Arnondo Chakrabarti, Jonathan Hitchin & James Partridge Allen & Overy LLP Terminating Contracts in an Uncertain World.

Arnondo Chakrabarti, Jonathan Hitchin & James PartridgeAllen & Overy LLP

Terminating Contracts in an Uncertain World

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Coming up…

Termination for breach (where no express provisions)

Express termination provisions - Events of Default MAC Event of Default

Market Disruption Clauses

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Do I have a right to terminate for breach?

Two separate issues Breach

Failure to perform a term or terms of the contract Remedy – damages for losses caused by breach of

the clause or clauses Repudiation

Manifesting an intention not to be bound Remedy – option to terminate prospectively and claim

damages for loss of the contract “Anticipatory breach” is not a case of breach at all

but, rather, of repudiation

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Do I have a right to terminate for breach?

The first step – classification of terms Condition Warranty Innominate terms

The types of repudiatory breach Breach of condition Serious breach of innominate terms Repeated other breaches in exceptional cases

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Options for the Innocent Party

Terminate contract and sue for loss of bargain Affirm contract – lose right to terminate

“No waiver” clause not sufficient to prevent affirmation by conduct (Tele2 International Card Co SA & ors v Post Office Ltd [2009] EWCA Civ 9)

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Risk of wrongful termination

Wrongful termination is, itself, a repudiatory breach For example

A has a loan facility with B Bank B Bank is in difficulty and it seems certain that it will be

unable to transfer funds on time Bridging finance will cost A £1m A replacement facility will cost A £15m B Bank’s profit on the facility is £20m If A sues on the breach alone he recovers £1m If A terminates with cause he recovers £15m If A terminates wrongfully, B Bank can sue for £19m

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Other ways of bringing contract to an end

Vitiation (eg. for misrepresentation or mistake) Frustration

Very narrow test – Davis Contractors Ltd v Fareham UDC

“Frustration occurs whenever the law recognizes that without default of either party a contractual obligation has become incapable of being performed because the circumstances in which performance is called for would render it a thing radically different from that which was undertaken by the contract.”

Automatic termination – no election required Must not be due to the act or election of the party seeking

to rely on it Expiration in accordance with terms of contract

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Express termination provisions

Two types of express termination clauses:

a) Failed performance (“Events of Default”)

b) Circumstantial events (“Termination Events”) eg. Insolvency

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Interpreting termination provisions

Do I have to give notice or can I terminate immediately?

Can I terminate for breach even if the breach is trivial?

What is a “material” or a “substantial” breach?

Can I still claim damages if I terminate?

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Interpreting termination provisions

Do I have to give notice before terminating?

Will depend on wording of contract

Generally:

Notice often not required if breach cannot be remedied

If can be fixed, usually have to give chance to do so – failure to rectify following notice adds to seriousness of breach

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Interpreting termination provisions

Can I terminate for breach even if the breach is trivial?

Garden Guardian case: a cautionary tale

Court rejected argument that “any breach” could cause the right of termination to arise

Alan Auld Associates: repeated minor breaches can be repudiatory if they deprive the innocent party of substantially the whole benefit of the contract

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Interpreting termination provisions

What is a “material” breach?

Not the same as a repudiatory breach

National Power – remediable breach likely to have serious effect on counterparty if not rectified

Dalkia Utilities – look at nature of breach – failure to pay three monthly instalments (out of 173) in a row was material

Why does “any breach” have to be a repudiatory breach while a “material breach” does not?

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Interpreting termination provisions

What is a “substantial” breach? Crane Co v Wittemborg – essentially the same as

repudiatory breach

So why is “substantial” any different from “material”?

Anticipatory breach was not a breach for the purpose of this clause

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Interpreting termination provisions

Can I still claim damages if I exercise contractual right of termination? Yes – but depends on construction of contract

Stocznia Gydnia v Gearbulk Holdings Ltd 2009 [EWCA]

Damages limited if breach is not also repudiatory:

Will recover loss suffered to date

Won’t get “loss of bargain” damages unless contract specifically provides for it

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Drafting tips

Be specific:

Breaches for which a party can terminate

What is meant by terms such as “material”, “substantial”, or “material adverse change”

Steps that are required to terminate (e.g. notice)

Consequences of termination e.g. damages for loss of bargain?

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Events of Default

Compared to termination clauses Variety of uses Material Adverse Change (MAC) clauses

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MAC Clauses

Types of clauses and their purpose Inherent uncertainty Relationship to frustration

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Business MAC

“Any event or series of events occurs which, in the opinion of the Majority Lenders, is reasonably likely to have a Material Adverse Effect.”

“Material Adverse Effect means a material adverse effect on:

(a) the business or financial coundition of any member of the Group or the Group as a whole;

(b) the ability of any Obligor to perform its obligations under any Finance Document; or

(c) the validity or enforceability of any Finance Document.”

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Elements of MAC clause

Adverse effect on what? A subjective test?

Paragon Finance v Staunton (2001)

What counts as material? What degree of certainty is required? What if event was foreseeable? M&A context – WPP/Tempus

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Practical steps

Document reasons for invoking MAC (eg. board minutes)

Compare borrower’s position at time agreement signed against position when seek to invoke MAC

Record alternative options Seek support of other lenders? Any other relevant provisions of agreement? (eg.

other Events of Default)

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Risks of invoking MAC

MAC clauses narrowly interpreted Burden of proof on party seeking to rely on clause Risk of breach of loan agreement Damages may include:

Losses from cross-defaults Cost of arranging alternative financing Increased cost of alternative finance Loss of business opportunities Loss of going concern value if borrower becomes

insolvent

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Conclusions on MAC

Consider actual wording Fact specific Getting it wrong could lead to large damages But leverage in negotiations

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Market Disruption

Market Disruption clauses in loan agreements - How do they work?

LIBOR does not currently represent the cost of funds of Banks

Current approach – are these clauses being invoked?

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Issues with the Market Disruption Clause

Reputational Risk? Practicalities for Facility Agent Competition Law concerns How is interest calculated where a market disruption

clause is invoked?

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Possible Solutions?

Lower the threshold Disclose only blended rates to borrowers A documented process for exploring appetite for

invoking the clause Use Reference Banks rather than Screen Rate Higher of a screen rate and a Reference Bank rate Adjustment to Screen Rate Reference to CDS spreads Increasing upfront margin

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Questions?

These are presentation slides only. The information within these slides does not constitute definitive advice and should not be used as the basis for giving definitive advice without checking the primary sources.

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