Do termination for convenience clauses cap loss of profit claims?

A recent decision of the Scottish Outer House has considered whether a loss of profit claim for repudiatory conduct was capped by the notice period specified by a termination for convenience clause, which could have been operated by the defaulting party. The limiting effect of such clauses has been upheld previously, but this appears to be the first case in which the question has been considered in circumstances where the contract was affirmed by the innocent party, rather than terminated. The innocent party’s affirmation of the contract resulted in its loss of profit claim being preserved for the remaining life of the contract and is an approach worthy of consideration by other parties in similar circumstances.

Termination for convenience clauses as limiters of liability

A party terminating a contract for repudiation or otherwise for default by the other party will usually be entitled to compensation for loss of the contractual bargain. This will often take the form of a loss of profits claim for the remaining term of the contract. However, complications can arise where the defaulting party nonetheless had a contractual right to terminate for convenience. Is the innocent party still able to claim for loss of profits for the remaining duration of the contract on the assumption that the right to termination for convenience would not have been exercised?

The cases on this issue are not entirely consistent. In a previous Law-Now, we reported on a Commercial Court decision (Comau v Lotus Lightweight) which had taken a strict approach, finding that a termination for convenience clause eliminated a right to claim for loss of profit (for our Law-Now on this case, please click here). The court noted that to find otherwise would ignore the limited nature of the innocent party’s “expectation interest” in the contract: “[it] was never entitled to profits on the whole of the goods and services to be supplied pursuant to the Agreement but was only ever entitled to such profit as it might have gained prior to any ‘termination for convenience’.”

A somewhat different line was taken by the TCC in Willmott Dixon v London Borough of Hammersmith and Fulham. There, a factual enquiry was deemed necessary to determine, in all of the circumstances, if and when the defaulting party would have exercised its right to terminate for convenience (for our Law-Now on this case, please click here). 

A recent Scottish decision has considered these arguments in somewhat different circumstances.

Dalton Group Limited v City of Edinburgh Council

Dalton Group entered into a contract with Edinburgh City Council to be its exclusive purchaser of scrap metal. A dispute arose regarding the degree of contamination of the scrap being purchased – with Dalton alleging numerous incidents of hazardous gas pressurised cannisters being present in the scrap. There was an email exchange between the parties, following which Dalton claimed deliveries of scrap stopped, whereas the Council claimed Dalton refused to accept the scrap.

Dalton claimed that the Council had wrongfully repudiated the contract and brought proceedings to recover its lost profits over the remainder of the contract term. Before the court heard evidence to determine the issues, the Council raised a preliminary issue concerning the effect of a termination for convenience clause in the contract allowing the Council to terminate at any time by giving 3 months’ notice. Given the Council had this right to terminate, it argued that damages should be assessed by the least burdensome method of lawful termination and therefore limited to 3 months’ worth of loss of profit, rather than loss of profit for the time left to run under the contract.

In response, Dalton relied on the doctrine of election which gives a party faced with repudiatory conduct a choice to either (1) accept the repudiation and therefore treat the contract as terminated; or (2) affirm the contract and insist upon performance. Dalton claimed that it had affirmed the contract and had remained ready to accept scrap metal from the Council. Accordingly, Dalton argued that the contract had not been terminated and so the termination for convenience clause was irrelevant.

Termination for convenience clause not relevant

The court noted the well-established position that in an action for damages for breach of contract, the claiming party is entitled to recover damages which would put it in the position that it would have been in had the defending party fulfilled its contractual obligations. Where, therefore, the breach of contract consists of a wrongful termination, the claiming party’s damages “will be assessed on the basis that the defending party would have lawfully terminated the contract”.

In the present case, however, Dalton’s position was that the contract had never been terminated (whether lawfully or unlawfully), because it had not accepted the Council’s wrongful repudiation (in line with a party’s choice to affirm the contract when faced with a repudiatory breach). The court noted that the Council could have exercised the termination provisions of the contract, but chose not to. The court therefore concluded that “in a case where the contract has not been terminated, damages do not fall to be assessed by reference to the least burdensome method of terminating the contract.”

As a result, the Council faced a full claim for loss of profit, not limited to the notice period of 3 months specified by the termination for convenience clause.

Conclusions and implications

Whilst the court’s decision does not resolve the tension between the Comau and Willmott Dixon case, it provides a potential strategy for parties on the end of repudiatory conduct where the defaulting party has the benefit of a termination for convenience clause. Accepting the repudiation and bringing the contract to an end will allow the defaulting party to argue that its liability is limited by reference to the termination for convenience clause. Affirming the contract, however, will avoid this result and, depending on the circumstances, may allow the innocent party to preserve a full loss of profit claim as illustrated in the present case.

This decision also provides a good example of the importance of carefully considering contractual options whenever breaking ties with a contractual counterparty. It is apparent from the judgment that the Council will seek to defend the balance of the proceedings on the basis that Dalton had itself repudiated the contract by wrongly refusing to accept deliveries of scrap metal from the Council. If that were the case, there may have been a different outcome if the Council had notified Dalton that, in the event it was incorrect as to Dalton’s repudiation, it was also terminating the contract for convenience. That would potentially have limited any claim by Dalton to the 3 month notice period provided by the termination for convenience clause. 

More generally, it is important that parties take a step back and assess the broader implications of any significant breaches of contract alleged between them. It can often be difficult to determine if a party has repudiated a contract as opposed to merely breaching it. What is more, a party needs to be aware that its actions or inactions may innocently or carelessly terminate a contract, opening it up to costly legal consequences. For example, if a party is looking to terminate its contract early, it needs to be alive to key practical issues and clearly communicate its intention to terminate (in line with the contract provisions). Furthermore, if the party wants to prevent a breached contract from continuing, it needs to be careful not to inadvertently affirm the contract through conduct.

References:

Comau UK Limited v Lotus Lightweight Structures Limited [2014] EWHC 2122 (Comm)

Willmott Dixon Partnership Ltd v London Borough of Hammersmith and Fulham [2014] EWHC 3191 (TCC)

Dalton Group Limited v City of Edinburgh Council [2023] CSOH 4