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Damages for underlap in time charters: Three subversive suggestions

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Chapter 6

Damages for underlap in time charters

Three subversive suggestions

Professor Andrew Tettenborn*

We have just lived through a seemingly interminable period of fragile finance and the flaccid freight rates that go with it. All this has, as one might expect, taken its toll on shipping, at its best a volatile business not well suited to the faint-hearted. In particular, the events of the last few years have led to a plethora of cases of charterers dropping charters as if they were hot potatoes. No wonder, then, that the remedies available to owners left in the lurch by such conduct have in turn become extremely significant, and lawyers who know about such things correspondingly in demand.

Two high-profile developments immediately come to mind. One is an increased interest in the owner’s right to eschew damages and just sit back, keep the charter going and (assuming the Charterer is not actually insolvent) watch the taximeter ticking up a debt claim with no further effort on his part; witness the controversial, and at the time surprising, decision in Isabella Shipowner SA v Shagang Shipping Co Ltd (The Aquafaith)1 in 2012. The other, this time due to the activism of charterers’ representatives, is pressure on the courts to scrutinise damage claims much more carefully, take full account of any advantages to owners, and thereby avoid compensating mere paper losses. This is illustrated by the Court of Appeal’s decision in Globalia Business Travel SAU of Spain v Fulton Shipping Inc of Panama (The New Flamenco)2 at the end of 2015, allowing charterers to argue that, albeit guilty of blatant breach, they had done the owners a big favour by freeing up the vessel and allowing them to sell her before the market entirely collapsed – thus saving themselves a very tidy sum indeed.3

But both these matters have been very competently covered already:4 and in any case the latter decision has been reversed by the Supreme Court,5 so there is no call at this stage to say anything definitive about it. As a result, this paper will look at three more low-key but still vital matters concerning damages for early redelivery (referred to for brevity as ‘underlap’).6 These are (1) the place of an available market in computing the owner’s compensation; (2) the time during which loss of profits can be claimed; and (3) the relevance of termination clauses to claims for damages for lost profits. In all three of these areas, it is submitted that some unorthodox suggestions may be in order.

6.1 Damages for breach of a charter: the place of an ‘available market’

If you ask a shipping lawyer about the measure of damages for underlap, or for its sibling, repudiation by the charterer before initial delivery, the orthodox view is simple. Compensation is quantified by analogy to damages for non-acceptance in sale of goods cases, which as everyone knows are presumptively set at price less value in cases where there is an available market (and if there is not at the estimated loss directly and naturally resulting, in the ordinary course of events, from the buyer’s breach).7 Thus if there is an ‘available market’ in charters at the time of the redelivery or accepted repudiation, you take the difference between the market and contractual rates at that time and project it over the rest of the charter,8 where necessary factoring in the prospect of the vessel going temporarily off-hire.9 The fact that the actual hire lost is smaller or larger is irrelevant: the former because an owner letting a vessel for more than the going rate is speculating at its own risk and deserves to keep any resulting profit, and the latter because an owner failing to take the opportunity to charter out at market rates has not properly mitigated its loss.10 We thus have (the theory goes) a simple rule, easily applicable by arbitrators, neatly bypassing the messy and time-consuming business of demanding proof of would-be income and the loss of it. Only where there is no available market, or where special issues such as consequential losses arise, do we fall back on forcing the owner-claimant to demonstrate his loss as best he can.11

This view may look plausible. But it is suggested that the closer one looks at it, the less beguiling it becomes. There are serious difficulties with regarding charters of ships as a sort of surrogate sale of units of a ship’s time, to be treated in law in much the same way as the disposal of a parcel of soya beans or a shipload of groundnut expellers.

The first reason is that charters are not like bulk commodities, where within reason a glance into cyberspace12 will yield an immediate spot price for almost anything. On the contrary: with time – and voyage – charters ‘available markets’ are very much the exception.

For one thing, just as the idea of an available market in sale of goods law predicates ‘sufficient traders who are in touch with each other to evidence a market’,13 thus excluding cases where there are only a handful of buyers for unwanted goods,14 so also with charters. There must be numbers of potential disponent owners and charterers able to interact so as to produce a fixture price based robustly on supply and demand.15 But this is not very likely with a ship left high, dry and unemployed, often in a location thoroughly inconvenient to owners and potential charterers alike. In such cases the courts have understandably declined to infer the existence of an ‘available market’ from the fact that it might be possible after prolonged haggling to fix the vessel with someone, somewhere.16

Again, and perhaps more importantly, an ‘available market’ implies general interchangeability between the subject-matter of the sale and that of the market. This fits bulk commodities perfectly: one 2016 Paranaguá soya bean from Brazil is hard to tell from another. But the same does not go for charters. Most of these are actually bespoke, as regards terms, trading limits, and duration. The relevance of this to available markets was made abundantly clear in The Kildare,17 in which a long-term charter to carry iron ore from Australia to China succumbed to the recession when the charterer refused to go on with 4½ years still left. David Steel J’s reasons for saying that this was not an ‘available market’ case were telling:18

If it existed the relevant market must have been for a 4½-year consecutive voyage/time charter on equivalent terms (other than freight/hire) for the carriage of bulk cargo including iron ore and coal. One question that arises is whether the requirement for equivalent terms includes broadly the same trading limits (i.e. Western Australia/China) or whether fixtures for the Brazil/China route would be material. In my judgment, in order to categorise the replacement fixture as a market substitute, the trading limits should broadly correspond with the existing fixture … Of course, if seeking to mitigate his loss, an owner might seek to charter his vessel for service on different routes, but such would not be by way of replacement on any relevant available market.

This is indeed a demanding criterion. But it is exacerbated by yet a further requirement. It has been decided that the available market must exist at the time of termination; a later available market is irrelevant.19 This matters. If a charterer is going to throw up a long-term fixture, in practice this is most likely to happen precisely when demand is weak to non-existent; when finding another charter is difficult, if not impossible; and hence where the chances are overwhelming that there is no market. Two cases at first instance encapsulate the point. In The Kildare,20already mentioned, a charter to carry raw materials from Australia to then-booming China was abandoned in the global collapse of 2008–09, when there was unsurprisingly no market of any kind. The fact that a year or so later some sort of fledgling market had established itself was ruled irrelevant. Again, in The Wren,21 where a three-year newbuild charter was repudiated after a few months, a revived market coming into existence some time later was ignored and the case treated as a ‘no market’ case.

Markets for charters are thus surprisingly uncommon beasts. But there is a further problem with the supposed ‘market rate’ rule. This is that, even assuming there is an ‘available market’, using it to compute underlap damages creates its own anomalies. To begin with, except for charters repudiated ab initio, it does not compare like with like. Imagine a five-year charter repudiated with two years to run. The orthodox measure requires us to compute the difference between two years at the agreed rate and two years at the market rate for a two-year charter. But the agreed rate is a rate appropriate to a five-year fixture, while the market rate to be subtracted from it refers to a two-year one. And these are not the same thing at all. Depending on whether rates are thought likely to rise or fall, you will pay more or less per day, as the case may be, for a five-year than for a two-year fixture. If more the owner will be under-compensated: if less, over-compensated: it will receive ‘proper’ market compensation only in the rare instances where rates are predicted to be steady in the long term. Furthermore, where a charter has some time to run it is hard to see any justification in logic for limiting the ‘available market’ rule to cases where the market exists at that time. After all, unlike a one-off contract for the sale of goods a charter is a continuing contract;22 and however appropriate a ‘breach date’ rule may be in the former case it is difficult to see why it should apply in the latter. As the losing counsel pointed out in The Wren,23 the arguments raised in favour of supplanting proof of loss with a market comparison – ease of computation, mitigation and causation of loss – would apply just as much to a subsequent available market. As it is, we have a situation where entirely different means are used to compute an owner’s loss according to whether a market exists at termination or only springs up shortly afterwards.

The suggestion I wish to make is simple. Little would be lost, and much simplicity gained, were we to abandon the ‘available market’ presumption altogether. It is a presumption which, for one reason or another, is often inapplicable anyway. When it is invoked, it is normally by an owner which despite being let down by a charterer has managed to hire out its ship at more than the going rate, and therefore wants to be over-compensated: a plea which is not noticeably meritorious.24 In so far as it is invoked by a defendant charterer to reduce damages, the work it does can be more easily, and straightforwardly, done by mitigation. In short, save perhaps for accepting that the going rate is some indication of what might have been obtained in the absence of clear evidence, there is much to be said for treating owners in a case such as this like other contract claimants and saying to them ‘Go prove your loss.’

6.2 The period over which damages are quantified

Imagine a time charterer paying $20,000 per day who repudiates the arrangement when it still has seven months to run. There is no available market, and for the owner left with an awkwardly-placed ship the only practical re-charter at that time is a one-year fixture at $16,000. On the other hand, had the old charter run its full course there would have been no difficulty at fixing the vessel again on redelivery for a reasonable time at the then going rate of $20,000. There is no doubt that damages here will be based on a figure of $4,000 per day ($20,000 – $16,000). But is the relevant period seven months or one year? In other words, is the award based on the difference between the rate agreed and the rate obtained capped at the duration of the unexpired fag-end of the charter, or may it take account of post-termination losses too?

Orthodoxy suggests the former solution: that is, a cap on recovery. Wilford, for instance, states simply that the ordinary measure of damages for early redelivery is the difference between the charter rate and the market rate, if lower, for the remainder of the charter period during which the Charterer was obliged to pay hire.25 As for the decisions, they seem at first sight to agree with this view. To begin with, take two 1980s cases on voyage charters, The Concordia C 26 at first instance and The Noel Bay27 in the Court of Appeal. In both a charterer failed to come up with a cargo; in both, damages were set at the difference between the freight lost and the freight actually earned on the replacement voyage organised by the owner. Importantly, however, it was decided that if the latter voyage occupied the vessel for longer than the former would have done, the relevant figure for damages was the difference between the would-be original freight and that proportion of the new freight corresponding to the duration of the original voyage.28 Exceptionally there might be an upwards adjustment if further loss was suffered, for example if the vessel was worse placed for future employment than she otherwise would have been,29 but this did not affect the basic measure of damages. Admittedly these were voyage charter cases: but in The Great Creation30 in 2014 Cooke J extended the reasoning in them to time charters. A vessel under charter at about $18,000 per day was redelivered 12 days early. Two days later, the owner, in an impeccable attempt to mitigate, concluded a much more lengthy trip charter at a nominal rate of about $22,000 per day, but which yielded an effective figure of about $13,500 because of the need for an unproductive voyage in ballast to the new delivery port. As it happened, however, the unproductive voyage took up the rest of the old charter period. His Lordship held the correct award of damages to be 12 days’ charter hire, rejecting an argument that losses beyond the end of the original charter could be in account:

The fact that an owner may act reasonably in accepting a lower ‘prompt’ rate does not however, in a case such as the present, in my judgment, mean that the period for which damages are claimed will ordinarily extend beyond the missing period of contractual notice which must be seen as analogous to the late redelivery position in The Achilleas. At the time of concluding the charter, liability for the difference in rates of follow-on fixtures, hypothetical and real, for their duration however long that might be, would not be in the contemplation of the parties.31

In addition to the authorities just cited, it is worth mentioning one further theoretical argument in favour of the orthodox position: namely, that a more open-ended liability might have the perverse effect of making a time charterer who throws up a charter worse off than one who does nothing at all, gives no orders and simply pays hire on a laid-up ship.

Nevertheless, despite everything that has just been said, it is suggested that there are good reasons to doubt the soundness of the supposed limitation of damages by reference to the unexpired charter period.

First, it is not clear how such an artificial limitation fits in with the general rule in contract damages, that losses consequential on breach are claimable, provided only that they are not too remote. Indeed one instance, accepted in the voyage charter cases,32 is the need to reposition the ship if she is redelivered in an inconvenient place: a rule which, it seems, equally applies to time charters.33 But there seems no reason why the same argument should not apply to loss of would-be profits which would have arisen after the charter came to an end. Although the analogy of The Achilleas,34 holding that an exclusion of such losses applied to late redelivery, was invoked by Cooke J in The Great Creation,35 it is not necessarily a good one. While it is true that late delivery may indeed lead to unpredictable, uncontrollable or disproportionate liability (as indeed happened in The Achilleas), the same is not true of early termination.

Secondly, it is not easy to see how a cap of this sort can be reconciled with the rules on mitigation. In general it is clear law that a contract defendant is liable for the expenses of, and losses caused by, reasonable acts in mitigation, even if those acts in fact increase the loss.36 Take the example given at the beginning of this section. In that case the act of the owner in entering into a charter on less advantageous terms extending beyond the end of the existing one may well be a reasonable act in mitigation: if so, there seems no reason why all losses caused thereby, including the loss of a potentially more lucrative fixture in the final five months, ought not to be recoverable.

Thirdly, the exclusion of post-termination loss of profits sits uncomfortably with authorities in certain different, but related, areas.

One is the 2008 collision case of The Vicky I,37 where such a rule was rejected in connection with a tort claim arising out of loss of charter profits. A VLCC was damaged in a collision: the necessary repairs caused her to miss the laycan for a very profitable charter. Having had her repaired, her owners later took a longer-lasting but much less profitable fixture as the best on offer. The Court of Appeal declined to limit damages arbitrarily to the period of the lost charter, and allowed a claim for all losses of profit due to the vessel being committed to the new longer-term arrangement. Admittedly this was a tort case: but there seems no reason here to say that contract should be treated differently from tort.

Another case, in 2009, actually concerned early termination of time charters, but in a slightly different context. In The Elbrus38 Teare J decided that matters occurring after the end of a charter could be in account in so far as they went to reduce loss. There, a wrongful redelivery 39 days early turned out to be a blessing in disguise for the owners, since as it happened it allowed the vessel to catch a very profitable laycan she would otherwise have missed.39 She began earning under this later, lucrative, charter seven days before the end of the original fixture, and continued to do so for a further month after it. Teare J rejected a contention that the owners could claim 39 days’ lost hire less only seven days’ earnings; instead, he upheld an arbitral decision that the owners had actually lost nothing because of the large profits made in the subsequent month.

Furthermore, and most tellingly, a recent decision has cast considerable doubt on whether damages for loss of profits from a voyage charter should be artificially limited to the would-be charter period. In The MTM Hong Kong40 charterers failed to provide a vegoil cargo for a chartered voyage which would have taken 43 days. Some 34 days after the charter was terminated, and by way of mitigation, the vessel’s owners successfully refixed her on, and performed, another voyage of roughly equivalent duration. This latter fixture, however, had its own knock-on effects: in particular it deprived the owners of the benefit of two further extremely profitable chemical charters which would have followed the original voyage. When the matter went to arbitration, the arbitrators made an award compensating the owners for their entire loss, including that of the chemical charters. The charterers appealed: the owners, they said, should have been limited to lost hire for the fag-end of the original charter less about nine days’ earnings during that period under the new charter. Males J, however, was having none of it, and upheld the arbitral award, stressing the overriding need for damage awards to represent actual loss (subject of course to matters such as remoteness). Interestingly, he read the earlier decisions in The Concordia C41 and The Noel Bay42 as laying down no fixed principles as to how that should be done, but merely representing attempts to fix the amount of loss in particular circumstances.

It is true that The MTM Hong Kong is merely one case not directly concerned with time charters, and that no decision has so far directly impugned the result in The Great Creation.43 Nevertheless, it is hard to think of any reason not to apply the reasoning in The MTM Hong Kong to time charters. Furthermore, in view of the other authorities mentioned above, one is increasingly driven to the view that The Great Creation,44 with its artificial cap on recovery, is something of an outlier which in addition is difficult to reconcile with the rest of the law of contract. The odds on its survival as a reliable authority are, it is respectfully suggested, lengthening appreciably.

6.3 Cancellation clauses and damages

It is all very well to discuss at length the quantum of damages for lost profits in the context of underlap. But it is easy to forget that a more fundamental question may well arise: namely, can such damages be had at all?

On the present authorities, an owner who has justifiably terminated a charter for breach cannot on that basis alone claim damages reflecting the benefit of the unexpired balance of the charter period. To obtain such damages, it must go further: it must show either that the charterer expressly repudiated the charter by unequivocally stating that it would not perform it at all, or that it committed some repudiatory breach of it (for example, by repeated failure to pay hire).45 As regards the question whether a breach satisfies this latter criterion, this may be shown in one of two ways. First, the breach may be one which would be repudiatory at common law, independently of any express right of withdrawal; for example, repeated failure to pay by a charterer where the circumstances are such as to make it fairly obvious that the non-payment is likely to be terminal.46 Alternatively, it is open to the parties to stipulate that a given breach of the charter is to be regarded as repudiatory even if it would not be so at common law; and, if this is done, then an owner who terminates on the basis of it retains his right to recover damages for loss of profits.47 But if neither of these factors is present and there is no other unequivocal repudiation by the charterer, then however lawful the act of the owner in bringing it to an end (for example, even if the charter gave it an impeccable right to do so), there can be no claim for future loss of profits.

Two cases illustrate this. Both involved owners faced with charterers in difficulties; in both cases the owners invoked a contractual power to terminate the charter for non-payment of given instalments, and then claimed lost profits in respect of the residue of the fixture.

In The Astra,48 the owners ended a five-year NYPE charter after about 18 months for non-payment, relying on a clause providing that ‘failing the punctual and regular payment of the hire … the Owners shall be at liberty to withdraw the vessel from the service of the Charterers, without prejudice to any claim the Owners may otherwise have on the Charterers’.49 In fact the owners’ claim for lost profits succeeded on orthodox grounds: namely, that on the facts the charterers had shown every intention to abandon the charter entirely, and furthermore that in any case an express term permitted the claim.50 In addition Flaux J also held, for good measure, that the failure to pay the hire on time also amounted to a repudiatory breach.51 But his Lordship clearly accepted that had these grounds not applied, and the charter had been cancelled merely on the basis of the contractual right of termination, the owners’ claim would have been unsuccessful.

The same matter was also considered in Spar Shipping AS v Grand China Logistics Holding (Group) Co Ltd.52 The facts and the withdrawal clause were very similar to those in The Astra;53 furthermore, here again the charterer was in fact held to have committed a repudiatory breach,54 so that the question of the owner’s rights in the absence of such a breach was moot. As it happens, the Court of Appeal, discountenancing the views of Flaux J on the point, expressed the view that non-payment of hire was not a condition at common law and hence there would not, absent the repudiatory breach, have been a right to claim damages for loss of profits. But that point is not the subject of discussion here. What matters is that the underlying rule applied – that the owner’s entitlement to loss of future profits depended on whether the charterer was in repudiatory breach – was the same as in The Astra.

What is curious about The Astra and Spar Shipping is the narrowness of the distinction they both embody. Leaving aside cases of straightforward repudiation and breach regarded as repudiatory at common law, it comes down to this. There is no claim for damages for future losses if the victim’s contractual right to terminate is expressed to arise on a given breach tout court, but the right to damages is preserved if that very same breach is stated in the contract not only to give a right to terminate, but also to amount to a repudiation of the contract concerned. One might be forgiven for thinking it rather queer that the exigibility of multi-million-dollar sums in damages should turn on what looks like a mere nuance of expression.

How have we got here? The reason goes back to a curious line of authority from the 1960s in a completely different area of the law, namely consumer hire-purchase. Although it there has never been any doubt that an innocent party who cancels in the face of a repudiatory breach preserves any right to damages for the lost value of the defendant’s performance,55 and it has since been made clear that parties can validly stipulate for any breach whatever to be regarded as repudiatory in this respect,56 a series of cases dating from the 1963 decision in Financings Ltd v Baldock57 decided that this did not apply where a breach created a contractual right to cancel but was not repudiatory. In such a situation, it was said, any future loss of profits had to be regarded as resulting from the innocent party’s decision to withdraw, and not from the original breach; hence any claim for them had, as a matter of law, to fail.58

This line of cases is difficult to justify.59 It seems contrary to earlier assumptions;60 moreover, the idea that lawful termination for a non-repudiatory breach does not as a matter of law cause the claimant’s loss of bargain seems oddly doctrinaire.61 Furthermore, any problem of owners terminating on slight but legally sufficient grounds and then claiming damages is, it is suggested, much better dealt with under the doctrine of mitigation; a charterer can, it seems, always plead that even if the owner has lawfully withdrawn the vessel, it is at fault in unreasonably refusing the offer of continued performance and to that extent undeserving of damages.62 Unfortunately, however, Baldock is binding Court of Appeal authority and thus immovable short of the Supreme Court. So the best that can be done is an exercise in circumvention.

The gratifying news is that this is not very difficult.

First, it has to be remembered, as stated above, that a charter can always provide that non-payment, or any other breach which the owner may care to invoke to terminate the contract, is to be regarded as repudiatory.63 True, the decisions in The Astra64 and Spar Shipping65 come to different conclusions on whether the NYPE boilerplate cancellation clause can be so interpreted.66 But there seems nothing to prevent those negotiating such contracts in future avoiding the whole problem by drafting a bespoke clause stating that, in given circumstances, late payment is (or, as the case may be, is not) to be regarded as repudiatory.

The second point is that it now seems that the whole problem of distinguishing between repudiatory and other breaches can be neatly bypassed in any event. For some years terms have been inserted into time charters saying not only that withdrawal is possible for non-payment, but that if this occurs the owner shall nevertheless have the right to recover lost profits for the remaining part of the charter.67 Indeed, one form now contains such a term as standard. Clause 11(c) of the new 2015 NYPE form provides for this succinctly:

Failure by the Charterers to pay hire due in full within three … Banking Days of their receiving a notice from Owners … above shall entitle the Owners, without prejudice to any other rights or claims the Owners may have against the Charterers:

  1. (i) to withdraw the Vessel from the service of the Charterers;
  2. (ii) to damages, if they withdraw the Vessel, for the loss of the remainder of the Charterparty.68

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