Offshore Oil & Gas Briefing - Termination Trap

The issue

Terminating a contract using contractual termination provisions can have unforeseen consequences. Most significantly, this may include losing the right to sue for loss of profit on the terminated contract.

Background

Absent clear provisions to the contrary, when faced with a repudiatory breach of contract by a counterparty, English common law permits the innocent party to 'accept' the breach, terminating the contract (generally with immediate effect), and sue for the loss of profit. This is a valuable remedy - loss of profit is likely to be uninsured, and can be substantial, especially in a market where day rates have moved significantly since the contract was agreed.

The problem of 'affirmation by termination'

This problem arises because, when faced with a repudiatory breach of contract, as a matter of English common law, the innocent party has two mutually inconsistent options: either to 'accept' the breach and bring the contract to an end, claiming damages for loss of profit, as mentioned above; alternatively, to continue with the contract – known as 'affirming' the contract.

The innocent party must chose one or other option. There is some flexibility about how quickly this choice must be made, but if left too long, a party will be deemed to have made a choice - usually to have decided to continue with the contract. Other circumstances in which the innocent party may be deemed to have chosen to continue with the contract include where it has taken steps which would be inconsistent with terminating the contract - for example by continuing to perform the contract, or insisting on performance of the contract by the counterparty.

There are many cases where the common law right to terminate has been lost by the innocent party saying or doing things which the court has considered amount to an 'affirmation' of the contract. In two cases reported in 2010 the English courts had to grapple with the question of whether an innocent party could affirm a contract (thereby losing its right to sue for loss of profits) by terminating it pursuant to an express contractual provision – hence the problem of 'affirmation by termination'. The decision in one of these cases proved expensive for Shell.

The Shell Egypt case

In Shell Egypt West Manzal GmbH v Dana Gas Egypt Ltd1 the question of 'affirmation by termination' arose in the context of a 'farm-in agreement'. The premise of the deal between Shell and Dana was that, by various steps, Shell would...