English & Welsh law recognises three types of contractual terms: conditions, warranties and innominate terms. A breach of a condition will cause termination of a contract. Breach of a warranty only entitles the innocent party to claim damages and does not give rise to a right of termination. Whether or not a party can terminate for breach of an innominate term will depend upon the drafting of that term, as examined in a recent Court of Appeal decision that we consider here:
The recent case of Ark Shipping Company LLC v Silverburn Shipping (IOM) Ltd (The “Arctic”)  addressed the issue of interpreting a contractual term and determining whether or not that term is a condition, a warranty or an innominate term.
Loosely, a condition is a term that goes to the “root” of the contract (and which breached would render the contract incapable of performance) and for which the innocent party can terminate the contract and claim damages for any loss sustained.
A warranty is a “promise” in a contract for which a breach only entitles the innocent party to claim damages (as termination is not an available remedy).
An innominate term is a term that cannot be clearly defined as either a condition or a warranty – and this is where the courts may often have to step in and interpret an innominate term and adjudicate upon whether or not such a term is a condition.
The Arctic case referred to above concerned a shipping contract and ultimately a dispute over whether or not a term within the contract was to be construed as a condition or as an innominate term. Ultimately, based on a number of factors, the Court of Appeal decided that the term in dispute was not a condition and was in fact an innominate term, rendering the attempted termination by Silverburn Shipping (IOM) Ltd wrongful.
Whilst contractual mercantile and shipping occupies its own corner of English & Welsh law, the decision in the Arctic case gives a good general insight into the courts willingness (or, perhaps more appropriately, reluctance) to interpret contractual terms. The Court of Appeal helpfully set out a number of questions (some relevant to mercantile and shipping law) to consider when determining whether a term of a contract is a condition or an innominate term.
However, the overarching issues that the Court of Appeal considered were:
- Was the term clearly labelled as a condition – either by its wording or as part of Conditions Precedent?
- What is the type and ultimate effect of the breach?
- What is the value of the contract and what would be the consequences of allowing termination for breach of a condition?
Termination is ultimately a “nuclear” approach and the courts, most recently reiterated in the Arctic case, have been reluctant to affirm a termination attempt and are, perhaps more importantly, reluctant to adjudicate retrospectively upon the respective parties’ intentions. This is a factor that becomes more relevant as the value of the contract increases – as the courts will assume that, in a contract of significant value, the parties’ will have spent considerable time negotiating the terms of the contract prior to executing it.
However, the implications of the Arctic case still have relevance to “smaller” agreements. It is important that, when you are negotiating the early stages of an agreement, that you ensure that any conditions should clearly be marked as such.
Furthermore, it is common for termination clauses, when referring to material breaches, to make reference to specific clauses that, if breached, would allow the innocent party to terminate the agreement. Both clearly demarcating a term as a condition and including specific reference and including breach of a specific clause as giving rise to a right of termination can avoid ambiguity when determining which terms are conditions and which are innominate terms.
What does the Arctic case mean for some businesses?
However, this is not always a commercial possibility. If there is ambiguity as to whether or not a term is a condition, and you wish to terminate a contract due to a breach of that term committed by the other party, you should ensure that the breach by the other party has rendered the contract incapable of performance. If there is any suggestion that the breach does not substantially adversely affect a term that goes to the “root” of the contract, you could be at risk of a wrongful termination and a claim for damages brought against you by the other party. Accordingly, terminating contracts is a tricky area in which specialist advice should be sought.