Facts
The parties had entered into an agreement dated 29 November 1999
by which Cobweb licensed Phoenix to incorporate its products
(basically, a compilation of business information from a wide
variety of sources) as the core element of a wider business
information package marketed by Phoenix as “IQ, the ultimate
business information service”. This would be marketed to
“subscribers”.
This agreement replaced an earlier agreement, and tried to deal
with what were perceived as shortcomings in the previous commercial
arrangements. Firstly, the new agreement re-defined “subscribers”
as entities as having less than 400 employees (rather than the old
50); secondly, it allowed Phoenix to sub-license the Cobweb product
to distributors who could themselves sub-license the product to
subscribers and finally, Phoenix paid Cobweb not only a percentage
of subscription fees but also of sponsorship, advertising and other
revenue received by Phoenix and its distributors.
Perhaps it was at least partly because the new agreement altered
the existing contract that the new contract was of frightening
complexity. Indeed, the judge commented at several instances on the
byzantine drafting, involving a consideration of numerous
interlinked clauses and schedules to the agreement. Much of the
judgment consists of a lengthy exposition of the most important
provisions, which it is not intended to recite here. Suffice it to
say that the scheme of the new contract was to allow Phoenix to
sell the combined product incorporating Cobweb's product only to
“subscribers” with fewer than 400 employees - small and medium
sized enterprises.
The important termination provision, however, needs to be read
in its entirety:
"Either party may terminate this
Agreement forthwith by notice in writing if the other of them is in
material breach of this Agreement and shall have failed (where the
breach is capable of remedy) to remedy the breach within 30 days of
the receipt of a request in writing from the party not in breach,
to remedy the breach such request setting out the breach and
indicating the failure to remedy the breach may result in
termination of this Agreement.”
Cobweb complained in early February 2000 that Phoenix had
breached the agreement by approaching organisations that were in
excess of the 400 employee limit. This was followed by a letter on
14 February purporting to terminate the agreement. It was in these
terms:
"We also understand that [Phoenix] has
dealt directly with Daily Mail, Spicers, Norweb, Hewlett Packard,
MCI/Worldcom and Lloyds TSB. None of these companies is capable of
being either a Distributor or Subscriber under the Agreement. Each
of these companies is an Excluded Organisation as defined in the
Agreement. Your dealings with these companies amount to breaches of
clauses 2.4, 2.5, 7.4, 7.6 and 15 of the Agreement. In light
of the above we consider [Phoenix] to be in material breach of the
Agreement on a number of counts. Furthermore, the majority, if not
all, of the breaches outlined above are incapable of remedy.”
Judgment
The matter came before the judge after an adjournment to permit
a mediation, which had failed to bring about a compromise. Phoenix
applied for declaratory and injunctive relief with regard to the
purported termination by Cobweb and applied for summary judgment.
The parties agreed that the matter should be finally disposed of by
the judge, and the evidence consisted of witness statements by a
representative of each party with exhibits.
The question therefore remained, given that there were breaches,
were they material and irremediable? The clause on termination
required that Cobweb could only have terminated the agreement if
the breaches were both material and irremediable. So there could be
no right to seek to terminate if the breaches were not material,
and the right to terminate forthwith could not exist unless the
breaches were irremediable. If they were remediable, 30 days'
notice had to be given, and if the breaches were remedied within
that period, that would be the end of the matter.
For materiality, Neuberger J. thought that the court should have
regard to the actual breaches, the consequences of the breaches to
Cobweb, Phoenix' explanation for the breaches, the breaches in the
context of the agreement, the consequences of holding the agreement
determined, and the consequences of holding that the agreement
continued.
Neuberger J. found that the actual breaches were that there had
been negotiations between Phoenix and some “Excluded Organisations”
for them to act as sponsors, possibly as distributors. The product
had been provided in some cases to some of these organisations for
the purpose of evaluation.
As to the consequences of those breaches, the judge observed
that the contact between Phoenix and the “Excluded Organisations”
had not gone beyond preliminary discussions. Where the
product had been supplied, there would have been at least implied
obligations of confidentiality, and if the negotiations had come to
nothing, the product would have been returned. While there might
have been some risk of damage, this could have been compensated by
damages. Phoenix could have called off the negotiations and asked
for the products to be returned. Accordingly, this would not be a
material breach.
There was a dispute as to whether Phoenix acted dishonestly. The
judge found no such dishonesty on the basis of the evidence he had
seen. “Pretty clear evidence” would be required before such a
finding, and the judge took account of the fact that there had been
no cross-examination of Phoenix' witness.
The judge compared the consequences of the agreement being
terminated or continuing. If terminated, the consequences for
Phoenix would be severe, with a large part of the considerable
amount of money invested by it in the product being wasted (or
Phoenix would be at Cobweb's mercy in any re-negotiations). There
were no such bad implications for Cobweb if the agreement
continued, even taking account of the bad feeling that had arisen
between the parties.
A final point to take into account was that the breaches took
place in an agreement that was to last for 3 years and possibly
over 8 years.
The question of remediability was related to materiality, and
there was some overlap. However, the judge was of the view that the
breaches were remediable. Unlawful negotiations could be called
off, and the products had been supplied under at least implied
obligations of confidentiality and they could have been returned
within the 30 days.
There was a dispute as to whether Phoenix would have put the
breaches right: it may have been that Phoenix would have persisted
in its alternative interpretation of the agreement and done
nothing. The judge regarded this as “irrelevant speculation”. The
breaches were capable of remedy and so Cobweb first had to require
their remedy within 30 days, and then had to establish that they
remedying had not been done in order to justify termination. Cobweb
did not require the remedying and as they had not established that
the breaches were irremmediable, the agreement was not terminated,
even if the breaches were material.
Commentary
Termination clauses are often treated by draftsmen as an
extension of boilerplate clauses, and all too often they are simply
taken from a precedent contract and then inserted into a draft
contract with scarcely a thought as to what they might mean in
practice. The type of termination provision which this case was
concerned with is one which might grace almost any commercial
contract in this jurisdiction, but how many commercial lawyers ask
themselves the simple question, “in the context of the sorts of
breach that might happen in this particular type of deal, what
sorts should give rise to a right to termination and what sorts of
breach are, or are not, remediable?”
Termination is always a difficult question in any agreement that
is likely to change over time - and this includes in the IT
context, outsourcing, distribution, and major systems development
or integration projects. It is with these sorts of contracts that
changes are most likely to take place, both in the context of
formal change control, and also “informal” change control, in the
myriad of little agreements that the parties make in the ordinary
course of working the contract. Sometimes, it is these little
agreements that can have a major impact on the future operation of
the contract, but their status outwith formal change control can
make them hard to identify.
This is typically the case with major systems developments.
There will be formal, signed off change control, and also other
variations to the agreement that perhaps never went through the
contractual mechanism, which may have resulted from agreements
reached at requirements analysis workshops or at Project Board
level. Similar points can be made about outsourcing or facilities
management contracts. It is the fact that they were not part of
formal change control that makes them so hard to identify, but many
of them undoubtedly do vary the formal terms of the contract, on
important issues, such as timescales. When called on to advise with
regard to termination for delay, for example, all these agreements
have to be taken into account in assessing whether the delay
complained of amounts to a “material” breach or not, seen against
the varied deadlines.
However, the story does not end there. Assuming that a proper
job has been done of re-constructing the contract in the light of
all the formal and informal change control, what is the proper test
to apply to determine if the victim of breach of contract can elect
to terminate? Applying the test of “repudiatory breach” is
immensely difficult in these cases. It is now quite some time since
the courts simply countenanced the existence only of “conditions”
(whose breach would give the other party the right to terminate)
and “warranties” (whose breach would give the other party the right
to damages only). This has all changed with the introduction of the
concept of “innominate” terms and this principle has been developed
since Hong Kong Fir Shipping Co Ltd v Kawasaki Kisen Kaisha Ltd
[1962] 2 QB 26. Lord Wilberforce in Bunge Corporation v
Tradax Export SA [1981] 1 WLR 711 said that Diplock LJ in
Hong Kong Fir:
"...illuminated the existence in contract
of terms which are neither, necessarily, conditions or warranties,
but in terminology which has since been applied to them,
intermediate or innominate terms capable of operating, according to
the gravity of the breach, as either conditions or warranties."
This sort of consideration was recently considered in the
context of what was effectively a facilities management contract in
the case of Rice v Great Yarmouth Borough Council. Rice had a four
year contract for the maintenance of Great Yarmouth's grounds and
sports facilities. Rice won against a bid from Great Yarmouth's own
services organisation. Part of Rice's case was that many of his
difficulties could be attributed to the reluctance of the council's
workforce to transfer to his employment and also the reservations
held by the council about using Rice, as opposed to the council's
own services organisation.
Notices of breach from the council followed quickly, some were
proved, some were not, others were trivial. The council purported
to terminate relying on a provision in the agreement allowing
termination if the contractor committed “any breach of its
obligations” under the contract. Lady Justice Hale gave the
judgment of the Court of Appeal and upheld the trial judge's
finding that a sensible, commercial construction had to be given to
the termination provision. It could not be the case that any
trivial breach could be a justification for termination but it had
to be interpreted to mean that only a repudiatory breach or an
accumulation of breaches that as a whole could be described as
repudiatory could be within the termination provision. The parties
could always specifically provide that a term was so important that
any breach would justify termination, but that was not the case
here. In other words, in such contracts, the court could read in
“material” into the contract's termination provisions even though
it was absent from the text.
In Rice, the judge did not think the contractor's behaviour
could be categorised as “repudiatory”. The Court of Appeal agreed.
It was not in all cases necessary to demonstrate an intention to
abandon contractual obligations and Hale LJ said that there are
really in this sort of case three categories of “repudiatory
breach”:
"(1) those cases in which the parties
have agreed either that the term is so important that any breach
will justify termination or that the particular breach is so
important that it will justify termination; (2) those contractors
who simply walk away from their obligation thus clearly indicating
an intention no longer to be bound; and (3) those cases in which
the cumulative effect of the breaches which have taken place is
sufficiently serious to justify the innocent party bringing the
contract to a premature end."
The important feature of such contracts is that they run over a
course of time, and it is possible to look at breaches cumulatively
and see what they say about the contractor's ability to perform in
the future. It is also permissible to look at the surrounding
circumstances – such as evidence of the council's behaviour and the
effect of the drought on Rice's performance. The question to ask
was whether the council had, in all the circumstances, been
deprived of a substantial part of the totality of that which it had
contracted for that year, subject to the additional possibility
that some aspects of the contract were so important that the
parties are to be taken to have intended that depriving the council
of that part of the contract would be sufficient in itself.
These words of the Court of Appeal, albeit in the context of a
local authority contract for facilities management, are of
immediate relevance to the IT industry and are important for an
understanding of Neuberger J.'s reasoning in Phoenix. It is not
permissible to look just at the contract's literal terms (after
taking into account change control) but also to look at the whole
commercial environment of the contract and of the breaches. These
factors are well described in both Phoenix and Rice.
Taking the example of an outsourcing contract which is performed
well below the levels in the Service Level Agreement, it is not in
every case that this would justify termination even for such
apparently serious failings. A court would look at the reasons for
the breaches, what they said about future conduct of the agreement,
the effect on the victim of the breach and so on.
A word should be said about “remediable”. It occurs so
frequently in commercial contracts that few give any thought to
what it means. What types of breaches are remediable and which are
irremediable?
Neuberger J. gave the common example of a clause in a lease for
doing decoration in the fifth year. In a sense, this is not
remediable after the end of the fifth year: without a time machine,
it is not possible to go back in time and do the decoration in the
fifth year. It is, of course, possible to do the decoration in the
sixth or subsequent years and so, in common sense, the breach is
remediable. As the judge observed, although the negotiations had
started with “Excluded Organisations”, it was possible to stop
them, and products delivered could be recalled. In this sense, such
breaches were “remediable”.
The judge did not cite, and it is not apparent that the
authority was provided to him, the case of Glolite Limited v Jasper
Conran Limited the Times 28 January 1998 on this subject. This is
all the more surprising since it is also a decision of Neuberger J.
Glolite also looked at “remediable” in the context of a long-term
agreement. There was a ten year agreement (extendable to twenty
years) for the manufacture of certain items designed by the
defendant for sale to retail and wholesale outlets in most of the
world. The parties were to agree on the publicity aspects from time
to time, and the defendant claimed that this had not happened. The
termination provision read:
“[either party] may terminate this
agreement forthwith by notice to the other if the other party
commits any material or irremediable breach of any term of this
agreement or (if such breach is capable of remedy) has failed to
remedy it within 28 days of a notice giving adequate particulars of
the alleged default.”
Where breaches had taken place, it was clear that the past could
not be undone, but on the facts the unauthorised publicity had not
been extensive and there was no evidence of harm to the Jasper
Conran reputation. The judge accordingly held that there was no
“material and irremediable” breach. Furthermore, the fact that the
clauses breached were very important to one party did not mean that
any breach would be material. The “remedy” was in not making any
more shirts with the offending logo on them and stopping the
publicity.
Glolite did cite other authorities, and those interested should
certainly look at Schuler v Wickman Tools [1974] AC 235
where the House of Lords also thought that “remedy” meant cure for
the future rather than putting right past breaches.
Phoenix is a perfect example of two things. Firstly, the fact
that advising on termination in the context of contracts that are
supposed to go on over a long period of time is so very difficult
and needs to take account of so many factors. Secondly, maybe it is
time for boilerplate termination provisions to be looked at anew
and some searching questions asked (and answered) about whether
they are suitable for the contracts in which they are so frequently
inserted without further thought.
