The judgement in the Classic Maritime Inc. v Limbungan Makmur SDN BHD, Lion Diversified Holdings BHD (2018) case shows that parties should be aware of the distinction between a frustration clause and an exceptions clause.
In the recent case of Classic Maritime Inc. v Limbungan Makmur SDN BHD, Lion Diversified Holdings BHD (2018), the High Court reviewed established jurisprudence concerning the need to prove causation when relying on a force majeure clause. The case arose out of the devastating events of the failure of the Fundao dam in the iron ore producing complex Germano, Brazil. The Court considered whether the dam’s failure was causative of the defendant’s failure to subsequently ship iron ore pellets.
The shipowner and claimant in this case, Classic Maritime Inc (“Classic”), had entered into a long-term contract of affreightment for the carriage of iron ore pellets with Limbungan Makur SDN BHD (“Limbungan”), the charterer and defendant.
The contract included an exceptions clause (or “force majeure clause”) which stated the following:
“Neither the Vessel, her Master or Owners, nor the Charterers, Shippers or Receivers shall be responsible for … failure to supply, load … cargo resulting from: Act of God, … floods, … accidents at the mine or production facility … or any other causes beyond the Owners’, Charterers’, Shippers’ or Receivers’ control; always provided that such events directly affect the performance of either party under this Charter Party.”
The events underpinning this case highlight the importance for businesses to be prepared for natural and man-made disasters
Following the failure of the dam, production of iron ore ceased at the mine, and Limbungan relied on the exceptions clause to excuse themselves for their failure to supply iron ore pellets in accordance with the contract of affreightment.
Classic argued that the failure of the dam was not legally relevant because; i) Limbungan failed to make relevant alternative arrangements to provide the cargo following its only supplier refusing to supply; and ii) Limbungan had missed several shipments before the failure of the dam. Classic tried to convince the Court that Limbungan would not have fulfilled its obligations irrespective of the failure of the dam.
Teare J carefully assessed the various arguments and concluded that Limbungan was not able to rely on the exceptions clause in the contract in order to avoid liability for non-performance. However, Teare J applied the compensatory principle to conclude that Classic were not able to recover substantial damages because even if Limbungan had been willing to perform in accordance with the contract, the failure of the dam would have prevented performance in any case.
In reaching this conclusion, Teare J provided some insightful commentary on what could previously have been seen as settled principles:
1. Alternative arrangements principle
Usually, in order to successfully rely upon a force majeure clause, the party relying on it must establish that it has attempted to mitigate the losses by considering alternative arrangements to facilitate the performance. In this instance, Teare J held that the principle was applicable here, and that if Limbungan was to be regarded as: i) having made arrangements to ship from alternative ports and ii) following the dam burst, as having made all reasonable efforts to ship from those ports with no success, then the dam burst could be regarded as the cause of its failure to supply the cargoes. Teare J considered this point when deciding on the causation element of the claim (see point 2 below). Importantly, Teare J rejected Classic’s argument that alternative arrangements required under the alternative arrangements principle must be legally binding.
2. “But for” test
Teare J discussed at length the significant difference between; a) a frustration clause; and b) an exceptions clause. A frustration clause does not require the satisfaction of a “but for” test, and operates to bring the contract, or what remains of it, to an end so that, thereafter, the parties have no obligations to perform. In contrast, an exceptions clause is concerned with whether or not a party is exempted from liability for breach of contract at a time when the contract remained in existence. Considering the wording of the exceptions clause in this contract, specifically the words “directly affect”, Teare J concluded that the clause imports the requirement to satisfy a “but for” test and as such must be an exceptions clause. As such, Limbungan had to demonstrate that “but for” the failure of the dam, the cargo would have been supplied in accordance with the contract. It was Limbungan’s failure to satisfy this test which prevented it from successfully relying upon the exceptions clause to claim an exemption from liability for breach of contract.
Notwithstanding the above, Teare J denied Classic substantial damages from Limbungan because of the operation of the compensatory principle; the principle requires a comparison between the wronged party’s position as a result of the breach of contract, and the position it would have been in had the contract been performed without breach. Here, the compensatory principle required a comparison between Classic’s position as a result of the breach and the position it would have been in had Limbungan performed its obligation. In this instance, Teare J held that if, “but for” the dam failure, Limbungan had been willing and able to ship the cargoes, no cargoes would in fact have been shipped because of the dam failure, and, therefore, the dam failure would have excused Limbungan for its failure to make the required shipments. Accordingly, Classic was not entitled to substantial damages even though Limbungan was not able to rely on the exceptions clause in the contract.
Owing to the wording of the exceptions clause, this judgment was distinguished from previously established case law in which it was suggested that force majeure or exceptions clauses did not require a “but for” test to be satisfied before a party could be exempted from liability. There are two significant points to note as a result of the judgment.
Firstly, parties should be aware of the distinction between a frustration clause and an exceptions clause, especially in respect of the thresholds which a party is required to meet before it can rely on the clauses.
Secondly, parties should be aware that the courts will consider the parties’ intentions irrespective of a force majeure event, if an exceptions clause is being relied upon. Parties should also be able to demonstrate a clear genuine effort to establish alternative arrangements for the fulfilment of the contract in such instances; albeit this case clarifies that such arrangements need not be legally-binding arrangements.
The events underpinning this case highlight the importance for businesses to be prepared for natural and man-made disasters which can create significant business disruption. Such risks are beginning to be recognised by insurers. For more information on the topic, please see the recently published report by Clyde & Co entitled “Closing the protection gap through inclusive insurance”.
Jessica Maitra and Ross Howells work at Clyde & Co, a global law firm focusing on insurance, trade and commodities, energy, infrastructure and transport. Ms Maitra can be contacted on +44 (0)191 249 5438 or at email@example.com.