Note: the decision in this case has been upheld by the Court of Appeal in a judgment delivered on 31 July 2009. To access the note of the Court of Appeal judgment, click here

Note contributed by Jim Leighton, BSc (Hons), LLB (Hons), LLM (Maritime Law), Trainee Solicitor and International Contributor to DMC’s CaseNotes.

Background
The Owners time-chartered their vessel to the Charterers. The Charterers agreed to hire the vessel "from the time of delivery, for about minimum 3 to about 5 months (about means +/- 15 days)". The vessel was delivered on 29 November 2006. Allowing for the plus 15 days margin, the last possible day for lawful redelivery ("the final terminal date") was 14 May 2007. The last voyage under the charter took 77 days, with the vessel being redelivered on 20 May 2007, which was 6.166 days beyond the final terminal date.

The Charterers paid hire at the charter rate for the duration of the charter up until the last redelivery date on 14 May 2007 and at the market rate for the 6.166 days the vessel was overdue. The Owners also claimed hire based on the market rate for thirty days before the latest date for redelivery in reliance on clause 101 of the charter, which stated:

"The Charterers hereby undertake the obligation/responsibility to make thorough investigations and every arrangement in order to ensure that the last voyage of this Charter will in no way exceed the maximum period under this Charter Party. If, however, Charterers fail to comply with this obligation and the last voyage will exceed the maximum period, should the market rise above the Charter Party rate in the meantime, it is hereby agreed that the charter hire will be adjusted to reflect the prevailing market level from the 30^th day prior to the maximum period [d]ate until actual redelivery of the vessel to the Owners."

At this time, hire rates were rising, so the additional claim was at a market rate of US$46,083.82 per day, as opposed to the charter rate of US$29,500 per day. On this basis, the Owners claimed US$471,603.32 over and above what the Charterers had already paid.

Only one question arose for decision in this case, which came by way of appeal under s.69 of the Arbitration Act 1996 from an LMAA arbitration award on a preliminary issue (made by Michael Baker-Harber, Alan Burbidge and Robert Gaisford), which was whether or not clause 101 of the charter was a penalty. The LMAA tribunal had found in favour of the Charterers that it was.

Judgment
The Judge set out the background to the law of liquidated damages and penalties in contract. Contractual penalties are unenforceable under English law. A clause providing for liquidated damages on breach of a contract is not a penalty where its function is to compensate the innocent party for the breach by providing a genuine pre-estimate of damage, rather than to act as a deterrent to the party breaking the contract. The question of whether a sum stipulated is a penalty or liquidated damages is a question of construction to be decided upon the terms and inherent circumstances of each particular contact, judged as at the time of making the contract, not as at the time of breach. Whether the contractual function of such a clause is as a deterrent rather than compensation can be deduced by comparing the amount that would be payable on a breach with the loss that might be sustained if a breach occurred. However, the court has to be careful not to set too stringent a standard and bear in mind that what the parties have agreed should normally be upheld.

Given that the contract was a timecharter, the relevance of legitimate and illegitimate final voyage orders came into play, which was an issue the Judge duly analysed. In the former, charterers give orders for the employment of the vessel which can reasonably be expected to be performed by the time for redelivery; in the latter, charterers give orders for employment which cannot reasonably be expected to be performed by the charter’s final terminal date. In the former, charterers are obliged to compensate in damages for the late redelivery at the charter rate or, if higher, the market rate for the overrun period; in the latter, charterers’ conduct amounts to a repudiation of the contract which owners may accept as bringing the charter to an end, whereupon owners can go out into the market to seek a new fixture, though in such circumstances owners suffered no loss. But, as the Charterers pointed out and with which the Judge agreed, if Owners nevertheless choose to comply with an illegitimate final voyage order leading to late redelivery, the resulting loss at law would be the same as if there had been a late redelivery following compliance with a legitimate final voyage order. In such circumstances, the Owners had not lost the opportunity of an early redelivery; they had instead chosen not to take that chance by following the Charterers’ orders.

The Judge pointed out that while the Owners were correct to submit that the comparison of the liquidated damages was to be made with the upper end of the range of the loss which may be suffered, the pre-estimate must nevertheless be a genuine pre-estimate of recoverable loss for the breach of the contract in question. The fact that in broad terms the potential loss of the Owners may be considered different and greater was not in point if such loss was irrecoverable in law. It followed that, whether the Charterers’ final voyage orders were legitimate or illegitimate, the Owners had suffered no legally recoverable loss in the nature of that provided for by clause 101 of the charter. As a result, clause 101 did not provide a genuine pre-estimate of recoverable damages, so amounted to a penalty and therefore was unenforceable.

Comment
The drafting of the charter in this case predated the House of Lords’ decision in The "Achilleas" [2008] UKHL 48. Following that decision, clauses of this nature may become more commonplace, in the right market conditions, should owners seek to recover damages more commensurate with the actual losses they may suffer due to late redelivery, but which are now (effectively) irrecoverable at common law on the basis that such losses are too remote and/or are losses for which charterers have assumed no responsibility. As the present case would appear to indicate, if such clauses are to stand any hope of being enforceable, they will need to be drafted very carefully, with a close eye on relevant guiding legal principles and to the material circumstances of the intended charter. At a minimum, such clauses would certainly have to avoid simply backdating a rise in the charter rate of hire following late redelivery of the vessel no matter how brief the overrun period, as that is undoubtedly punitive in nature.

However, given the Judge’s analysis of the relevance of legitimate and illegitimate voyages and the interplay of losses which are and are not legally recoverable at common law, there could well be room for charterers now to argue that any clause which seeks to alter the result in The "Achilleas" ought to be struck down as a penalty. Such arguments would need to be tempered by reference to the principle of freedom of contract and the distinction between a clause that is drafted such as to be a true penalty and that which is legitimately negotiated between owners and charterers to be a true reflection of real (though not necessarily legally recoverable) losses that may flow from a late redelivery caused by illegitimate final voyage orders. It is also arguable that the Judge’s reasoning should be limited to the context in which it was made, namely a clause which specified a fixed period before the final terminal date of the charter without distinction between legitimate and illegitimate final voyage orders.

As Chitty on Contracts makes clear (2008 ed. at para. 26-125, fn. 655 and the cases there cited), an agreed sum may take account of loss likely to be suffered which may not fall within the normal remoteness test. This indicates that the Judge’s distinction between recoverable and irrecoverable loss at common law is not an absolute and determinative proposition of law when considering whether a clause is a penalty. In each case it is a matter of degree as to whether or not a sum that may or would be too remote at common law to recover is liquidated damages or a penalty.

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