Judgment - Total Gas Marketing Limited v. ARCO British Limited and Others  continued

(back to preceding text)

The contractual terms impinging of the dispute

      It is now necessary to describe in greater detail the terms of the contract so far as they are relevant to the dispute. The parties executed a Letter Agreement dated 15 February 1995 which provided for an agreement to execute a "Fully Termed Agreement" containing the terms of the Letter Agreement and otherwise substantially in the form of an annexed Draft 1 of an Agreement for the Sale or Purchase of Natural Gas. No further contractual document was executed but it is common ground that a binding contract was made on 15 February 1995. The Letter of Agreement provided that the agreement to be executed "shall include the conditions precedent detailed in Clause 2.8 of the Draft Agreement." Under the Draft Agreement the First Delivery Date is the date "on and from which National Gas produced from the Reservoir is first to be delivered to the Buyer." Because of the difficulty of specifying, far in advance, the exact date on which all arrangements will be in place to allow gas sales to begin, the contract contains a "funnel mechanism" whereby the Seller can select a first delivery date within an agreed "window." It works as follows:

     "2.1 (a) . . .

      (b) The First Delivery Date shall be within the period from 15 September 1996 to 15 December 1996 inclusive.

      (c) The Seller shall give the Buyer the following notices of the period within which the Seller expects the First Delivery Date will fall:

            (i) by 1 March 1996 a period of two (2) months falling within the period specified in Clause 2.1 (b) above; and

            (ii) by 1 May 1996 a period of one (1) month falling within the period notified under Clause 2.1 (c)(i) above.

      (d) The Seller will give the Buyer sixty (60) days prior notice of the First Deliver Date which date shall fall within the month notified under Clause 2.1(c)(ii) above.

      (e) In the event of the failure by the Seller to provide notice under any of Clauses 2.1(c)(i), 2.1(c)(ii) and 2.1(d) above, the First Delivery Date shall be the last Day of any period previously notified under Clause 2.1(c)(i) and Clause 2.1(c)(ii) above. For the avoidance of doubt, if no periods are notified by the Seller in accordance with Clause 2.1(c), the First Delivery Date shall be 15 December 1996."

      For convenience I will refer to a First Delivery Date which comes into existence as a result of a notice or notices by the Seller as "the selected First Delivery Date" and to the date, which becomes operative by default if no notices are given, as "the residual First Delivery Date." Substantively, I have to add that once a First Delivery Date is determined, it is fixed and cannot be altered except by agreement. Moreover, it is not a mere target date or starting point; it has a dispositive effect on the rights and obligations of the parties. Clause 2.7.2 is relied on by the Sellers. It reads as follows:

     "2.7.2 The Buyer may terminate this Agreement if deliveries of Natural Gas have not been made by the Seller for a continuous period of twelve (12) months other than as a result of an event (or events) of Force Majeure."

      The critical provisions of the Draft Agreement appear under the heading "Approvals, Consents and the Allocation Agreement." Those provisions read as follows:

     "2.8.1 This Agreement is conditional on:

       (i) the Seller securing all relevant approvals from the Secretary of State for Trade and Industry of a development plan for the Reservoir compatible with its obligations under this Agreement;

       (ii) the Seller receiving or procuring the receipt of all necessary consents for (a) the construction of the Delivery Facilities (including any modifications to the same required before the First Delivery Date) and; (b) the construction of additional facilities and/or modifications to or at the Delivery Terminal; and

       (iii) the Seller becoming party to the Allocation Agreement.  2.8.2.  The Seller shall use its reasonable endeavours to obtain the approvals and consents and become party to the Allocation Agreement referred to in Clause 2.8.1 above by 1 March 1996. . . .

       If the approvals and/or consents are not obtained by 1 March 1996, either the Seller or the Buyer may terminate this Agreement at any time thereafter provided that the Seller shall not be entitled to so terminate this Agreement if the Seller has not used reasonable endeavours to obtain any approval and/or consent which has not been obtained by such date."

      The contract contained an elaborate Force Majeure clause, which provided that if force majeure subsisted for a period in excess of 18 months during which period no deliveries of gas were made to the Buyer, each party would be entitled to terminate the contract by giving 60 days notice to the other party. The contract contained no arbitration clause but it did provide for a resolution of points of difference by a duly appointed expert.

The fate of the conditions precedent

      It is now necessary to relate what happened about the three conditions precedent. By 1 March 1996 the Seller had obtained the relevant approvals and consents specified in Clause 2.8, thereby complying with those two "conditions precedent." But the Seller had not yet become party to an allocation agreement. Under the "funnel mechanism" the Seller gave the following notices:

     (a) On 28 February 1996 the Seller advised the Buyer that the First Delivery Date would be between 1 October 1996 to 30 November 1996.

     (b) On 29 April 1996 the Seller advised the Buyer that the First Delivery Date would be between 1 October to 31 October 1996.

     (c) On 28 August 1996 the Seller advised the Buyer that the First Delivery Date would be 31 October 1996.

      Under the contract 31 October 1996 therefore became the First Delivery Date. Unfortunately, when that date arrived the Seller had not yet become a party to the allocation agreement. It is not alleged that the Seller was in breach of the obligation to use reasonable endeavours to become a party to the allocation agreement. But, by late 1996 there had been a downturn in gas prices and the Buyer decided to take advantage of the failure of the Seller to become a party to the allocation agreement to try to rid itself of a contract that had become unfavourable to it.

The proceedings

      By a writ issued on 10 January 1997 the Buyer sought a declaration that they were not bound by the terms of the contract. Jonathan Parker J. dismissed the Buyer's claim and found in favour of the Seller. By a majority (Peter Gibson L.J and Otton L.J) the Court of Appeal allowed the Buyer's appeal and held that the contract was discharged by reason of the fact that the Seller had not become a party to allocation agreement by 31 October 1996. Nourse L.J. dissented.

The issues

      On appeal to the House of Lord's the argument of the Buyer (the respondent) was that the Seller's failure to become a party to the allocation agreement by 31 October 1996 (the selected First Delivery Date) amounted to the non-occurrence of a condition which caused the contract to be automatically discharged. The Seller (the appellant) put forward three separate counter arguments. The first was that, despite the failure to conclude an allocation agreement, the contract was not brought to an end on the selected First Delivery Date (31 October 1996) or even on the residual First Delivery Date (15 December 1996). The Seller argued that the contract was merely suspended. This was the Seller's primary case and it was one which was in substance upheld at first instance by Jonathan Parker J. This argument was rejected by all three members of the Court of Appeal. Secondly, the Seller argued in the alternative to its primary contention that the contract could only be discharged if no allocation agreement was concluded by 15 December 1996. This argument was also rejected by all three members of the Court of Appeal. Thirdly, the Seller supported the reasoning of Nourse L.J. in the Court of Appeal. Nourse L.J. held that the condition requiring the conclusion of an allocation agreement had to be fulfilled within a reasonable time. He added:

     "I would therefore hold a reasonable time to have been such a period after the First Delivery Date as was reasonably required for it to be ascertained whether the allocation agreement would be concluded or not."

      In the result the House has been asked to consider and choose between four suggested interpretations of the contract.

Clearing the decks: The terminology and structure of Clause 2.8

      Before examining the rival arguments it is necessary to consider briefly the terminology and general structure of Clause 2.8. The contract provided for three separate "conditions precedent," viz in respect of consents, approvals and an allocation agreement. The word "conditions" and the phrase "conditions precedent" are used in a number of different senses in English law. Lewison identifies six current meanings of the word "condition": see The Interpretation of Contracts, 2nd ed., (1997), p. 389. This is a source of recurring confusion. But the prospects of persuading lawyers to adopt a more rational terminology are bleak. After all, as a distinguished commentator has observed, "there is probably no change in the law harder to achieve than one of terminology": G.H. Treitel "Conditions" and "Conditions Precedent," 106 L.Q.R. 185, 192. Fortunately it is possible in the present case to deduce from the contractual context with tolerable certainty what the parties had in mind by the use of the word "conditions" and the phrase "condition precedent."

      In civilian legal systems a condition is sharply distinguished from the actual terms of a contract. It is reserved for an external fact upon which the existence of the contract depends: see Cheshire, Fifoot, and Furmston, Law of Contract, 13th ed., (1996) 151. In English law a condition frequently means an actual term of the agreement. It is therefore necessary to distinguish between promissory and contingent conditions. Clause 2.8 is in promissory form insofar as it imposes a reasonable endeavours obligation on the Seller to secure the fulfilment of the conditions precedent. Nevertheless the three conditions operate contingently upon the non-occurrence of the contemplated events. The fact that in respect of approvals and consents Clause 2.8 provides for a bilateral option to terminate does not alter the basic contingent nature of the conditions. That brings me to what is meant by "conditions precedent" in the present contract. Traditionally, a distinction is made between conditions precedent and conditions subsequent. Given that one is dealing with contingent as opposed to promissory conditions, one can for present purposes say that a fact is a condition precedent to a contract for the creation of which it is necessary; and that a fact is a condition subsequent to a contract that it extinguishes: see Corbin on Contracts, 1960, vol. 34, s. 739; and the judgment of Stephenson L.J. in the Court of Appeal in Wickman Machine Tool Sales Ltd. v. L. Schuler A.G. [1972] 1 W.L.R. 840, 859E-G. On the other hand, "condition precedent" is sometimes used in the sense of a condition subsequent. That is not so surprising. The question is: condition precedent to what? And in this case the question can then only receive the answer: the operation of the contract.

      Clause 2.8 is, however, structurally incomplete. It explicitly provides for a right to terminate if approvals and consents are not obtained by 1 March 1996. But, although there was a reasonable endeavours undertaking to become a party to an allocation agreement by 1 March 1996, the consequence of that date passing without the Seller becoming a party to the allocation agreement are not spelt out. But, during oral argument counsel were in agreement that, if no allocation agreement was concluded by 1 March 1996, the Seller remained under an obligation to continue to use reasonable endeavours to become a party to the allocation agreement. Such an implication is plainly necessary to render the contract workable. It may be of significance when that implied obligation of reasonable endeavours terminates: on the selected First Delivery Date (3 October 1996), on the residual First Delivery Date (15 December 1996), or even thereafter. On this point there was no agreement between counsel. This is an aspect to which I will have to return.

Choosing between the four interpretations

      The question is which of the four interpretations put forward best matches the expressed contractual intent of the parties. This question must be considered in the light of the contractual language, the contractual scheme, the commercial context, and the reasonable expectations of the parties. And it must be judged as at the time of the conclusion of the contract, viz 15 February 1995. Approaching the matter in this way, I am satisfied that there are compelling reasons why two of the interpretations cannot be right, viz the Seller's primary construction and the construction upheld in the Court of Appeal by Nourse L.J. I will first explain my reasons for this view.

The Seller's Primary Submission: Only Frustration Ends The Impasse

      Counsel for the Seller contended that even if no allocation agreement is concluded by the selected First Delivery Date or by the residual Delivery Date (15 December 1996) the contract is not discharged. Counsel submitted that in the absence of the Seller becoming a party to the allocation agreement the contract will only be terminated by operation of law, viz by commercial frustration. Invoking the analogy of Clause 2.7.2 he suggested that a delay of 12 months after 15 December 1996 in the Seller becoming a party to the allocation agreement would frustrate the contract. He emphasized the fact that there is no explicit provision stating that non conclusion of an allocation agreement by a given date would discharge the contract. He pointed out the enormous sums expended by the Seller in anticipation of a commercial relationship intended to last some 14 years. And he stressed that the approach to the construction of such contracts must take into account the commercial need for flexibility. But in my view there are a number of reasons which cumulatively show that this argument is unsustainable. First, despite the deliberate use of the word condition precedent in regard to the allocation agreement, the argument contemplates that the contract will never be discharged under and by virtue of the contractual provisions. It contemplates that, subject to discharge by frustration, the contract is simply suspended and continues. Given contractual language redolent of conditionality, as well as the fact of the indispensability of an allocation agreement to any performance, this construction is prima facie implausible. The contractual language shows that the parties contemplated that under the contract a time would come when it was too late for the condition regarding an allocation agreement to be fulfilled, and that the contract would then be discharged. On the other hand, the construction put forward on behalf of the Seller treats the words "condition precedent", so far as it relates to the Seller becoming party to an allocation agreement, as devoid of meaning. It is true, of course, that there is no provision setting out the consequences of the non-occurrence of this particular contingent condition. But, in regard to contingent conditions, it is not necessary for parties when stipulating for a condition precedent or a condition subsequent to spell out the consequences of non-occurrence of the condition: these are prima facie inherent in the use of such terms: compare the observation of Lord Wilberforce in Wickman Machine Tool Sales Ltd. v. L. Schuler A.G. [1974] A.C. 23J, 262G which is unaffected by the difference of opinion in Wickman. In this legal context an interpretation which gives no effect to the words "condition precedent", so far as it applies to the allocation agreement, ought to be received with an initial sense of incredulity. Secondly, it is common ground that a reasonable endeavours obligation rested on the Seller to become a party to an allocation agreement even after 1 March 1996 if no such agreement was concluded by that date. This must be an implied obligation. It would be strange if such an implied obligation lasted beyond the residual First Delivery Date (15 December 1996). And it would make no commercial sense to say that, although the reasonable endeavours obligation to become a party to the allocation agreement would lapse at least on 15 December 1996, the contract would still continue beyond that date and could only be terminated by frustration. Thirdly, a suspension of the contract for 12 months after 15 December 1996 is commercially an inordinately long delay. But one cannot even be confident that, if no allocation agreement was in place, the contract would on analogy with Clause 2.7.2. become frustrated after 12 months. The analogy of the 18 months period under the force majeure Clause might be more appropriate. In any event, the doctrine of commercial frustration operates prospectively: the question of discharge is to be determined by reference to the time of the occurrence of the allegedly frustrating event, i.e. the non conclusion of the allocation agreement: see G.H. Treitel, Frustration and Force Majeure, 1994, 365-366. It is a matter of speculation how long a prospective delay would be regarded as sufficient to bring the contract to an end by operation of law. The judge would have to make a value judgment. The result would be uncertainty and unpredictability. Yet the Buyer, as a purchaser for resale in the domestic market, would have wished to know with certainty by a fixed date whether its agreement with the Seller is effective, or whether its supplies would have to be sought elsewhere. The Seller would have been aware of this fact. The primary argument of the Seller is therefore contrary to the reasonable expectations, which the parties must have shared. And the parties chose language which is apt to shut out the spectre of prolonged uncertainty. It shows that the parties wanted to know where they stood, and would not have wanted to await the uncertain outcome of a dispute as to frustration. For these reasons I reject the Seller's primary argument.

      For the avoidance of doubt I must make clear that my conclusion is entirely uninfluenced by the argument of the Buyer based on the decision in Aberfoyle Plantations Ltd. v. Khaw Bian Cheng [1960] A.C. 115, and in particular Lord Jenkins' canon of construction at p. 124 that "Where a conditional contract of sale fixes a date for the completion of the sale, then the condition must be fulfilled by this date". Having come to a conclusion adverse to the Seller on the language of the contract, Peter Gibson L.J stated that Aberfoyle and like cases gave by analogy some support for his conclusion. Like Jonathan Parker J. at first instance, and Nourse L.J. and Otton L.J. in the Court of Appeal I consider that there is such a vast difference between the simple situation under a typical sale of land and the complex position under a long-term contract for the sale of gas that the canon of construction extracted from Aberfoyle can provide no assistance.

      But, as I have explained, the primary argument of the Seller must fail on a proper contextual interpretation of the contract.

The construction of Nourse L.J.

      While counsel for the Seller formally placed before the House the construction adopted by Nourse L.J., he accepted in oral argument that it involves a test which in practice would be difficult to apply. It also finds no support in the language of the contract. I am afraid the contract cannot be upheld on this basis.

The real choice: Termination on the selected First Delivery Date or at the Residual Delivery Date

      My Lords, it follows that the contract would become discharged either by a failure to conclude an allocation agreement by the selected First Delivery Date (1 October 1996), or by the residual First Delivery Date (15 December 1996). Which date best matches the intention of the parties? This is a narrow but not entirely easy point on which my views have fluctuated. Counsel for the Seller argued that if the market had moved against the Buyer, the latter should not be prejudiced by an automatic termination prior to 15 December, simply because the Seller happens to have nominated an earlier First Delivery Date. Equally, he argued, if as happened the market moved against the Seller, it should not be prejudice as a result of notices given months earlier. Counsel emphasized the random nature of such results. These are considerations of some weight. But perhaps such results can to some extent be said to be inevitable in a provision for automatic termination in the event of non-occurrence of a contingent condition dependent on the will of a third party or parties. But, in any event, there are contrary considerations. Given the need to imply a continuation after 1 March 1996 of a reasonable endeavours obligation to procure an allocation agreement, the question arises whether that obligation terminates on the selected First Delivery Date (1 October 1996) or on the residual First Delivery Date (15 December 1996). It seems right to imply such an obligation only to the extent that it is necessary to render the contract workable. On this supposition the reasonable endeavours obligation terminated on the selected First Delivery Date. In these circumstances it would be curious to say that the contract continues after the obligation to use best endeavours to become a party to an allocation agreement ends. More broadly I agree with the submission of counsel for the Buyers that, for the purpose of the narrow issue under consideration, the straightforward commercial construction is that in the event of a First Delivery Date being selected the residual First Delivery Date simply falls away for all purposes. The natural interpretation is that the condition precedent regarding an allocation agreement is linked with the operative First Delivery Date viz the selected First Delivery Date or in default of one the residual First Delivery Date. While this issue was finely balanced, I have been persuaded that the Buyer's construction is correct. The contract was therefore discharged on 31 October 1996.