Contracts Matter

The dispute concerned a marine insurance policy issued by the claimant insurer, MS Amlin Marine NV (the Insurer) to Bintan Mining Corporation (the Charterer and second Defendant) regarding the Charterer’s liability. The vessel was time chartered by King Trading Ltd (the Owner and first Defendant) to the charterer when it grounded in 2019. The Owner and its Protection and Indemnity Club (the Korea Shipowners’ Mutual Protection & Indemnity Association and the third Defendant), obtained and arbitral award against the Charterer exceeding US$47 million. The Charterer subsequently entered insolvent liquidation.

The insurance contract consisted of a policy booklet and a certificate. Part 1 of the booklet contained the insurer's indemnity against liability to third parties. Part 5 contained a "pay first" clause, which required the insured to pay any third party liability before it could claim on the indemnity.

The Insurer claimed that the clause meant that, as the Charterer had not and could not pay the award (as it was insolvent), the Insurer had no liability to the Owner and the Club, even if the Charterer’s liabilities passed to the Insurer under the Third Parties (Rights against Insurers) Act 2010. The Insurer issued proceedings seeking a declaration to that effect. The Commercial Court declared in favour of the Insurer: that the pay first clause was incorporated; was enforceable against the Charterer; meant that no indemnity was payable by the Insurer; and the clause survived the vesting, under the 2010 Act, of the Charterer’s rights under the Policy in the Owner and Club.

The Owner and the Club appealed on the grounds that the clause was inconsistent with the insuring clause; was an unusual or onerous term that was not fairly and reasonably brought to the attention of the Charterer (the red hand ground); and was not incorporated in the policy.

The Court of Appeal upheld the Commercial Court’s decision.

In relation to the commercial contract red hand doctrine, Sir Geoffrey Vos, Master of the Rolls, reviewed the authorities, stating that the principle is better described as the onerous clause doctrine, which “provides that, where a particularly onerous or unusual term of a contract (an onerous clause) is contained in one party’s standard terms, and where the other contracting party does not actually know of that term, it will not bind the other contracting party unless the party seeking to rely upon it shows that the clause in question (whether individually or as part of the standard terms) was fairly and reasonably brought to the other contracting party’s attention”.

Whilst acknowledging that some of the authorities suggest that a sliding scale applies so that the more onerous a clause, the more notice is required to be given to make it effective, he commented that he “would not formalise that as part of the onerous clause doctrine. It is sufficient to say that both the question of how onerous or unusual the clause needs to be and the question of what amounts to fair and reasonable notice are questions of fact and degree that the court needs to decide taking into account all the circumstances of the case in question. It is always unwise to lay down strict conditions for the application of simple principles, since one cannot predict the facts and circumstances of future cases.” He emphasised that the there is a high threshold to demonstrate that a clause is onerous or unusual in the first place, particularly in a commercial (rather than a consumer) context.

In this case, it was held that the pay first clause was not unusual or onerous. Caselaw and analysis showed that such clauses were common in marine insurance generally. Despite significantly limiting the Insurer’s liability it did not reach the high threshold of amounting to an onerous clause in an agreement between two commercial parties. While it was acknowledged that the location of the clause was not helpful to give a clear understanding of the cover under the policy, Sir Voss suggested that “the onerous clause doctrine could never be applicable in any normal case in which a party has its own professional broker or adviser acting for it in the transaction”. In relation to this ground, it was held that ultimately, this was a commercial contract between parties of equal bargaining power, in relation to which the court show be slow to intervene. As a result, the red hand ground of appeal was dismissed.

Beyond the context of marine insurance contracts, the decision clarifies the relevance of the newly restated onerous clause doctrine.

To avoid the possibility of a term meeting the high threshold of being held to be onerous, the case flags the importance of a party seeking to rely on an onerous term:

• ensuring that term is not hidden away and is clear in its effect; and
• insisting that a weaker party has professional legal advice.

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London Credit Ltd (LC) agreed to loan £1,881,000 to the third appellant, CEK Investments Limited (CEK), for a period of 12 months. The loan was secured by a debenture over CEK’s assets, personal guarantees from CEK’s directors and third-party mortgages over their family home and several buy-to-let properties. Following drawdown of the loan, LC alleged that a non-occupation covenant had been breached and demanded repayment of the full loan amount, plus default interest.

The main issue revolved around the default interest rate clause in the facility agreement, and whether it constituted a penalty which would render the default interest provision unenforceable. On the first occasion in the High Court, the judge concluded that the default interest did not protect any legitimate interest of LC and was therefore a penalty.

The Court of Appeal reversed this finding, holding that the judge had misapplied the Cavendish test and remitted the penalty issue for fresh determination. The Court of Appeal directed the court to determine "whether, having regard to the legitimate interest in the performance of the primary obligation, the default interest provision is extortionate, extravagant or unconscionable in amount or effect”.

At the start of this lengthy judgment, the judge considered that the events of default could be sensibly grouped into different categories of primary obligations, in order to consider the question of legitimate interests. A lender obviously has a legitimate interest in repayment interest – also in all representations and warranties being true and correct in all material respects (representations interest) and in enforcing obligations for the protection of the security (security interest). On this occasion (in contrast to the initial judgment), the judge also accepted that an unregulated lender has a legitimate interest in seeing a non-residence provision observed (non-residence interest). In principle, a lender also has a legitimate interest in primary obligations that go to preserve a borrower’s ability to repay the debt when due (credit risk interest). However, the judge considered that this is by far the most complex of interests identified, as the term ‘credit risk’ can cover different concepts.

The judge considered that maintaining conceptual clarity between the different interests is useful when it comes to applying the legal test. As Makdessi makes clear:

• the court must carry out the analysis at the point of formation of the agreement, when it is not known which primary obligation or obligations will be breached;
• where the same secondary obligation protects diverse primary obligations representing different legitimate interests in the same way that remains an “ indicia of penalty”; and
• if by reference to any primary obligation the provision is a penalty, it is unenforceable in its entirety.

The judge emphasised that the default rate in this case responded to a variety of defaults and so a variety of interests; if it was extortionate in respect of any of them, the clause fails in respect of all of them.

The initial judgment had determined that the credit risk interest was extortionate and therefore the clause was deemed to be a penalty. On this second occasion, after lengthy legal analysis, the judge determined that the credit risk interest was tied to the sensitivity of this particular re-financing and it was therefore not extortionate for LC to attach an above market default rate to the credit risk interest.

Having heard the expert evidence regarding commercial acceptability, the judge concluded the 4% rate was “plainly above the range of market rates but not, in itself, unreasonable," and when assessed against the repayment interest, it was "high, not extortionate" and therefore not penal.

• When drafting default interest provisions, it should be noted that where uniform rates apply to all events of default, each separate default must reflect a need to protect a legitimate business interest, otherwise the entirety of the provision fails.
• The decision confirms that credit risk considerations can justify default rates even for non-payment breaches, particularly where defaults might affect the defaulting party's creditworthiness or ability to meet its obligations. However, this issue is complex and will be fact specific.
• Expert evidence on commercial acceptability remains important, but rates at the upper end of market norms can only survive scrutiny where strong legitimate interests exist and parties with comparable bargaining power were properly advised.

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URE Energy Ltd (URE), a start-up electricity supplier, entered into an initial four-year supply contract with Genesis Housing Association in September 2017 with a view to securing a longer contract in due course. In February 2018, Genesis passed a resolution to amalgamate with Notting Hill Housing Trust, and the merged entity, Notting Hill Genesis (NHG), was formed in April 2018. URE was notified of the proposed amalgamation in March 2018 and raised no objection, continuing to supply electricity and invoice NHG for seven months.

The contract included provisions entitling URE to terminate in certain events, including (at clause 10.2(d)) the right to terminate if Genesis passed “a resolution for its winding up which shall include amalgamation... (other than a solvent amalgamation... approved in advance by the Supplier)".

Following a deterioration in the parties' relationship and NHG's withdrawal from negotiations for a long-term contract in October 2018, URE obtained legal advice and subsequently asserted that the amalgamation had triggered a contractual right to terminate under clause 10.2(d), claiming a termination payment of nearly £4 million. NHG contended that URE had lost its right to terminate by reason of the amalgamation, having affirmed the contract on numerous occasions.

The High Court held that URE had not waived its right to terminate and NHG appealed on points of law relating to waiver by election.

The Court of Appeal dismissed NHG's appeal, holding that URE had not waived its right to terminate because it did not know that it possessed such a right until shortly before exercising it. The court reaffirmed the principle established in Peyman v Lanjani [1985]:

"knowledge of the facts which give rise to the right to rescind is not enough to prevent the plaintiff from exercising that right, but he must also know that the law gives him that right yet choose with that knowledge not to exercise it".

Critically, the court held that the principle in Peyman v Lanjani applies equally to express contractual termination rights and is not limited to common-law rights such as rescission for misrepresentation. The court rejected NHG's argument that a party should be deemed, as a matter of law, to be aware of all the rights given to it by the terms of its contract, stating that "it would be unrealistic to expect the parties to carry in their heads" all such provisions.

The court also distinguished L'Estrange v Graucob [1934], clarifying that there is no rule of law that, for the purpose of the principle of waiver by election, a party is deemed to know the terms of its contract. Whether the party has the requisite knowledge is a question of fact.

• A party may continue to perform a contract following an event that triggers a contractual termination right without losing the ability to terminate, provided it is genuinely unaware that the relevant clause exists or applies to the circumstances. This affords some protection where termination provisions are complex or "buried" in detailed agreements. However, courts will be sceptical of ignorance claims and will have regard to the actual advice received by the party.
• Even where waiver by election does not apply, delay in exercising termination rights may still prove fatal. A contractual right to terminate may be construed as requiring exercise within a reasonable time, causing it to lapse if not exercised promptly. Also, if continued performance amounts to an unequivocal representation that the termination right will not be exercised, and the counterparty relies on this to its detriment, estoppel may preclude termination.
• The decision underscores the importance of flagging material termination provisions to clients at contract signature, particularly where clauses are complex or concern unusual trigger events. Parties should implement processes to monitor potential trigger events throughout the contract lifecycle to avoid inadvertently losing valuable rights.

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A Jordanian manufacturer, trading as Hitex, entered into a supply contract with Uniserve for the supply of face masks at the height of the Covid 19 pandemic.

Hitex experienced difficulties in meeting the agreed delivery schedule, which ultimately led to Uniserve purporting to terminate the contract. Hitex contended that Uniserve’s purported termination was unlawful and claimed damages for Uniserve’s failure to accept and pay for the goods as and when deliveries fell due.

The High Court found in favour of Hitex (albeit on a basis not contended by Hitex) and awarded Hitex over US$ 16 million. Uniserve appealed.

The Court of Appeal overturned the High Court’s decision, concluding that Hitex was not in a position to perform the contract and Uniserve was entitled to terminate. The related commission claim by Hitex’s agents was also dismissed.

In reaching its decision, the first issue under consideration by the Court of Appeal was whether Uniserve was entitled to rescind the supply contract for misrepresentation. The court upheld the trial judge's finding that Uniserve had not relied on pre-contractual representations about Hitex's production capacity; Uniserve knew that the representations were incorrect but decided to proceed anyway. The court observed that this was unsurprising given the acute demand for PPE during the pandemic, noting that Uniserve had contracted on terms enabling termination if its doubts about Hitex's performance proved well founded.

On the question of whether Uniserve had been entitled to terminate the supply contract, the court found that Hitex had not accepted Uniserve's repudiation, meaning the contract remained alive and Hitex remained under an obligation to comply with the revised delivery schedule. Applying the principle from The Simona [1989], the court confirmed that when a contract is kept alive following wrongful repudiation, it remains alive for all purposes.

Hitex's own evidence showed that 15% of its stock was reserved for the Jordanian government and therefore unavailable for supply to Uniserve. When this 15% reservation was properly accounted for, Hitex did not have sufficient stock available to meet its cumulative delivery obligations in June - July 2020, breaching obligations where time was of the essence. Accordingly, Uniserve was entitled to terminate the contract.

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• Contracting parties should clearly specify notification requirements for delivery and the point at which delivery is deemed to have occurred. In this case, the designation of delivery dates as being "of the essence" proved critical to Uniserve's entitlement to terminate lawfully when Hitex failed to meet its cumulative delivery obligations.
• A party that elects not to accept a breach as terminating the contract must continue to perform all of its own obligations.