springwell argued (at first instance) “breach of contract, negligence, breach of fiduciary
duty, negligent mis-statement and/or misrepresentation under s.2 of the Misrepresentation
Act 1967..”. In the second case, the claims included lack of authority, misrepresentation,
breach of contract and breach of duty of care.
However, these two cases offer interesting examples of the courts’ approach to
sophisticated investors in this position; in neither case was the investor successful in its
claims.
Suing Agents and Arrangers and other third parties: When borrowers become
insolvent, lenders may seek redress from other parties such as the bank that has arranged
the loan, for example claiming misrepresentation or breach of contract. However, Agents
and Arrangers now include extensive disclaimer language in the loan agreement itself and
in the preliminary documents, which was found to be effective in IPE Fund SA v Goldman
Sachs International [2007] EWCA Civ 811.
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Penalty clauses: Penalty clauses are void in English law: Dunlop Pneumatic Tyre Co Ltd.
v New Garage and Motor Co. Ltd [1915] A.C. 79. Parties in the financial markets have tried
to argue that various terms of their contracts are ‘penal’ in nature and therefore void. For
example, a bank recently claimed that contractual provisions in the ISDA Master
Agreement which allow the early termination and ‘close out’ of transactions were
unenforceable for this reason. However, in this case the court found that there was no
realistic prospect of this argument succeeding. BNP Paribas v Wockhardt EU Operations
(Swiss) AG [2009] EWHC 3116 (Comm) (QBD)
What appears to be the approach of the English courts when considering these sorts
of claims brought by participants in the financial markets?
However, it is also worth noting here the ramifications for the financial markets of
decisions such as:
Hazell v Hammersmith and Fulham LBC [1990] 2 QB 697; and
Haugesund and another v Depfa ACS Bank [2009] All ER (D) 34.
5.
Derivatives
Derivatives have long played a valuable part in the commodities and agricultural markets
e.g.
the
derivatives
traded
at
the
Chicago
Mercantile
Exchange
(http://www.cmegroup.com/trading/commodities/). However, from the mid-1990s complex
credit derivatives were used to trade risk separately from underlying assets; this market
exploded in size and contributed to the build up to the financial crisis as described in the
2009 Turner Review.
Legal definition
A derivatives contract is, very broadly, a bilateral contract
(i) under which the rights and obligations of the parties are derived from or defined by
reference to, a specified asset type, entity or benchmark [for example oil, agricultural
products, shares, bonds, currency, ship charter rates, electricity, weather, bandwidth ...]
(ii) the performance of which is agreed to take place on a date significantly later than then
date on which the contract is concluded. i.e. settlement date more than 3 business days,
possibly decades after the trade date.
(Benjamin, paragraph 4.31)
Exchange-based vs. over the counter (OTC) products
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‘an exchange creates a private and closed contractual world, buttressed by limited access
(‘members only’), a detailed regulatory framework (to try to ensure an orderly and fair
market), standard rules and procedures, standard contracts and standard procedures to
resolve disputes’ (Murray, p 279).
By contrast, OTC derivatives are entered into off-exchange. They are privately negotiated
and can be highly bespoke products, for example used by many large companies to hedge
specific risks. Derivatives lawyers will normally be focus on issues arising in relation to the
OTC markets. ISDA is the trade association for off-exchange derivatives dealers and other
participants in these markets, and it has over 800 members worldwide.
Sources of legal risk in the OTC markets

Authority: Hazell, Haugesund

Disputes about the making of contracts: Confirmations and Master Agreements.
Traders calls recorded. Powercor Australia Ltd. V Pacific Power [1999] VSC 110.

Credit default swaps: Serving notices and Credit Events: ISDA Determinations
Committee.

Jurisdiction disputes: Calyon v Wytwornia Sprzetu Komunikacynego PZL Swidnik
SA (‘PZL’) [2009] EWHC 1914 (Comm)

Global markets: e.g. Metavante case: A NY bankruptcy court’s recent ruling on a
clause in the ISDA Master Agreement in the context of the Lehman Brothers
administration has given rise to much debate, not least because goes against the
finding in a similar case in Australia in 2003.

The impact of precedent on widely used standard terms e.g. see BNP Paribas
case above about early termination under the ISDA Master Agreement.
Proposed reforms
OTC derivatives, and in particular a type of credit derivative called credit default swaps,
have attracted widespread regulatory attention in the fall out of the financial crisis. This is
because of the opacity of this market, its explosive growth and its role in contributing to
systemic risk in the run up to the crisis. For example:
The role of CDS in the near-collapse of AIG
Many of AIG Financial Products’ bespoke CDSs with European banks included ‘credit
rating triggers’ so that in the 15 days or so that followed its credit ratings downgrade on 15
September 2008, AIG FP had to funded approximately US$32 billion of collateral calls. Its
subsequent rescue by the US Treasury was in part motivated by the large net selling
position the insurer had in the CDS market, as a counterparty to CDS of over
73
US$400billion. Had AIG had collapsed, this ‘highly concentrated’ market would have left
very many protection buyers without the protection of their CDS contracts, leading to
widespread destabilisation across the world markets.
One reform which has been mooted is the product regulation of CDS contracts along the
lines of insurance. See The Turner Review, page 108 onwards.
However, while product regulation remains a long way off, the FSA, HM Treasury, the G20,
the European Commission and the Obama Administration have all endorsed the idea of
extending central counterparty (CCP) clearing to the CDS markets. Much about this
proposal remains undecided at the time of writing- e.g. which CDSs will this be required
for? What will happen to the highly bespoke products? How will global co-operation be
achieved? However what is certain is that more CCP clearing will go on in this market in the
future. As contract lawyers, it is interesting to note that many of the central benefits of such
arrangements derive from the standardisation and novation of contracts so that the CCP
may act as buyer to every seller and seller to every buyer.
Questions for discussion in class:
1.
Do you think that the usual rules of contractual construction should be applied by the court
to a standardised financial contract which is very widely used around the world?
Consider as part of your answer:

What if the usual rules of contractual construction were applied in a case between
two particular parties, resulting in a precedent which massively disrupted the
international markets?

Does it make sense for the court to try and find the ‘intention of the parties’ if the
parties are using a market standard contract drafted by a trade association?
2.
A year ago Barley Ltd and Maple Bank entered into a five year derivatives contract. This
was one of Maple’s new interest rate swaps.
Under the terms of the swap, Barley has to pay Maple a variable rate of interest on a
notional amount (£250 million) each month. This interest payment is calculated by
reference to a formula so complex it needs special software installed at Maple’s offices to
work it out each month (Amount 1). In return, Maple has to pay Barley a fixed rate of
interest on the notional amount each month. (Amount 2). In practice, Amounts 1 and 2 are
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netted so that only one sum is paid each month, depending if amount 1 is bigger than 2, or
vice versa.
Barley Co. is a very experienced international investment company which has extensive
positions in shares and bonds, but it has not used derivatives before. It intended this deal to
be an investment yielding an income over the 5 years, and it explained this to Maple. When
it became a client of the bank, Barley signed the usual disclaimers that it recognised that
investments can go ‘up or down’ and that it was not getting investment advice from Maple.
Before signing the derivatives deal Barley was given a long handbook about the deal,
including details of the formula to produce Amount 1, but Barley’s representatives did not
understand the first few pages so did not read the rest. At the signing meeting before the
paperwork was completed, one of the salespeople at Maple told a director of Barley that
this was ‘the deal of a lifetime’, and that other clients of Maple had signed up to similar
derivatives recently.
The deal has been a disaster for Barley so far, and it has had to pay £100 million to Maple
Bank. No one at Barley thought that the formula could have such drastic results and they
wish to terminate the contract immediately. Moreover, it turns out Barley was the only client
of Maple to take this product.
Advise Barley.
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Day 12 Financial law (2): Debt finance 25/7 JB
1.
Introduction
In the previous session we defined financial law and explored how contract law
underpinned the positions that market participants enter into. We also discussed unfunded
contracts called derivatives. The purpose of this lecture is look in detail at another area of
financial law, namely the law relating to debt finance. In particular, we will focus on loans
and bonds. Both these types of debt finance represent important examples of how
commercial contract law may work in practice.
The first part of the lecture will cover the background to the topic of debt finance,
contrasting debt and equity as means of raising finance and, within debt, contrasting loans
and bonds. The second part of the lecture looks at loans, in particular the facility agreement
between lender(s) and borrower, in more detail. The final part of the lecture discusses
bonds, explains some of the jargon associated with that market and examines the nature of
the contracts in place between the different parties involved in a bond issue and in the
secondary market.
Reading
(1) Background to debt finance
J. Benjamin, Financial Law (OUP, 2007) chapter 8
(2) Loans:
A. McKnight, The Law of International Finance, (Oxford: Oxford University Press, 2008) ,
3.1-3.14 inclusive and chapter 9 (not 9.2.5). [N.B. J. Benjamin, Financial Law (OUP, 2007)
section 8.1.2 (bank loans) and R. Cranston, Principles of Banking Law (OUP, 2002) chapter
11 both cover the same issues but in less detail.]
The LMA’s Guide to Syndicated Loans, especially section 3 (Parties to a syndicated loan).
http://www.lma.eu.com/uploads/files/Introductory_Guides/Guide_to_Par_Syndicated_Loans
.pdf
Raiffeisen Zentralbank Osterreich AG v Royal Bank of Scotland Plc [2010] EWHC 1392
(Comm) (attempt by a member of syndicate to claim that it had been induced to participate
by misrepresentations made by the Arranger bank).
(3) Bonds:
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Before the lecture, use the FT to find a recent article about a corporate or a
sovereign bond.
A. McKnight, The Law of International Finance, (Oxford: Oxford University Press, 2008),
chapter 10, with focus on sections 10.2-10.6 and 10.9.
P. Wood, The Law and Practice of International Finance: University Edition, (London:
Sweet & Maxwell, 2008), paras 11.01- 11.32 (comparison of loans and bonds)
Bank of New York Mellon v GV Films Ltd [2009] EWHC 3315. Case about an events of
default under bond documentation, which entitled the trustee to accelerate the payment of
bonds. The trustee was awarded summary judgment (i.e. judgment without a full trial).
Satinland Finance SARL and ar v BNP Paribas Trust Corp UK Ltd & Irish Nationwide
Building Society [2010] EWHC 3062 (Ch). Case brought by holders of subordinated bonds
against background of financial problems of the issuer (INBS) and government intervention
into its business.
The following are not required for the course but may be of interest:
S. Valdez, An Introduction to Global Financial Markets (Basingstoke: Palgrave Macmillan,
2007)
E. Ferran, Principles of Corporate Finance Law (2008, Oxford OUP)
2.
Background to debt finance
The basic purpose of the financial markets is to match borrowers in need of funds with
entities and individuals willing to lend them money on the promise of a return of some kind.
When creditors lend capital they are assuming a risk that the borrower will not repay them,
but in return they receive (usually) some sort of return, e.g. interest or a dividend.
Companies, governments, banks and public sector bodies like the European Financial
Stability Fund all rely heavily on debt finance. In 2010 alone, the British Government issued
£143,870 million in debt2 while UK listed companies raised £347,715 million by issuing debt
securities on the London Stock Exchange’s Main Market.3
Gearing (or leverage) is the ratio of debt to equity. A higher level of debt than equity is
regarded as desirable for companies in the interests of economic growth. However,
2
3
Table 4, The London Stock Exchange Main Market Statistics, December 2010
ibid, Market Summary.
77
sometimes gearing can become dangerously high. For example, before the US hedge fund
LTCM crashed 1998 its gearing reached 50:1.
2.1
Contrasting debt and equity

Examples

Income

Capital

Ownership

Ranking on a winding-up
However, note the convergence between debt and equity in the form of convertible bonds,
bonds with warrants and ‘equity’ tranches of bond issues.
You are in a position to provide funds to the following. Would you chose debt or equity?
 A new social media website set up by two undergraduates in London.
 A large UK-based supermarket chain
 A French clothing company which is looking to raise sterling in London in order to
expand into the UK.
2.2
Contrasting loans and bonds
Loans and bonds are both funded positions and types of debt finance. Some of the contract
terms in loans and bonds may look similar, for example both may include a ‘negative
pledge’. However, legally speaking and otherwise, there are some important distinctions
between them:
3.

Size of the potential investment pool

Nature of potential investors

Privacy v publicity

Documentation

Listing on a regulated market, e.g. the London Stock Exchange’s Main Market.

Regulatory treatment

Transferability
Loans
Bank lending ranges from overdrafts to very large syndicated loans made as part of
leveraged buy-outs. Because there is almost no public sector regulation which will protect a
lender extending funds to a borrower, any protections need to be negotiated and included
in the contract under which funds are lent. This means that lawyers acting for banks spend
78
a lot of time negotiating, drafting and approving the facility agreement before a deal is
signed and the funds drawn down.
3.1
Syndicated bank loans

Syndicated and bilateral loans. Why might a bank lend as part of a syndicate? What
are the advantages for a) the banks and b) the borrower of a syndicated loans?
What are the possible downsides?

Role of the Arranger and the Agent in a syndicated loan. Why should a bank take
on these roles?

In a syndicated loan the lenders have ‘several’ liability. Where would this leave the
borrower if one of the syndicate became insolvent?

Different types of loans reflect the needs of different borrowers, for example, term
loans and revolving credit facilities.
3.2
Facility Agreements
The facility agreement is the contract governing how and when the loan will be drawn down
and paid back with interest.

The role of the Loan Markets Association and how documentation is prepared in practice.

A facility agreement for a syndicated loan to a commercial borrower can be broken down
into those parts (1) governing the relationship between the borrower and lenders and (2)
other supporting provisions.

The borrower/ lenders relationship:

Operational provisions e.g. how and when money will be lend and repaid. The rate of
interest may be fixed or floating and will usually reference the London Interbank Offer Rate
(LIBOR) plus a margin of a certain number of ‘basis points’ (each 0.01%).

Clauses designed to protect the lenders’ margin.

Credit risk mitigation. This includes conditions precedents, representations, covenants and
events of default (see below).

Supporting provisions

For example, there will be provisions describing how lenders can transfer their share of the
loan to a new lender.

Why might a lender want to transfer its share of the loan? How as a matter of law
might a lender transfer its rights and its responsibilities under a contract to another
party? Will the borrower have to be informed?
3.3
Events of default
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Events of default are designed to protect the Lenders if something goes wrong, or threatens
to go wrong, with the Borrower. On the happening of an event of default, the Lenders
immediately have the right to stop lending and demand the drawn down funds back. Absent
events of default, the Lenders would have to rely solely on (1) their rights under contract
law, for example suing for breach of contract if the Borrower did not pay interest when due,
and (2) their rights under insolvency law as creditors. If this is the default position, why
might Lenders seek to improve their position?
Events of default usually include (amongst others):
- non-payment of sums due under the agreement
- breach of a financial covenant
- breach of the facility agreement
- misrepresentation
- cross-default (which is designed to give the Lenders the same rights as other creditors of
the Borrower enjoy under their contracts).
- insolvency
- unlawfulness
The consequences of an event of default are very serious for the Borrower. Usually the
Lenders can cancel the Borrower’s right to any sums not yet drawn down, declare that the
loan plus interest is immediately repayable and/ or put the loan on demand. Moreover, an
event of default may trigger cross-default clauses in other contracts which could have
devastating effects for the Borrower.
How might an event of default be ‘softened’ during negotiations, i.e. drafted to give
the Borrower breathing space to rectify matters before the Lenders take action.
Case study: Liverpool F.C.
The extensive contractual rights afforded to Lenders under loan agreements mean
that they can play a decisive role in negotiations about the Borrower’s financial
difficulties, restructuring or change of control.
Consider, for example, the role played by Lenders (including RBS and Wachovia) in
the recent litigation about the change of ownership at Liverpool F.C. Before its
takeover by New England Sporting Ventures (NESV), the club had over £300m debt.
As a result, the Lenders were closely involved in the dispute about the takeover bid
80
for the club in October/ November 2010. This culminated in RBS securing an
injunction preventing the then owners Hicks and Gillett making changes to the board
of the club with a view to preventing the sale. The sale to NESV finally went through
on 15 October 2010.
Despite all the protections built into the typical loan agreement, the Lenders may still end
up exposed if the Borrower and/or the Guarantor of the Borrower’s liabilities fail. In this
case, the Lender may look to sue another party such as the Arranger. There are a range of
possible causes of action here, including misrepresentation, breach of contract, breach of a
duty of care and even breach of fiduciary duty.
Consider Raiffeisen Zentralbank Osterreich AG v Royal Bank of Scotland Plc [2010] EWHC
1392 (Comm).
4.
Bonds
Bonds are a second type of debt finance and a type of capital market instrument. They are
issued by public companies, such as Tesco plc, sovereign entities, municipalities and even
by special purpose vehicles (SPVs) as part of complex structured products.
The bond market is huge, dwarfing the equity market. As noted, UK listed companies
issued debt worth £347,715 million in 2010 on the Main Market of the London Stock
Exchange. In the same year and on the same market, UK listed companies raised £19,306
million by issuing equity.4
4.1
What is a bond?
Bonds are debt securities which are issued in return for subscriptions made by investors.
After the initial issue, there is usually subsequent (secondary) trading in the bonds.
While the loan agreement will describe the circumstances in which the Lenders will make
funds available to the Borrower, in the case of a bond, the debt is ‘represented by and
encapsulated in the bond instrument itself’ (McKnight: 490) which is expressed as being
payable to the bearer. This is important in a number of respects. Most importantly, it means
that the person holding the bond is entitled to the interest and repayment of capital. This
makes transferability much easier than with a loan.
4.2
4
Jargon
Ibid.
81
What are the following?

Eurobond

Foreign bond

Medium Term Note Programme

Commercial Paper
The FT in January 2010 reported that ‘Investors snap up ‘Yankee’ bonds’. The article described
how ‘Non-US companies and banks have sold a record amount of dollar bonds in January, making
it the busiest month to date for the so-called ‘Yankee bond’ market. The lure of the US capital
markets reflects the huge pool of investors looking to buy dollar bonds …’5
What kind of bonds are ‘Yankee’ bonds?
4.3
A bond issue
We will briefly consider the stages of a bond issue, including the following:
•
Mandate
•
Working towards listing
–
[Why? quoted Eurobond exemption from withholding tax. Broader investment base]
•
Signing: Subscription Agreement and Agreement Amongst Managers
•
Closing: Listing effective
The bond terms and conditions are found:
- printed on the reverse side of the global bond (and the definitive bonds if they are issued);
- in schedules to the fiscal agency agreement or trust deed
- in the prospectus or listing particulars.
In several respects the bond terms and conditions mirror those in a loan. For example, there will be
Events of Default in both. However there will be important differences in the extent and nature of
such terms as between bonds and loans.
Do you think such terms will be drafted so as to be more onerous for the recipient of capital
in a bond issue or under a loan?
5
A van Duyn and N Bullock and R Milne, ‘Investors snap up ‘Yankee’ bonds’ Financial Times (30 January 2011).
82
4.4
Litigation
In the wake of the financial crisis, there have been several instances whereby noteholders have
gone to court to try to preserve their position as issuers have encountered financial difficulties.
However, the court is not always sympathetic to such attempts, especially if they would involve
‘side-stepping’ clear contractual terms:
Satinland Finance SARL and ar v BNP Paribas Trust Corp UK Ltd & Irish Nationwide
Building Society [2010] EWHC 3062 (Ch). This case was brought by holders of
subordinated bonds against the background of the grave financial problems of the issuer
(INBS) and government intervention into its business. The bondholders’ claims (seeking to
have trustee take enforcement action and present a winding up petition as regards the
issuer) were dismissed: there was no contractual basis in the bonds’ terms which justified
the action and there was no basis on which court could exercise its discretion to direct and
control trustees.
For an action brought by the trustee (on behalf of the bondholders) against an issuer on the basis
of a number of events of default, see :
Bank of New York Mellon v GV Films Ltd [2009] EWHC 3315. There were several events of
default under the bond documentation, which entitled the trustee to accelerate the payment
of bonds. The trustee was awarded summary judgment (i.e. judgment without a full trial).
Referencing these cases, what advantages can you see for bondholders in having a trustee
represent their interests?
83