In depth

Corporate update: the latest corporate law developments August 2022

Gateley Legal

Article by

In this month’s update we:

  • consider what is a reasonable period to exercise a right to terminate – and how that right can be lost;
  • examine a case in which the informal novation of a contract was found valid despite a lack of required notice; and
  • review the first three months of the new regime for intervening in transactions on the grounds of national security.

Contractual right to terminate: use it or lose it

In DD Classics Ltd v Chen [2022] EWHC 1404 (Comm) the High Court explained that unless a contractual right to terminate was exercised within a reasonable timeframe, that right would be lost and any associated breach considered waived.

The facts

An individual had agreed to sell a Ferrari to a company for €3.2 million. A contract was signed on 24 March 2021 which provided that the sales price was due immediately on the contract being signed and would be paid within five business days.

The contract contained a right of termination for the seller as follows: "If the buyer does not meet its payment obligations…within 5 business days after the due date, the seller is entitled to withdraw from this contract".

In fact the balance was not paid to the seller's bank until 9 April and was then not released into the seller's account until 25 May. The seller exercised his right to withdraw from the contract on 13 April.

The buyer argued that, by not immediately terminating the contract when payment was not made within five business days of the due date but instead delaying that decision for 13 days, the seller had lost his right to terminate the contract - the seller had waived or affirmed the breach that would otherwise have permitted termination.

The decision

The judge noted that when a repudiatory breach occurs the innocent party has a choice: it can choose to terminate the contract or it can choose not to terminate it. Once the choice is made, that is it.

The judge found that, in this case, the contractual right to terminate had to be exercised within a reasonable time. It was not a right that could be exercised at any time without limit after it had been triggered. A 'reasonable time' in this context did not mean a reasonable time to give the other party an opportunity to make up for non-performance. It meant a reasonable time for the innocent party (in this case, the seller) to decide what to do, ie whether or not to withdraw from the contract.

Exactly what was a reasonable time would depend on the specific circumstances but, in this case, the judge said it was "entirely simple and straightforward" for the seller to decide what to do on non-payment by the buyer. According to the judge, 13 days could not possibly be considered a reasonable time in which to decide how to respond to the buyer's non-payment. Instead, the reasonable time within which the seller had to exercise his contractual right to withdraw was "a very short period".

The judge went on to hold that the seller had in fact affirmed the contract - that is the seller had treated the contact as continuing notwithstanding the breach by the buyer. This was due to the seller's conduct after the right to terminate had arisen when the seller had requested performance by the buyer and had actively taken steps to encourage performance and to facilitate the smooth operation of the purchase with Ferrari who had custody of the vehicle.

Comment

As the judge noted, depending on the specific language of the relevant contract, a right to terminate must either be exercised within a reasonable period of time or may be exercised at any time. In this case, there was nothing in the relevant contract to suggest that it was a right that applied without limit in time and therefore it was one which could be lost if not exercised within a reasonable period.

The seller could have retained his right to terminate by including the words "at any time" in the relevant contractual provision. But he had chosen not to do this. And, even if those words had been included, the right to terminate could still have been lost where, as in this case, the innocent party was found by its actions to have affirmed the contract.

Informal novation of contract valid despite requirement for written notice of termination

In the case of Gama Aviation (UK) Ltd v MWWMMWM Ltd [2022] EWHC 1191 (Comm), the court held that an informal novation of a contract was valid notwithstanding that the contract required three months' written notice of termination and no written notice was actually given.

Novation and termination

Novation enables one party's rights and obligations under a contract to be transferred to a third party. Strictly speaking, novation extinguishes or rescinds the original contract and replaces it with another, with the incoming third party taking up the same rights and obligations as the original outgoing party. All parties to the original contract, and the incoming party, must consent to the novation for it to be valid.

In most cases, a novation does not need to be in writing and, therefore, the majority of  contracts can be novated informally. However, there are some situations where writing will be required, including where the terms of the contract prohibit oral novation or novation by conduct.

Some contracts will give the parties an express right to terminate by written notice. It has been suggested that a requirement for written notice will prevent any informal termination of the contract and so could, in turn, also prevent the informal novation of the contract. This was one of the issues that the court was asked to consider in the Gama Aviation case.

The facts

The case related to a claim for unpaid sums under a contract for the provision of aircraft support services. The services were originally supplied by IJC to the owner of the aircraft (the defendant) but after a company reorganisation, and at the request of the defendant, Gama provided the support services instead of IJC. Gama invoiced the defendant directly and the defendant corresponded with Gama about the services, including paying the invoices and agreeing to an increase in the service fees. The defendant continued to pay the service fees for a further two years but stopped paying in January 2019.

Gama applied to the court for unpaid fees under the service agreement. It contended that the agreement had been novated from IJC to Gama by conduct and, therefore, Gama was entitled to payment for the services it had provided.

The defendant argued that the implied novation of the services agreement was ineffective due to the presence of an express termination clause. The termination clause stated that the agreement would continue "until such time as either party gives the other not less than three months' notice in writing of termination." The defendant argued that:

  • the original services agreement had not been terminated because written notice of termination had not been given; and
  • as termination of the original agreement was an essential element of its novation, the implied novation had not been effective.

The decision

The Court held in favour of Gama, finding that the services agreement had been novated.

The Judge concluded that the requirement for three months' notice was only applicable if one of the parties unilaterally terminated the contract -  it had no bearing on whether or not mutual termination was available.

IJC and the defendant had mutually agreed to terminate the contract and the defendant had agreed to Gama taking over the provision of the services from IJC. As a result, the termination clause did not apply and the novation of the services agreement by conduct was valid.

In any event, the Judge concluded that the defendant would be estopped from denying the validity of the novation.  The defendant had acted as if the novation was valid, and Gama had relied on that conduct when it provided services to the defendant. The defendant could not now deny the novation merely because it had not been in writing.

Comment

This case is another example of the importance of careful and precise drafting – if the parties want an event, such as novation, to be subject to specific contractual formalities, then this should be expressly and specifically provided for.

Since the Supreme Court's decision in Rock Advertising, there has been an increased emphasis on compliance with the exact formalities in a contract when attempting to vary or terminate that contract. Failure to comply with those formalities may result in the variation or termination being void, even though the parties have all (informally) agreed to that change.

As illustrated by this case, particular difficulties can arise if it is unclear whether the relevant formalities apply to a variation or termination in all circumstances. When initially giving his judgment, the Judge had decided that the termination clause did prevent the novation by conduct of the supply agreement (but found in favour of Gama based on estoppel.) It was only later (in an addendum) that the Judge concluded that the only commercial common-sense construction of the termination clause was that it applied only to unilateral, and not mutual, terminations.

On the basis that Gama had supplied and been paid for services for almost two years, it would have been surprising if the court had reached any other conclusion.

National security and investment act – First annual report

The Department for Business, Energy and Industrial Strategy and published its first annual report (the Report) on the National Security and Investment Act 2021 (the NSI Act). The report assesses the operation of the NSI Act for its first three months post-implementation.

Background

The Act introduced a new regime for the screening of, and intervention in, UK transactions on the grounds of national security. It was aimed at preventing state and non-state actors who may wish to do harm to the UK from acquiring parts of the UK economy.

The NSI Act tackled this via a three-pronged regime:

  • a mandatory notification regime for some transactions in certain specified sectors;
  • a voluntary notification regime for certain transactions outside those specified sectors which may still give rise to national security concerns; and
  • call in powers under which the government can review transactions which should or could have been notified under either the mandatory or voluntary notification regimes.

When the NSI Act was introduced on 4 January 2022, it was anticipated that the new regime could result in up to 1,800 notifications being made each year, with up to 95 of those notified transactions being called in for review.

The Report's findings

Key highlights from the Report include:

  • 222 notifications were made to the Investment Security Unit (ISU) between 4 January and 31 March 2022. Of those, 196 were mandatory notifications, relating to transactions within the specified sectors; 25 were voluntary notifications; and one was a retrospective validation application (made where a transaction subject to the mandatory notification regime is completed without such a notification being made and therefore needs retrospective approval in order to be valid and not void).
  • The sectors attracting the most notifications were Defence, Military and Dual Use, Critical Supplies to the Government, Artificial Intelligence and Data Infrastructure.
  • Of the 222 notifications made, 17 transactions were called in for review on the grounds that there was a reasonable suspicion of the transaction giving rise to a risk to national security. Of those 17, three were cleared to proceed and the remaining 14 were still under investigation as at 31 March 2022.
  • Again, the sectors attracting the most call-in notices were Defence, Military and Dual Use, and Critical Supplies to the Government.
  • Notifications are generally being accepted by the ISU within 3 to 5 working days of being made. The main reason for a notification being rejected is that it was made under the wrong regime (seven mandatory notifications were rejected as they should have been made under the voluntary regime).
  • The average time taken to call in a transaction for review following notification was 24 working days (the ISU has a maximum period of 30 working days within which to do this) although one transaction was called in in just 11 working days.

Comment

As the Report notes, three months is too short a period to draw any long-term conclusions or identify any trends. Nonetheless, the government believes the data shows that the system is performing well. Based on an extrapolation of the reported figures, the number of notifications and call-ins is slightly below the level anticipated before implementation but it may be that a lack of awareness is resulting in notifiable transactions being missed. It seems likely that the overall number of applications will increase as the regime beds in.

Unfortunately there is no way to fast-track an application even where it is clear that the transaction raises no national security concerns. Parties need to ensure they consider and assess the impact of the NSI Act on any potential transaction early in the process in order to ensure any delays to the timetable, and increases in costs, caused by the need to notify are kept to a minimum.

Although the government has already published guidance on the operation of the NSI Act, the Report confirms that it intends to publish market guidance notes in due course. These will give practical advice to businesses and their advisers about dealing with the requirements of the NSI Act.

First published in Accountancy Daily.

Gateley Plc is authorised and regulated by the SRA (Solicitors' Regulation Authority). Please visit the SRA website for details of the professional conduct rules which Gateley Legal must comply with.