The 20 second summary
This English high court case gives paying by instalments a “health warning” – and reminds us to keep a close eye on termination provisions.
A sale contract may provide that ownership doesn’t pass until all instalments have been paid. If so, missing an instalment can have serious consequences. If the contract can be terminated “without prejudice to accrued rights”, as in this case, the buyer may end up not being the owner, but still having to pay all instalments that have become due. On top of that, the buyer may be liable for damages for the further instalments that would have become due. Arguments that instalments should be repaid on termination are not easily won.
Ownership wasn’t acquired, but the buyer was still liable to pay the instalments due – plus damages
Cadogan Petroleum Holdings Ltd v Global Process Systems LLC  EWHC 214 (Comm) concerns a settlement reached between Cadogan and GPS. GPS had built two gas plants and sold them to Cadogan. However, the parties fell out (over alleged secret commissions and who owned certain technology). As part of the settlement of their disputes, the parties entered into a sale agreement. The key terms were that:
- GPS would buy back the two gas plants for US$37.5m, payable by a series of instalments;
- GPS would not acquire ownership of the gas plants until it had paid the full price, but in the meantime it would have the right to market them for resale;
- if GPS defaulted in paying the instalments, Cadogan could terminate – and termination would be without prejudice to the parties’ accrued rights or Cadogan’s right to claim damages.
GPS paid the first few instalments, but then defaulted on the next ones due. GPS remained in default, despite Cadogan notifying its intention to terminate and granting GPS more time to pay. Cadogan then served notice of termination.
The court enforced the termination provisions in the sale agreement. Termination was “without prejudice to the parties’ accrued rights”: Cadogan had an accrued right to the instalments that had become due, but GPS had no accrued right to own the gas plants.
Accordingly, Cadogan remained the owner of the two gas plants – and was also entitled to:
- keep the instalments that had already been paid by GPS (totalling US$7.5m);
- be paid the further instalments that were already due when notice of termination was served (totalling US$20m); and
- claim damages for the balance of the total contract price that would have been payable (ie US$10 – the difference between the total contract price of US$37.5m and the aggregate value of the instalments that GPS had paid and those that were already due, ie US$27.5m).
GPS put forward various counter-arguments, but the court rejected them and held that:
It wasn’t a condition of the payments that ownership passed
GPS argued that the payment of each of the instalments was conditional on it acquiring the gas plants. But the court came to the conclusion the payments weren’t conditional: to argue that they were ran against the plain language of the agreement, which provided that termination was without prejudice to the parties’ accrued rights.
The court’s conclusion was supported by the care the parties had taken over the termination provisions (eg providing that on termination GPS lost the right to market the gas plants) - and the fact that it would be extremely uncommercial for Cadogan’s rights to accrued instalments to be replaced on termination by a claim for damages.
There wasn’t a “total failure of consideration” just because ownership didn’t pass
Of course, it is a general legal principle that for a party’s promise to be enforceable as a contract, consideration – ie “something of value in the eye of the law” - must pass. GPS argued that it had received nothing in return for the instalments it had paid, as it had not acquired ownership of the gas plants (and the court accepted - for the sake of argument only - that other potential consideration under the terms of the settlement (eg GPS’s right to market the gas plants), should not be taken into account).
Accordingly, GPS argued that there had been a “total failure of consideration”. On that basis it claimed that the instalments it had paid should be returned, and that it should not have to pay any further instalments.
But the court held that if a contract provides that on termination a party can retain or obtain benefit – even if it hasn’t yet performed its obligations, then:
- that means there can be no “failure of consideration” in relation to that benefit; and
- in any event, the terms of the contract will govern what happens to that benefit.
Here, there was no failure of consideration, because the basis upon which the instalments were paid was that they were unconditional and could be forfeited on termination. In any event, the terms of the contract expressly provided that termination was without prejudice to the parties’ accrued rights – and so those terms governed what should happen to the instalments.
The provisions did not amount to an unenforceable “penalty”
GPS argued that the provisions amounted to an unenforceable penalty. But the court held that:
- the rule against penalties only applied to obligations triggered by breach. Accordingly, the rule did not apply to GPS’s obligation to pay the instalments – because that obligation was not triggered by breach; and
- even if (for the sake of argument) the rule applied to the provisions which resulted in the instalments being forfeited on termination, those provisions were not penalties. Those provisions could not be regarded as having been set to deter breach, rather than to compensate. A “generous margin” was allowed before a provision would be held to be penal. Here the value of the gas plants was uncertain; GPS had failed to find a buyer for them; Cadogan had no need of them; and would incur expenses in selling them.
For further consideration of the rule against penalties, see the review of Cavendish Square Holdings v Talal el Makdessi . Read more.
“Relief against forfeiture” would not be just
Finally, GPS argued that even if strictly it was required to forfeit the instalments that were due – it should be relieved from forfeiting them.
The court held that:
- it is generally very difficult to establish a case for relief against forfeiture in a commercial context involving a freely negotiated contract;
- there is a strong view that the form of relief should generally be limited to allowing the defaulter more time to pay; and
- no relief was appropriate in this case - even though counsel accepted that the court’s jurisdiction went beyond simply allowing more time to pay.
Relief is only available on such terms as may be just. In this case, it would not be just to order repayment of the instalments paid or to excuse the payment of the instalments already due: on the face of it Cadogan was entitled to those sums; the gas plants had not been sold to anyone else (despite extensive marketing); and their value was uncertain.
But what happens if the gas plants are sold?
The court ordered that on a sale of the gas plants:
- Cadogan should receive the net proceeds of sale, up to US$10m (plus any applicable interest) – ie the balance of the contract price payable, after deducting the instalments that it had already become entitled to; and
- any proceeds left over would be paid into court (or otherwise secured) pending a further court order - or agreement by the parties – as to how they should be paid out.
It would be interesting to know how those proceeds are shared. If the parties come to an agreement, we may well never know. But if they don’t, they will be back in court – and you can expect an update from us.