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Contracts: getting out of a bad bargain

Bill Dixon comments on a recent case the firm was involved in (Gold v BDW) on getting out of contracts which have come unprofitable.

This firm recently acted for the successful claimants in two important decisions in a case in the Technology and Construction Court:  Gold Group Properties Limited v BDW Trading Limited [2010] EWHC 323 and [2010] EWHC 1632.

In 2007 Gold entered into a joint development agreement with BDW (formerly Barratt Homes) to build and market 100 flats on Gold’s site in Surrey. The profits were to be split between Gold and BDW according to a formula.  After the contract was signed but before construction had started, the property market was faltering and prices had started to fall.  BDW took the view that the minimum sales prices for flats set out in the development agreement were unlikely to be achieved.  As a result, they walked away from the contract.  Gold started legal proceedings.

In the light of what subsequently happened with the property market, BDW had clearly entered into a bad bargain in 2007.  The key question was whether there were any relevant principles of contract law which allowed them to back out of the deal.  During the course of two hearings the court looked at three legal issues.

1.  Frustration

In very limited circumstances, the law will allow a party to escape a contract which has become impossible to perform under the legal doctrine of frustration.  However, the decision in Gold v BDW reiterates the long-established principle that one cannot rely on frustration as a basis on which to avoid a contract just because the agreement is no longer economically viable.  Accordingly BDW’s attempt to get out of the contract on this basis failed.

2.  Duty of good faith

Under the development agreement, the parties agreed to act in good faith towards each other and not to seek to increase profit or reduce losses at the other’s expense.  This kind of “good faith” clause is quite common in some development agreements.  BDW argued that Gold was under a duty to renegotiate the financial arrangements between the parties to achieve a “fairer” profit split once the impact of the market collapse became clear.  The court rejected that argument.  It held that such a clause could not “require either party to give up a freely negotiated financial advantage clearly embedded in the contract”.

3.  Repudiatory breach

BDW had written to Gold claiming it could stop work and end the development agreement on the basis of frustration (see above). Because in fact there was no valid frustration, BDW were therefore potentially in repudiatory breach of contract.

A “repudiatory breach” takes place where someone makes clear they will no longer perform the contract or, alternatively, where they commit a contractual breach which is sufficiently serious to allow the other party to terminate the agreement (rather than just claiming compensation by way of damages).

Crucially, for the contract to come to an end, such a breach has to be “accepted”.  Sometimes, however, correspondence reflecting an ongoing commercial discussion between the parties does not fit neatly into the relevant legal categories of acceptance or non-acceptance. This is what happened in Gold v BDW.  The court had to go through the correspondence in some detail in order to establish precisely when the moment of acceptance of the repudiatory breach occurred.  Even though BDW stopped all construction work, wrote to Gold to say they were withdrawing and even returned the site keys, the court held that on the particular facts it was a further nine months before Gold accepted the breach.

Practical lessons:

  • After a commercial contract has been entered into, sometimes circumstances change.  The deal may cease to be economically viable. It is not sensible to rely on legal doctrines such as frustration or clauses providing for a general duty of good faith to deal with such a situation.  Ideally the position should be anticipated at the contract drafting stage.  If there is a risk this could arise, it is far better to spell out in advance in the contract details of what the consequences for each party should be if the financial circumstances change.
  • In choosing the legal basis on which to try to end a contract, great care needs to be taken.  Choose the wrong legal basis and one may put oneself into a position where one has committed a repudiatory breach.
  • Where the other contractual party has potentially committed a repudiatory breach of contract, it is worth thinking carefully about what one wants to achieve. If necessary, one should take appropriate legal advice.  Is it best to bring the contract to an end, for example, or would one prefer the other contracting party still to be under an ongoing obligation to perform?  If one wishes to accept the repudiatory breach, has this been done in a way which is clear enough to satisfy the courts?