Oil and Gas / Shipping: The legal remedies for breach of a restrictive covenant

Summary

In Priyanka Shipping Limited v. Glory Bulk Carriers Pte Limited (the “Lory”) [2019] EWHC 2804 (Comm), the Commercial Court was asked to consider the remedies available to address a breach of a restrictive covenant in a memorandum of agreement (“MOA”) for the sale of a vessel. In concluding that the correct remedy in the context of the MOA was an injunction, as opposed to “negotiation damages”, the decision provides a useful insight into the advantages of drafting effective restrictive covenants.

Facts

Glory Bulk Carriers Pte Limited, (the “Seller”), was the owner of the 2002-built Capesize bulk carrier (the “Vessel”), which was purchased by Priyanka Shipping Limited (the “Buyer”). The purchase was conducted pursuant to the terms of the MOA. Clause 19 provided that the Buyer would not trade the Vessel and would sell it for the sole purpose of demolition.

However, one month later, having had little interest from potential scrap buyers and in circumstances where the market price for tonnage for recycling had dropped but the freight market for bulk carriers had risen, the Buyer began to make enquiries about obtaining cargo for the Vessel for a laden voyage. The Seller refused to waive the requirements of Clause 19. Three months following delivery of the Vessel the Buyer did, in fact, conclude two trading arrangements and a third was fixed for a day before the trial commenced.

The Seller claimed for:

1. an injunction to restrain a breach of Clause 19;
2. “negotiation damages”, which represent such a sum of money as might reasonably have been demanded by the claimant from the defendant as a quid pro quo for permitting the continuation of the breach of covenant assessed by reference to a hypothetical negotiation between the parties –such an approach is not available in the case of a breach of any contractual right, but only where the breach of contract results in the loss of a valuable asset created or protected by the right which was infringed (see, e.g., One Step (Support) Ltd v Morris-Garner [2018] UKSC 20, at [4], [25] and [95(10)]); or
3. both.

The Buyer claimed that the Seller was entitled to no more than nominal damages.

The Commercial Court’s Decision

David Edwards, QC (sitting as a judge of the High Court), analysed the approach under English law to the enforcement of negative covenants and, in that context, the relevance of the adequacy of damages. Following this, he derived five principals:

1. negative covenants will ordinarily, although not invariably, be enforced by injunction;
2. it is not a precondition to enforcement by injunction that the party seeking an injunction should prove that it would otherwise suffer damage;
3. an injunction is nonetheless an equitable, and therefore a discretionary, remedy;
4. there may be cases where circumstances are such that the grant of an injunction would be unconscionable or oppressive and in these situations an injunction should be refused (whilst a mechanistic approach should not be followed, inconvenience or hardship to the defendant is, however, not enough); and
5. the burden lies on the party bound by the negative covenant to show why the covenant should not be enforced by the injunction.

It was significant that the breaches of Clause 19 were deliberate. The onus was on the Buyer to argue that an injunction would be oppressive.

The Commercial Court decided that the Buyer had voluntarily made a bad economic decision in entering into the MOA and this was not a valid reason to ignore the terms of the MOA. Consequently, the Commercial Court granted the Seller an injunction to prevent any further breaches of Clause 19 of the MOA and any further use of the Vessel by the Buyer for trading.

With regard the negotiation damages claim, the Commercial Court set out that once the Vessel had been sold to the Buyer:

“the Seller had no proprietary interest in the Vessel, no right or ability to use the Vessel to trade, and no right or ability to profit from the Vessel’s use (and equally no responsibility for any costs or liabilities incurred in relation to the Vessel’s operation). The Seller is entitled to be placed, so far as money can do it, in the same position it would have been in if the Buyer had not breached Clause 19 of the MOA. But…it is not obvious how further trading of the Vessel by the Buyer, albeit in breach of Clause 19, could cause the Seller any loss.”

If the Vessel was not scrapped, it would contribute to the ongoing oversupply causing depressed freight rates. But this would be in an immeasurably small way. The Commercial Court discerned that this was the reason why the damages claim was advanced as one for negotiation damages, rather than normal common law damages.

However, as the Seller had no proprietary or financial interest in the Vessel after the sale, a breach of Clause 19 could not involve the Buyer in the “loss of a valuable asset” of the Seller. Clause 19 of the MOA was viewed more in the nature of a non-compete clause (as was the case in the One Step case), which was not considered a part of the category of cases where negotiation damages were available as a measure of a claimant’s loss.

The Commercial Court therefore dismissed the Seller’s claim for negotiation damages in respect of the breaches of the MOA.

Comment – Injunctions

The analysis of the Commercial Court is detailed and a helpful reminder of the approach to remedies for breach of a restrictive, or negative, covenant. The Commercial Court makes clear that the starting point is that restrictive covenants will ordinarily be enforced by injunction, as it did in this case in respect of all trading arrangements in breach of Clause 19.

An injunction could be said to “promote” a contractual obligation to an obligation towards the court. As far back as the 1870s, Lord Cairns LC said in Doherty v Allman (1878) 3 App. Cas. 709: “the injunction does nothing more than give the sanction of the process of the Court to that which already is the contract between the parties”.

Restrictive covenants are found in many types of contract in the oil & gas and shipping industries, most notably in sale and finance arrangements. The precise terms of these restrictions, especially where this impinges upon the right of the party giving the covenant to conduct its business in a certain way, to take out finance or to provide security, can be one of the most heavily negotiated aspects of the deal.

As the case shows, vessels are particularly sensitive to the imposition of restrictive covenants. A vessel is not a commodity good, or a simple chattel, where title generally passes by delivery. Vessels can sometimes be said to be treated in a way that more closely resembles real property. For example, a vessel’s ownership, registry and any liens/mortgages are recorded and title searches are conducted.

Restrictive covenants over the use of a vessel can appear in vessel sales contracts, to restrict the use of the vessel by the purchaser, or in charter parties, whereby the charterer restrains the use of the ship by the owner for the duration of the charter party. In both cases, an injunction is a potential remedy for the seller and charterer, respectively.

Where a bank exercises a security right over a vessel, or where a purchaser purchases a vessel that is under charter, a question will arise as to whether the bank or purchaser is bound by any restrictive covenant in the charter party (e.g. on the use of the vessel). The bank or purchaser might seek to argue that, in the absence of privity of contract between it and the charterer, it cannot be bound the restrictive covenant. This area of law has seen a number of old cases of high authority doubted in more recent years.

The modern view is that an injunction could be awarded by the Courts where the conduct of the bank or purchaser is such as to constitute the tort of knowing interference with the charterer’s rights under the charter party: Law Debenture Trust Corp v Ural Caspian Oil Corp Ltd [1995] 1 All E.R. 157.

Comment – Negotiation Damages

On the other hand, the claim for negotiation damages failed. It did so because it failed to meet the key test: whether the breach resulted in the loss of a valuable asset created or protected by the right which was infringed.

The English Courts have identified scenarios where this test can be passed, e.g. the breach of a restrictive covenant over land, an intellectual property agreement or a confidentiality agreement.

However, the Commercial Court viewed the covenant in this case as falling outside the above examples, and instead being more akin to a non-compete obligation and “the breach of a non-compete obligation may cause the claimant to suffer pecuniary loss resulting from the wrongful competition, such as a loss of profits and goodwill, which is measurable by conventional means, but in the absence of such loss, it is difficult to see how there could be any other loss” (One Step, at [93]).

This aspect of the claim is now on appeal and so the Court of Appeal may clarify the law. Conceivably, it should remain open to parties to a contract to agree a liquidated damages regime upon breach of a restrictive covenant, if the concern is that the breach in question would risk falling between the two stools of common law damages and negotiation damages. This, in turn, would have to satisfy the “proportionate protection of a legitimate interest” test for penalties in Cavendish v. Makdessi [2015] UKSC 67.