Impact of Fundamental Breach on Contract Exception Clauses: Photo Production v. Securicor, Study notes of Law

Download Impact of Fundamental Breach on Contract Exception Clauses: Photo Production v. Securicor and more Study notes Law in PDF only on Docsity! CASE COMMENT PHOTO PRODUCTION LTD. v. SECURICOR TRANSPORT LTD., [1980] 1 All ER 556 The House of Lords in this case once again had an opportunity to clarify an issue which has bedevilled the law of contract for some time, namely the relationship of the doctrine of fundamental breach with discharge by breach, and more particularly its effect on exception or limitation clauses. The facts which are somewhat amusing may be stated briefly. The plaintiff company, a factory owner, entered into a contract with the defendants, a security firm, whereby the latter were to provide secur­ ity services at the factory including night patrols, principally to protect the premises from theft or fire. However whilst carrying out such a patrol one night, an employee of the defendant set fire to a pile of car­ tons with the consequence that the entire factory burnt down. It was not however established whether the latter consequence was an intended one or not. The plaintiff sued for £615,000 damages, being the total value of the factor"y and stock, on the grounds of breach of contract, and/or negligence, the defendants being vicariously liable for the acts of their servants within the scope of their employment. There was no doubt that the defendants were prima facie liable but they pleaded (inter alia) both an exception clause and a limitation of liability clause which were as follows: 1. Under no circumstances shall the defendant be responsible for any injurious acts or default by any employee ... unless such act or default could have been foreseen and avoided by the exercise of due diligence on the part of the defendant ... nor in any event shall the company by held responsible for: (a) any loss suffered ... through fire or any other cause, except insofar as such loss is solely attributable to the negligence of the defendant's employees.... 2. If notwithstanding the foregoing provision, any liability on the part of the defendant should arise. . . such liability shall be. . . limited to a maximum of £25,000 for the consequences of such incident involving fire. . . . No negligence was alleged against the defendants. The trial judge Case Comment 115 held that the defendants were entitled to rely on the exception clause. The Court of Appeal ([1978] 3 All ER 146) reversed his decision, holding· that there had been a fundamental breach of the contract by the defendants which precluded them from relying on the exception clause. It was held by the House of Lords, present Lord Wilberforce, Lord Diplock, Lord Salmon, Lord Keith of Kinkel, and Lord Scar­ man, that there was no rule of law by which an exception clause in a contract could be eliminated from a consideration of the parties posi­ tion when there was a breach of contract (whether fundamental or not), or by which an exception clause could be deprived of effect. The question therefore whether an exception clause applied when there was a fundamental breach, breach of a fundamental term, or any other breach, turned on the construction of the whole of the contract, including the exception clauses. Their lordships were thus emphat­ ically restating the view of the majority in Suisse A tlantique Societe d'Armement Maritime S.A. v. Rotterdamsche Kolen Centrale ([1967] 1 A.C. 361). To understand the controversy which has raged in this area of the law it is perhaps convenient to start with the decision of Lord Denning in Harbutt's "Plasticine" Ltd. v. Wayne Tank & Pump Co. Ltd. ([1970] 1 Q.B. 447). That was also a case of fundamental breach, being defined as a breach going to the very root of the contract which either automatically terminates the contract, or at least gives the inno­ cent party the election of discharging it. The Master of the Rolls was of the opinion that where the contract was terminated following a fun­ damental breach, then it was settled law that the innocent party could sue for the breach unimpeded by the exclusion clause; notwithstand­ ing that on its proper construction the clause concerned would have excluded liability for the breach that occurred. Lord Denning in reaching such a conclusion was purporting to follow the House of Lords in Suisse A tlantique but it is clear that this was the view of only a minority of their Lordships in that case, namely Lord Reid and Lord Upjohn. This so called 'rule of law' that, where the breach is fundamental and the contract is not affirmed, the court will itself deprive the guilty party of the benefit of the exception clause whether it covers the breach or not, has a long and established history. It began with the deviation and quasi-deviation (bailment) cases, and more latterly has been applied to a wide variety of consumer contracts by the English Court of Appeal led by Lord Denning, who has nurtured and developed this rule despite the protestations of the House of Lords. One of the early authorities for the doctrine is the House of Lords decision in Hain Steamship Co. v. Tate & Lyle Ltd. «1936) 41 Com. Cas. 350). Here deviation of a ship was said to be a fundamental 118 Auckland University Law Review In commercial matters generally, when the parties are not of unequal bargaining power, and when risks have normally been borne by insurance, not only is the case for judicial intervention undemonstrated, but there is everything to be said ... for leaving the parties free to apportion the risks as tney think fit and for respecting their decision. Furthermore the decision does not mean that the courts are reduced to a state of impotence when confronted with widely drawn and possibly unfair exclusion clauses. As was pointed out by Coote «1970) C.L.J. 221, at 238) there is in existence an imprecise array of inter­ pretative devices for containing exclusion clauses, including the contra preferentum rule, the repugnancy rule, and the exclusion of negligence from the operation of such clauses. It must also be remembered that as a matter of construction (adopting the wide concept of 'construc­ tion' enunciated by Lord Denning in Photo Production v. Securicor Transport Ltd.) it will not often be the case that the parties can be said to have intended that the exclusion clause would excuse liability for a fundamental breach of the contract, or a performance totally dif­ ferent from that contemplated. While it is clear that Suisse A tlantique and Photo Production Ltd. v. Securicor Transport Ltd. have over-ruled cases such as Karsales (Harrow) Ltd. v. Wallis, Harbutt's HPlasticine" Ltd. v. Wayne Tank & Pump Co. Ltd., and Farnsworth Finance Facilities Ltd. v. Attryde, there remains the problem of what to do with the deviation cases. Have they also been over-ruled so that the application of an exception clause after a deviation is also a matter of construction, or are they sui generis and should therefore be allowed to stand as a special case for historical reasons? Lord Atkin in Hain Steamship Co. v. Tate & Lyle Ltd. felt that deviation fell within the ordinary law of contract. This view seems to be echoed by Lord Wilberforce in Photo Productions Ltd. v. Securicor Transport Ltd. Perhaps these cases can be reconciled with the construction rule by saying that, since the deviation is such a gross misperformance of the contract (as often insurance contracts will no longer cover the voyage), it cannot have been contemplated by the parties that the exclusion clauses would apply to the new adven­ ture. I will conclude this article by discussing briefly how the two approaches, construction and rule of law, stand with the theory of contract law, and in particular discharge by breach. Now it is clear that the discharge of the contract following a breach (whether fun­ damental or not) occurs after the breach and does not operate retros­ pectively to some time before the breach. This means that at the time of the breach the contract, including any exception clause, was valid and subsisting. Consequently it is hard to see how there can exist a rule of law that the guilty party cannot rely on an exception clause in the case of a fundamental breach leading to the discharge of the contract, Case Comment 119 because at the very point in time the breach occurred the contract was still operative. It must be further borne in mind that even where the contract is not affirmed, it is only discharged in respect of future obligations, and not terminated or ended absolutely. Even Lord Den­ ning conceded the point in Harbutt's "Plasticine". Furthermore the effect of discharge by breach may depend on what the courts conceive to be the function of an exclusion clause. If it is to operate merely as a procedural obstacle to a suit for damages then it has been argued that it cannot be relied upon since the contract together with the exception clause has been discharged after the breach. However this analysis assumes that when the parties exclude or limit liability for breach, the liability is one imposed at the point of adjudication. But a much more natural interpretation is that the liability concerned accrues at the moment of the breach (See Coote, loco cit. at 232). At the moment the contract is still in existence, and even on the view that exception clauses are mere procedural bars to recovery of damages, it is hard to see why the clause would not be operative. Another view is that exception or limitation clauses modify the obligations of the contracting parties. Thus an exception clause will modify the primary obligation of the contracting party for whose benefit it was inserted, and a limitation clause will modify the second­ ary obligations of the guilty party to pay damages in the event of a breach of one of the primary obligations. On this theory the exclusion clause will have the effect of preventing what would otherwise be a breach of a promise (or primary obligation) entitling the innocent party to discharge the contract from being a breach at all. This accords with the comments of Lord Wilberforce in Suisse Atlantique where he said: (at 431) An act which, apart from the exception clause, might be a breach sufficiently serious to justify refusal of further performance, may be reduced in effect, or made not a breach at all by the terms of the contract. It is this approach which found favour with Lord Diplock in Photo Productions Ltd. v. Securicor Transport Ltd. His Lordship recog­ nised that the contracting parties are free to determine for themselves what primary obligations they will accept. He further recognised that the secondary obligation to pay damages in the event of a breach of a primary obligation can be modified by agreement between the parties. Discussing exclusion clauses he was of the opinion that they could exclude or modify obligations whether primary or secondary, that would otherwise arise under a contract or by implication of law. Applying the above theory in the instant case Lord Diplock found that the exclusion clause modified the primary obligation of the defendant to liability only for a failure to exercise due diligence in 120 Auckland University Law Review their capacity as employers. Since this was not alleged the claim of the plaintiffs had to fail. It will be seen therefore that this theoretical view of the function of exception clauses squares nicely with the construc­ tion approach to fundamental breach and its effect on such clauses. If accepted that these clauses modify the obligations of the parties, it is clear that this would be inconsistent with any rule of law disentitling the guilty party from relying on the exclusion clause in the event of a fundamanental breach, since on a proper construction of the clause it is possible that the event complained of may not be a breach at all. It is submitted that there can be no doubt that the rule of law approach has been over-ruled in favour of the proper construction of the exception clause. However the deviation cases may have to remain as an anomalous exception for whatever reasons. It is hoped that their Lordships latest pronouncements will sound the death knell of the doctrine of fundamental breach, that is the substantive rule of law that in the case of such breaches an exclusion clause cannot be relied on by the guilty party. Coote submits that the doctrine should remain where Suisse A tlantique left it, decently interred (loc. cit. at 238). The ball is now in Lord Denning's court. DAVID PLUNKETT JOHNSONv. AGNEW, [1979] 2 W.L.R. 487. The plaintiffs contracted to sell properties to the defendant pur­ chaser, in order to pay their mortgagees. The defendant failed to com­ plete, and although the plaintiff obtained an order for specific performance, it proved abortive. The plaintiffs' mortgagees enforced their security by selling the properties, but as the proceeds were insuf­ ficient to discharge the mortgagees, the plaintiffs now sought an order that the defendant pay the balance (the difference between the price the defendants had agreed to pay and the actual price received on the sale) to the mortgagees. The Court of Appeal discharged the order for specific performance and awarded damages in lieu. The House of Lords however said that damages were available at common law. Specific Performance and Discharge for Breach Lord Wilberforce who delivered the Lords' judgement overruled the unfortunate decision of Capital & Suburban Properties v. Swycher ([1976] Ch. 319) and affirmed the older and more sensible decision of Austins of Eastham Ltd. v. Macey ([1941] Ch. 338). A plaintiff who Case Comment 123 for which it stands. His Lordship overrules the case because it was in fact a case for discharge for breach and not rescission, and therefore damages should have been available. While this may be correct, the principle of the case as it has been subsequently understood must be correct, Le. where a contract is rescinded ab initio, damages for breach are not a possibility because there is no longer any contract to refer to. This is surely logical and is accepted without question in America. Note: Mr David Poole is presently writing a dissertation on Equitable Damages, and the present writer is completing a thesis on conditions, which includes a chapter of some forty pages on discharge for breach. STEVEN DUKESON Ed. Note: The House of Lords has recently reconsidered the question of discharge for breach in Photo Productions Ltd. v. Securicor Transport Ltd. as to which see the previous case note. Mr Dukeson has asked that his comments on this area of the law be considered in the light of the decision in that case. Re BOND WORTH LTD [1979] 3 All ER 919. This case although only at High Court level has important implica­ tions for commercial lawyers attempting to secure "purchase-money" finance without the necessity for registration; and also serves as a warning against poor drafting. Monsanto Ltd. supplied synthetic fibre on credit to Bond Worth Ltd., the buyers, each separate delivery to constitute a separate con­ tract. The terms were that risk passed on delivery but "equitable and beneficial ownership" was to remain with the sellers until full pay­ ment or prior resale. In the latter event beneficial entitlement was to attach to the proceeds. Further if fibre was made a constituent of or converted into other products, the seller was to have the same' 'bene­ ficial" ownership of the goods or proceeds thereof. The buyer spun the purchased fibre to produce yarn, which in turn was processed and woven into carpet. Once spun it was inseparable and indistinguishable from other fibre. Bond Worth Ltd. became insolvent owing £587,000 under contracts with Monsanto Ltd. The latter claimed to be able to trace into the yarn and carpet and the proceeds therefrom. Moreover they contended that they were a beneficiary under a trust, or alter­ natively they held an equitable charge which they did not "create", and which was not registrable under section 95 Companies Act 1948 (U.K.), (section 102 Companies Act 1955 (N.Z.». The buyer claimed that Monsanto Ltd. had only a charge which was void in the cir- 124 Auckland University Law Review cumstances of section 95. Slade J dealt first with the incorporation of the "special conditions" including the "beneficial ownership" clause into the separate contracts. The importance of his judgment arises when he turned to consideration of that clause, and the legal effect, if any, it was capable of having. Several points were clear: (a) they were absolute contracts for sale; (b) legal property passed when the fibre was delivered and not just a special property; (c) risk also passed then; (d) it was not intended to reserve to the seller all rights enjoyed by a sui juris person having sole beneficial title to property as against a trustee, e.g. the seller couldn't call for redelivery while the buyer had far reaching rights to deal which were not normally possessed by a trustee; (e) the buyer could resell and pass good title. This goes beyond section 27(1) Sale of Goods Act 1908 (N.Z.) which does not authorise the sale between the buyer in possession and his vendor; (f) it was intended that on sale the equitable ownership would attach to the proceeds; (g) the buyer was entitled to use them for manufacture; (h) it was intended that on manufacture the seller would have equitable owner­ ship in the new goods, but that the buyer could resell them and pass good title. The equitable ownership would then attach to the proceeds. Since property had passed the contract could not constitute a bail­ ment or agency, but had to confer on the seller an equitable interest if any. Obviously the rights conferred on Monsanto Ltd. were not hypo­ thec or in re aliena but were in re propria under a split ownership. Equity has never recognised that where total ownership is vested in one person he has a "dual" ownership, in the sense that he may trans­ mit his equitable interest free 9f the legal dominium. An equitable claim is recognised in equity because of the relationship which exists between two persons, and while equity will recognise a "split" owner­ ship to effect good conscience,e.g. the mortgagor's equity of redemp­ tion, or purchaser's equitable interest, nonetheless it is only by a declaration of trust that a full owner may consensually cause equitable recognition of his transmission of beneficial rights to another. (Where a person already owns the beneficial but not a legal ownership he is free to alienate it without the necessity of trust since here equity follows the law.) Thus the contract here must have been a declaration of trust, and on the plain meaning a trust whereby the seller was the sole beneficiary. Slade J felt however that he was entitled to regard the contract as a whole, and since the whole purpose of the clause, when viewed objec­ tively, was to afford security for the payment of the purchase price, the plain meaning was displaced. Since a person may create a charge over assets by declaring he holds them in trust for a creditor by way of security for a specified debt that alternative possibility seemed more Case Comment 125 likely. This conclusion was supported by two arguments; first that any contract which by way of security for payment of debt confers an interest in property defeasible on repayment must necessarily be regarded as creating a mortgage or charge. The existence of the equity of redemption is quite inconsistent with the existence of a bare trustee­ beneficiary relationship. Secondly all the characteristics of a mortgage or charge as enumerated by Romer LJ in Re George Inglefield Ltd. ([1933] Ch. 1, at 27-28) were present. The mortgagor was entitled to get property back by repaying money (the right to redeem); the mort­ gagee where he realises more on the sale of the property than owed has to account for the surplus; the mortgagee where he realises less than owed on sale may sue the mortgagor for the balance. Slade J then considered whether the trust by way of security was to take effect as an equitable mortgage or a charge, but while considering the latter more likely felt that there was no practical distinction here since both were a charge within the meaning of section 95. Logically he should have considered the next point first, that is, was this a simple disposal of the legal title and the equity of redemption so that the balance of the beneficial ownership always remained in the seller, and thus he did not "create" the charge under section 95. Slade J dis­ tinguished Re Connelly Bros Ltd. (No.2) ([1912] 2 Ch. 25) on the grounds that it was not concerned with a buyer-seller reservation of title but was a case where the buyer took the ownership of the goods on trust to give effect to a third party's rights; and where the real issue was equitable priorities. After considering the authorities Slade J found that there was no authority to the effect that on a sale the buyer can expressly exempt an equitable title or charge to secure unpaid pur­ chase money; and following Capital Finance Co. Ltd. v. Stokes ([1969] 1 Ch. 261 at 277) he held that the correct conveyancing pro­ cedure was a sale and grant back. Wilson v. Kelland ([1910] 2 Ch. 306) which was not cited may have been an authority in favour of reserva­ tion, but the judgment of Eve J is so short and difficult to fathom that grave difficulties exist in contending that he went further than finding a bone fide purchaser of a legal interest takes free of prior equitable interests without notice. At least in the case of a charge it is obvious that reservation is not possible since the hypothec rights are not ownership rights and only arise because a charge has been given. Thus the seller only has a charge by definition when he has rights against not in another's property and I while that property is not in the chargor he can have no rights against it. He may of course have a contractual obligation to have or give a charge but this goes to the question of competing equities with third I parties and not "split ownership" questions. With a mortgage the mortgagee's rights are of a mixed hypothec character but to some