Default under a Trade Contract: Declaring It the English Way
2 August, 2024
776
Participants in commodity trade contracts often choose the law of England and Wales as the governing law.
English law attracts participants in commodity trade contracts due to its wide prevalence and authority. In fact, English law is the preferred governing law for business transactions worldwide, even for those with no geographical connection to the United Kingdom.
This is because English law is characterized by well-known, developed and authoritative case law.
In this regard, it is important to understand which principles and rules govern contractual relations in this jurisdiction.
Under the general principle of English law, contracts must be performed by the parties (pacta sunt servanda). English law doctrine provides that a contract may be terminated in several ways: performance; expiry; avoidance (restitution); frustration (further performance of the contract becomes meaningless); and termination and cancellation (termination due to circumstances that have arisen), with the latter two methods generally used as a consequence of a breach of contract.
A breach of contract under English law is the failure of one of the parties to a contract to fulfil its obligations, or the expression of an intention not to fulfil its contractual obligations. In the event of a breach of contract, a party has the right to declare the other party in default and claim damages.
Default is the failure to perform contractual obligations. Under the default procedure, a party may claim compensation for all losses arising from the default from the party that breached its obligations.
How to Determine the Date of Default?
Under the general rule set out in the Sale of Goods Act 1979 (sections 50 and 51), the damages of the innocent party in the event of a breach of contract by the other party are calculated as the difference between the contract price and the market value of the goods at the time the goods should have been delivered (accepted), or at the time of refusal to deliver (accept) the goods.
The mechanism of the default provisions in the standard forms of GAFTA (the Grain and Feed Trade Association) and FOSFA (the Federation of Oils, Seeds and Fats Associations), which are governed by English law, is virtually identical: the party declaring default must serve the corresponding default notice and then, depending on the terms of the contract and the form used, claim compensation for losses arising from non-performance of the contract. Under the general approach in the GAFTA and FOSFA forms, default may be declared by the innocent party at any time after expiry of the contract period/breach of terms, in which case the date of default is deemed to be the business day following the default notice. At the same time, certain forms, such as GAFTA 78 (contract for goods by rail), directly establish a cut-off date after which default occurs automatically if it has not been declared earlier.
Contradictions in determining the date of default arise where the party in breach declares itself in default “early” on its own initiative. In such a case, this statement will constitute a statement of anticipatory breach, and the date of such a notice will not be regarded as the date of default and, accordingly, as the date on which the innocent party’s damages are calculated. In this situation, as a general rule, the date of default will be the date of acceptance of such a statement.
How much time a party needs (and whether it needs any at all) to accept is a highly disputed and ambiguous question.
The precedent of Jonathan v Agnew [1979] 1 All ER 883 established a well-known principle of English law: if, after a breach of contract, the innocent party reasonably continues to treat the contract as still in force, damages may be assessed by reference to the price of the goods on the last day on which the innocent party terminates the contract.
The decision in Tai Hing Cotton Mill Limited v Kamsing Knitting Factory [1979] A.C. 91 also states that if a party agrees to and accepts the other party’s breach of its contractual obligations, the innocent party’s damages must be assessed as of the date of acceptance of the other party’s breach. But if the breach was not accepted by the innocent party, the damages must be assessed as of the end of the delivery period under the contract.
Based on our experience in English arbitration practice regarding trade contracts governed by English law, we can state that the date of default in fact depends on many factors, including the parties’ intent. For example, in one of our recent cases we managed to significantly reduce the amount of the default claimed by the counterparty against our client, because we were able to “clarify” the date of default declared by the counterparty.
The Default Clause and the Consequences of a Breakdown in Contractual Obligations
The standard forms of GAFTA and FOSFA contracts contain a clause defining the consequences of non-performance of obligations under the contract — the default clause. If one of the parties fails to fulfil its obligations, the extent of its liability and the consequences of such a breach must be determined in accordance with the terms of this clause.
Default clauses provide that, in the event of a breach of contract by the counterparty, the innocent party is entitled to declare default, namely to:
- serve a default notice on the party in breach;
- resell or buy back the agreed lot of goods;
- determine the price difference — the default price;
- claim compensation for the price difference and any additional losses.
When a party believes that the other party does not intend to fulfil its obligations and compensate for losses, it may initiate GAFTA/FOSFA arbitration proceedings. It is important to note that this requires the existence of a corresponding arbitration clause between the parties.
Why GAFTA/FOSFA Is the Best Arbitration Forum for the Trade Industry
GAFTA/FOSFA arbitration is the preferred instrument for alternative resolution of commercial disputes. It is distinguished by procedural flexibility, speed of dispute resolution, and relatively low cost. The GAFTA/FOSFA arbitration rules establish a minimum number of formalities and delays for the parties, which facilitates access to fair and prompt resolution of disputes.
It should be noted that, in order to refer a dispute to GAFTA or FOSFA arbitration, the parties do not need to be members of the respective associations. However, the parties must agree on this in advance. For example, if a contract is concluded on the basis of standard GAFTA/FOSFA forms, such forms already contain their own arbitration clauses, under which all disputes are resolved in the relevant arbitration tribunals.
However heated a dispute may become during arbitration proceedings, the parties always retain the right to settle the dispute amicably. In this case, the arbitrators will only require payment for the time actually spent.
Interlegal’s experience shows that around 80% of disputes do not reach arbitration, as the parties reach an amicable settlement.
In one of Interlegal’s recent GAFTA arbitration cases, the client’s counterparties were very reluctant to negotiate a settlement right up until the claim was filed. However, after receiving the claim, they promptly expressed a willingness to engage in dialogue in order to avoid additional costs for legal services, arbitration fees, and accrued interest.
If the respondent maintains its position in the arbitration and the tribunal issues an award following the proceedings, there are no problems with enforcing that award. The enforcement procedure is carried out in accordance with the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. As of today, around 160 countries are parties to this Convention and apply common legislative standards for the recognition of arbitral awards within their territory.
