Classification of contractual terms: What businesses need to know

9th October 2019

Gwendoline Davies, Head of Dispute Resolution at Walker Morris explains why businesses need to understand the different categories of contractual terms. In light of the recent Court of Appeal case of Ark Shipping v Silverburn Shipping [1], Gwendoline clarifies the correct approach to the classification of terms, and offers practical advice for anyone involved in contract drafting or interpretation.

What do businesses need to know about the categories and classification of contractual terms?

In the fast-paced world of commercial negotiations, contractual language is often deployed without parties necessarily appreciating the correct legal meaning, and practical impact, of certain words. However, whether a contractual provision is classed, as a matter of law, as a ‘condition’; a ‘warranty’; or an ‘innominate’ (or ‘intermediate – these latter two are interchangeable) term is a technical issue which can have very significant practical and financial implications. The classification of a contractual provision is crucial because it can determine the remedies that will be available in the event of breach.

• If a provision is a condition, then the innocent party will, in the event of a counterparty’s breach, be entitled to both terminate the contract and to claim damages.
• If a provision is a warranty, then an innocent party will only be able to claim damages – it will not be entitled to terminate the contract.
• A provision will be an innominate term if it is neither a condition nor a warranty. Where an innominate term is breached, the remedy or remedies available to the innocent party will depend on the nature and effect of the particular breach. Pursuant to case law [2], if the breach substantially deprives the innocent party of the benefit of the contract overall, then the remedy will be as for a breach of condition (that is, entitlement to terminate and to claim damages). If, on the other hand, the breach is not so significant as to undermine the contract as a whole, then the remedy will be as for a breach of warranty (that is, entitlement to claim damages only).

It is essential that anyone involved in the negotiation, drafting or interpretation of commercial contracts understands the different categories of contractual terms. In particular, where appropriate, it is important that parties are able to decide upon their requirements and then to provide for conditions, warranties and/or innominate terms accordingly within their contractual arrangements.

In the recent Ark Shipping case, the Court of Appeal provided a cautionary reminder of the different categories of contractual terms. The court also clarified the correct approach for classifying terms.

What are the key takeaways, and what practical advice arises?

Overall, in the absence of express wording, the categorisation of contractual terms is a balancing exercise. In accordance with prior authority, the court should generally find that a term is innominate unless it is clear on the face of the contract that the term is a condition or a warranty; and in making that assessment, the court will take into account the language, structure and scheme of the contract, together with business common sense.

A key point for contract negotiators and drafters to appreciate is that, in many cases, a judgment call will be needed as to whether a contractual term should be expressed to be a condition or a warranty, or whether the terms should be innominate. There is, of course, the advantage of certainty on the one hand; but the flip-side is that it can be undesirable for trivial breaches to carry the consequences of a breach of condition.

As a general guide, where a point is absolutely critical to your business and to the success of the contractual arrangement, such that you would require termination to be an option in the event of breach, it may be best to expressly state within the contract that the term is a condition. Where, however, flexibility will be preferable, the contract should perhaps remain silent as to classification of the term.

What happened in the case?

Ark had leased, by way of an industry standard charterparty contract, a vessel from Silverburn. The contract included, amongst other terms, certain obligations on Ark for the ongoing maintenance of the vessel. Several disputes arose between the parties and, in December 2017, Silverburn argued that a specific maintenance obligation was a condition and that Ark had breached it. Silverburn therefore sought to both terminate the contract and claim damages. The Court of Appeal was asked to determine (solely) whether the obligation was a condition or an innominate term. In doing so, the Court of Appeal confirmed that the correct approach as to the classification of contractual terms is as follows:

• Questions as to the classification of contractual terms are a matter of contractual construction and interpretation.
• As Walker Morris has reported in an earlier briefing, the correct approach to contractual construction and interpretation is that the starting point must be the wording of a contract itself. The court’s task is to ascertain the meaning of the language which the parties have chosen to express in their agreement when read in the context of the factual background known or reasonably available to the parties at the time of the agreement; but where a term might be interpreted in different ways, the court is entitled to prefer the interpretation which is consistent with business common sense.
• In accordance with earlier Court of Appeal authority [3], the court should find that a term is innominate unless it is clear on the face of the contract that the term is a condition or a warranty.
• Undertaking a step-by-step analysis in the current case, the court took the following factors into account:
  • Wording: The provision in question was not expressed to be a condition.
  • Time/Interdependence: The provision was not a ‘time clause’, a ‘condition precedent’, nor any other form of interdependent clause on which other contractual obligations relied.
  • Drafting: Looking at the drafting as a whole, the particular provision was part of a wider clause. It was unlikely that the parties’ intention could have been for just that one element within the wider clause to be a condition; but it would be too extensive and commercially illogical if all other elements within the clause were also conditions, and that could not have been the parties’ intention.
  • Drafting – Industry Standard Contract: Further considering the drafting as a whole, the provision was within an industry standard contract, which one would expect to expressly specify where a term was meant to be a condition.
  • Consequences of Breach: The consequences of breach of the provision could range from trivial or very serious. Such a wide range of possible consequences is consistent with a provision not being a condition.
  • Ongoing obligation: The provision dealt with an ongoing maintenance obligation. Typically within the industry, continuing obligations as regards the maintenance of vessels are not conditions.

The Court of Appeal concluded on this occasion that the provision was an innominate term. Consequently, albeit this was not a matter for the Court of Appeal to decide in the current proceedings, an assessment must be made as to whether the remedies available in the event of breach will be as for a breach of condition (termination and damages) or as for a breach of warranty (damages only). Any such assessment will depend upon on the particular facts and circumstances of any individual case.

If you would like any advice or assistance with the negotiation, drafting, interpretation or application of any of your contractual terms, or if you would like any further information or advice relating to the classification of contractual terms, please do not hesitate to contact Gwendoline or any member of the Commercial Dispute Resolution Team.

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[1] [2019] EWCA Civ 1161
[2] Hong Kong Fir Shipping Co Ltd v Kawasaki Kisen Kaisha Ltd [1961] EWCA Civ 7
[3] Spar Shipping AS v Grand China Logistics Holdings (Group) Co Ltd [2016] EWCA Civ 982