Finance litigation update - July 2022

FINANCE LITIGATION UPDATE – JULY 2022 22 Contractual termination: avoiding problems The recent High Court claim of Lombard North Central Plc v European Skyjets Ltd [2022] EWHC 728 (QB) provides some important reminders on what may (and may not) be required to validly terminate a contract, as well as when a right of termination may be lost through 'waiver'. The case concerned default by an airline business on a secured loan and the lender's entitlement to terminate (and thus 'accelerate') the loan. While the case will be of particular interest to financial institutions, the principles apply to all commercial contracts. Termination – the basics Exercising a contractual right of termination under any commercial contract is often not as straightforward as one might expect. To start with, the law requires that any valid termination notice must comply strictly with any termination conditions set out in the contract. To borrow the analogy of Lord Hoffman in the leading case of Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1997] UKHL 19 concerning notice validity, “[i]f the clause [in a contract] had said that the [termination] notice had to be on blue paper, it would have been no good serving a notice on a pink paper". Identifying and satisfying termination conditions is often more complex than just using the right coloured paper. Secondly, even where a termination notice is correctly drafted and validly served, a right of termination can be inadvertently lost where a party acts in a manner which is inconsistent with the termination of the contract. A common example is where a party demands payment of arrears which have accrued under a contract, causing them to 'waive' the right to terminate for those arrears. The stakes are high when it comes to correctly terminating a contract: if a party incorrectly terminates then they will, in general, be liable to the other party for the losses resulting from that incorrect termination. In high value commercial contracts, the losses could be substantial. Background In 2008, European Skyjets Limited (the "Borrower"), took out a loan in the sum of USD 8.77 million for the purchase of an aircraft (the "Loan Agreement") with Lombard North Central Plc (the "Lender"), secured by way of a first priority legal charge over the aircraft. Between 2009 and 2012, the Borrower regularly paid the monthly instalments late. During this time, the Lender sought to apply late payment charges (in addition to default interest) on any outstanding arrears. Although there was no contractual right under the Loan Agreement to apply late payment charges, the Lender sought to apply such charges as a condition of it not enforcing its rights in respect of future late payments. In 2012, the Lender emailed the Borrower stating that its account was in arrears and that it remained uncomfortable with the Borrower's payment history and short-term cash flow. Nevertheless, as "a gesture of goodwill", the Lender offered to "allow more time to bring the balance of the arrears up to date". This email contained the statement that it was"… without prejudice and [that the lender] fully reserves its rights in respect of the identified breaches being arrears on the Loan Agreement…"(a so-called "Reservation Statement"). The Loan Agreement provided that the Lender was entitled to terminate" [a]t any time after the occurrence of an Event of Default" (emphasis added) by giving notice to the Borrower (the "Termination Clause"). After receiving advice by an independent firm of accountants that the Borrower was insolvent, the Lender terminated the Loan Agreement by giving notice relying on purported arrears as an 'Event of Default'. The Lender subsequently sought to enforce its security over the aircraft by selling it for USD 3.1 million. Thereafter, the Borrower went into administration. Whether or not the Borrower was actually in arrears at the date that the notice was served was in dispute (the Borrower maintaining that it had cleared the arrears before the notice was served). The Lender later brought a claim against the Borrower for the outstanding balance of USD c.5.78 million under the Loan Agreement. The Borrower denied the claim on the basis that the Lender had no entitlement to terminate the Loan Agreement (and thus to sell the aircraft) and counterclaimed for damages of USD 26 million arising for breach of contract and/or conversion.