In the first article for the Baltic Briefing’s ‘Legal corner’, Holman Fenwick Willan LLP provides insight into a demurrage dispute with a significant outcome.

By
Holman Fenwick Willan LLP,

MSC v Cottonex [2015] EWHC 283 (Comm)

The Dispute

This was an everyday dispute with a very significant outcome.

The receiver of a shipment of containerised cotton failed to take delivery at the discharge port in Bangladesh. Disputes raged behind the scenes between the receiver and its bank. The result was that the containers languished on the quay and the Carrier looked to the Shipper (who was also the seller of the cotton) to pay demurrage in accordance with the terms in the relevant BLs. The Shipper refused to pay (it had been paid for the cotton by the bank under an LC, and so no longer had title to either the cotton or the containers) and it looked to the Carrier to take the necessary steps to recover their containers. The Carrier responded by saying that the Bangladeshi customs authorities would not permit anyone to remove the containers while the dispute between the receiver and its bank was ongoing.  The result was an impasse in which the containers remained stuck at the port with no immediate prospect of their return to the Carrier. 

In an action in the Commercial Court, the Carrier claimed that demurrage continued to run for as long as the containers remained unreturned – an accrued debt of more than $1 million and counting. It was common ground that the containers themselves were worth no more than about $100,000. 

The Judgment

In an important judgment from the Commercial Court, Leggatt J concluded that once on demurrage not always on demurrage.

Instead, it was held that demurrage ran only up to the point when the Shipper made it clear that it would not pay (i.e. the moment the Shipper repudiated the BL contracts). The judge considered that thereafter the Carrier had no legitimate interest in keeping the BL contracts open, i.e. the Carrier could not claim demurrage indefinitely. In short, out of the demurrage claim of in excess of $1 million (and counting), the Shipper was found liable for only $90,000.

Good Faith

In coming to its conclusion, the Court identified the “increasing recognition in the common law world of the need for good faith in contractual dealings“. In effect, “a contractual discretion must be exercised in good faith for the purpose for which it was conferred, and must not be exercised arbitrarily, capriciously or unreasonably“.

Whilst the concept of good faith has so far developed in the context of the exercise of an express contractual discretion or option, Mr Justice Leggatt held that the concept and line of authority should apply equally to the exercise of an option to terminate the contract.

The confirmation of the increasing importance of the concept of good faith in commercial contracts is extremely important, and the industry needs to be aware of it.

No “legitimate interest”

In reaching its decision, the Court found that there was no duty to mitigate in the context of demurrage clauses (going against the views expressed by the authors of Voyage Charters, amongst others).  It followed that in order for a right to claim demurrage to come to an end, there must be a repudiation or frustration of the contract.  In the present case, it was held that once it was clear that there was “no realistic prospect of the Shipper being able to arrange for any of the containers to be collected” and the delay in collecting the goods had become “so prolonged as to frustrate the commercial purpose of the venture“, the contract had been repudiated.  Thereafter, the question was simply whether the Carrier had a “legitimate interest” in keeping the contract alive and claiming demurrage, as opposed to terminating the contract and claiming damages.   

The Court found that at all times following the date the Shipper repudiated the contract, the Carrier had no legitimate interest in continuing the contract, as it was not suffering any loss as a result of the Shipper’s breach. In the words of Mr Justice Leggatt:

“In these circumstances I conclude that the Carrier had no legitimate interest in keeping the contracts of carriage in force after that date in order to continue claiming demurrage.  Its election to do so, and to go on doing so ever since, can in my view properly be described as wholly unreasonable. It is wholly unreasonable because the Carrier has not been keeping the contracts alive in order to invoke the demurrage clause for a proper purpose but in order, in effect, to seek to generate an unending stream of free income.” 

Lessons learned

This case is significant, and will have important ramifications beyond just the container market.  First, the decision that there is no duty to mitigate in the context of a demurrage clause is significant, and contrary to the view expressed in leading textbooks.  It remains to be seen whether the judgment of Leggatt J will be the last word on that important issue.

Secondly, the judgment provides helpful guidance as to the circumstances in which the right to claim demurrage will come to an end, and the scope of the “legitimate interest” principle.  The Judge’s elucidation of the relevant principles in this regard will have implications for the whole of the law of contract. 

Finally, the emphasis placed on the concept of “good faith” in the judgment is of note.  All in the industry, from containers to bulk, will need to check that their demurrage provisions and standard procedures withstand good faith and penalty clause scrutiny. The judgment also serves as a reminder to Shippers of their potential demurrage exposure in the event receivers default.

Prepared by Holman Fenwick Willan LLP (solicitors for the Shipper) for the Baltic Briefing