David Lowe: Welcome to our commercial contracts podcast, where we are going to look at a case bringing together a contracts lawyer of new draft contracts – that is me, David Lowe – with a lawyer who specialises in disputes.
Andrew Smith: That is me, it's Andrew Smith.
David: And today we are going to look at a case, a logistics contract called Kemball and K Line. So Andrew, what is all this about?
Andrew: Well, it is an interesting case, David, and whenever a lawyer says it is interesting, you have always got to be slightly worried, but it is a good case because it helps one to understand some of the pitfalls of termination. It also helps with some pretty interesting drafting points, which can help you not to talk to somebody like me, i.e. a litigator, get you out of the problem before it arises.
David: Yeah, and I found it interesting for all those reasons. Also the fact that it felt like a kind of contract that I might have drafted and it felt like the kind of dispute I see our clients having which, you know, many contract law cases you are sort of looking, well, I would never have done that anyway. And so yeah, this is Kemball and K Line, so a recent case and it is about a transport contract where there was a minimum order quantity, so it was a three-year contract and in each year the customer needed to buy a certain number of jobs and the customer decided towards the beginning of year three that due to a restructuring, it was not going to be able to purchase the minimum level of jobs, and it told the supplier, and the supplier was not very happy, was he?
Andrew: No, it was not and I think seeing that it was about to lose £12 million worth of turnover to its business for the next year it kind of was very quick and, as we will talk about, too quick to decide that that was a, you know, really bad breach of the contract, which entitled it to terminate and essentially what it wanted to do was monetise that £12 million of loss in litigation.
David: And I guess if the supplier, you know, not having read the contract, that was not an entirely unreasonable reaction, £12 million worth of business being taken away, that is a three-year contract, surely the customer should be obliged to in some way to finish the contract or if they are not able to do so, that is a breach and I can terminate? That would be a reasonable, instinctive reaction if you had not bothered to read the contract.
Andrew: Yes, or if you had not read the contract carefully enough, which is what this case is really about, which is you have got to make sure that your contract is drafted correctly but also that if you are going to push the big red shiny button with 'termination' on it that you have really understood what your rights are.
David: OK, so the supplier goes for termination and goes for claiming £12 million, how did that unfold?
Andrew: Not very well for the claimant, is I think the simple answer to that. So in relation to this case, their biggest problem was that there had not been a breach, let alone a breach that entitled them to terminate. But just before we go into the reasons for that - which is more your work - I would like to talk about, you know, the idea of termination, because it gives us an opportunity to look at a case and perhaps assist in other matters that our clients might have in relation to deciding whether to terminate, and how to terminate, and really termination can be one of two ways. You can either terminate for a breach so serious that it just entitles you the sort of… a general right in law to terminate because it is a fundamental breach of the contract, or you can terminate because the contract itself gives you an express right to do so. They are very different things and in this case, although actually the claimant had no right to terminate at all, it also made the mistake of trying to terminate on one narrow ground and there was a lot of argument in the case as to whether in fact it could terminate on different bases. And the lesson there is, number one, make sure you have the ability to terminate, fairly obviously, but secondly if you are going to terminate, try and make the termination notice as broad as possible, preferably with alternatives, which as most of us know lawyers love – 'if it is not this, it is that, and if it is not that, it is the other'. Try and terminate in a way that covers as many bases as possible because termination is not easy anyway and you do not want to shoot yourself in the foot.
David: And when you, you talked about those two ways of terminating, one in accordance with the contract, so that would be your normal clause that usually says 'party can terminate due to a material breach' or whatever, but the other non-contractual right, that general right, you talked about a fundamental breach, I think that is what is known as… well, that is the repudiatory breach, is it not?
Andrew: That is right. It is such a… it goes to the heart of the contract and therefore entitles you to terminate. An example would be declare… the other side declaring an intention no longer to be bound by that contract at all.
David: Right, so in this case, if there had a been a breach, let us imagine there was a breach, and let us imagine it was a big breach, probably the claimant should have been advised to try and terminate for both reasons and preserve all legal rights to see what then evolves so that you are in a stronger position.
Andrew: Indeed, and maybe not even just the two reasons, lawyers love to have three, or four, or five.
David: Well, I noticed even that the judge picked up on another reason they could have terminated for which they did not even plead, so you know, the judge even spotted lots of other options in this one. OK, so the advice that is the people who are terminating contracts due to breach, you really need some level of legal advice to make sure you go off in the right direction and do a broad terminations right, but not so broad to shoot yourself in the foot.
Andrew: Yeah, and talking of shooting, it is… deciding to terminate is a dangerous… it is an extreme sport. So it is a bit like a Mexican stand-off like in Reservoir Dogs, if you decide to terminate and pull the trigger and you go off half-cocked, or it fails to fire, the real problem is that you get your own head blown off, because essentially if you get a termination wrong you yourself have committed the repudiatory breach we talked about earlier, because you are saying the contract is no longer going to carry on and the other side can claim damages over you, so it fires up in your face basically.
David: And that is what happened here, didn't it?
David: Because the judge found that there was no breach of contract and therefore there was no entitlement to terminate for any reason whatsoever. And I sort of found that interesting, because before I read the case, and before I read the contract it refers to, I was sort of instinctively expecting, well, there is a minimum order quantity and there is a breach of that – well, that is a breach of contract. Because normally in a contract with minimal quantity it says 'this is the minimum order quantity in a year', and it will say that is an obligation into the contract and therefore if you fail to order that quantity that is a breach. Now there might be a debate whether it is material or not, or a fundamental breach, but it is a breach. What I found really interesting about this case is actually the minimum order quantity clause wasn't a simple one which then said "that is a breach". It said "if you fail to order so many jobs" which is the wording in the contract, then there is a formula that then worked out how a shortfall payment is calculated. So a really nice, clear, well-drafted payment mechanism that said 'if x happens, then you will pay us y'. And the customer in this contract who had said "I can't" had volunteered to the supplier, had he not…
David: … that "hey, I realise I owe you some money under clause 'blob' to pay under this formula but I am not in breach", and the judge read that, read the contract as a whole and said "yeah, that is exactly what was intended. It makes sense to me that you have anticipated this thing happening and you set out a consequence and therefore no supply… I disagree with you, there is no breach of contract. The mechanic works and you are owed a shortfall amount of whatever thousand pounds that will be".
Andrew: So essentially the contract drafting saved the customer from a breach of contract situation, which in normal circumstances probably would be, so it does (and you know I do not like to say this, David) it does show your value in some shape, manner or form!
David: [Laughs] Well, I do my best to keep my contracts out of your hands, Andrew, after all! Yeah, I mean I think there is an interesting point because firstly there is a very clear payment mechanic and I think that the key drafting point for everyone on this is; if you have got a contract with a minimum order quantity, say what happens if it is not reached because it makes it so much easier. I had a recent dispute where it did say 'if you fail to meet the minimum order quantity then you will then have to pay us the full amount that you would have paid us anyway', and then when the customer tried to dispute that one, they had nowhere to go. So be clear about what the consequences are, be clear whether it is a breach, or as in this case, whether there is a payment mechanic.
The other thing in this contract which really nailed them was the fact they used the words "sole and exclusive remedy". So not only is there a payment mechanic, it expressly said "and this is a sole and exclusive remedy", and the judge seized upon that, did he not? He said 'Oh, there you are'. He makes the point, this is intended to be how… what happens when this happens, trying to claim breach is rubbish, it is irrelevant.
Andrew: And indeed even if there had been a breach, which there was not in this case, termination is a remedy in the law. And therefore if the sole and exclusive remedy was this payment mechanism, as you have just described, then termination does not come anywhere in it. So even if there had been a breach, they could not have called it a material breach and been able to terminate.
David: The judge did not have much time for the supplier to claim that that was not a commercial interpretation, did he?
Andrew: No, he did not because, and rightly, and you often see this in cases. Commerciality is an important factor in the interpretation of contracts, but it is as at the date that the contract was entered into, and as we all know truth can be stranger than fiction, you know, all kinds of weird and wonderful things can happen within contracts that the parties at the time they entered into the contract had not envisaged. The judge's job is to decide what a reasonable person would have understood the contract to mean at the time it was entered into, and what may appear to be slightly uncommercial when the weird and wonderful happens does not mean to say that that risk allocation for the unknown – do not want to sound like Donald Rumsfeld and you talk about unknown unknowns!
Andrew: But, you know, that is the point, you have to interpret it in an objective manner but as at the date of the contract.
David: Yeah, so from a trial of course you have the benefit of hindsight and so what you are not meant to be bringing that, are you? You are meant to be saying "did this make sense at the time they signed the contract?" And this clearly did, it is so well… I mean, it is a really well-drafted contract, is it not, which is unusual.
Andrew: So was it… there is another element, which although academic because as we have just described the judge found that there is no breach but there was a bit of, another piece of very clever drafting in relation to the termination provisions, the consequences of termination provisions which you see quite a lot in contracts. And David, did you find that bit interesting because it was quite unusual, was it not?
David: Yeah, definitely. So the judge went and looked at the consequences of the termination clause. Now when you are drafting a contract, you are starting to glaze over a bit when you get to that clause, you know, it is the clause that says "if this contract is terminated, it is terminated and the confidentiality clause will continue to survive and you will pay the invoices", and all this kind of stuff and you do not really think too hard about that. You have already done the hard work in drafting a contract by that point and there is usually a bit of boilerplate in the consequences of termination clause that will say something about clauses that survive termination. And there are lots of different ways people do, sometimes they list the clauses, sometimes they just say "any clause that expressly or implicitly survives termination". And so what is interesting about this case is the judge went and looked at that clause and noted that this particular clause referred only to those expressly stated to survive termination. So it did not have, 'or implicitly', it just had 'expressly' and the judge said 'well, if in this case the supplier had had a good reason to terminate and had done so then that means the minimum order quantity shortfall language would not survive because it was not expressly stated to survive termination and therefore if that had happened' – so lots of 'ifs' now, have we not? – if there had been a breach and if that had allowed the supplier to terminate then having done that, if there was a shortfall they could have sued in damages because the shortfall wording had not been expressed to survive termination.
And I read that with sort of slight alarm bells because I am thinking, 'oh well, I usually glaze over and though I had really properly checked that I had listed all the right clauses' and of course what you normally see is a list of clauses or any other clause that implicitly survives termination and if this contract had that wording it would have had a different comment from the judge.
Andrew: Yeah, I suppose actually thinking about it, although the claimant lost because there had been no breach it could not terminate, this particular clause works in its favour, or at least potentially, because the way the judge interpreted it, because that 'sole and exclusive remedy', the mechanism for payment of a sum, if that fell away as a result of the termination, then the claimant could have claimed just general damages and those losses often are much greater than a set sum.
David: Yeah, so interesting, but the customer survived for another day. So from my point of view, Andrew, the issue that I think was interesting in this case is; if you have got a contract with minimum order quantities, do draft to say what happens next. In this case it was drafted well and properly and it worked and in particular those words 'sole and exclusive remedy' worked. And then the other thing I had taken as a drafter is the survival point that we have just been talking about. That when you list out the clauses that survive termination, add on, and those clauses that are implicitly stated to survive termination, that implicit might well just rescue you in a dodgy situation. So they are the two points I would take from it, what are the two points you have for it?
Andrew: I think my main ones are on termination. Although it was somewhat academic in this case, I think it was a very useful reminder that if you think that you have a right to terminate you have got to think very carefully - so the Reservoir Dogs point I was making before. If you get it wrong, it goes horribly wrong for you, so you have got to take stock, you have got to think about it. Dare I say, take legal advice before you make that decision. And then the second point would be, once you have decided, if you have decided to terminate, make sure you get the termination notice right. It is a minefield frankly in terms of making sure that you cover off the way that you want to terminate. There is this repudiatory breach point, then there is a termination under the clause of the contract point, or better still as the judge suggested in this case, why not do both, one in the alternative to the other?
David: Great. We have also got a client alert on this topic, it is on our website if you want to read and understand the case. Thank you very much for listening to this commercial contracts podcast and if you enjoyed it you can subscribe to our newsletter and other podcasts on our website. Thank you.