View source for Shell Egypt v Dana Gas

DMC/SandT/11/13

'''England'''

'''Shell Egypt West Manzala GmbH and another v Dana Gas Egypt Limited''' 

'''Queen’s Bench Division (Commercial Court): Tomlinson J: [2010] EWHC 465 (Comm): 10 March 2010'''

John McCaughran QC, instructed by Messrs Herbert Smith LLP, for Shell Egypt

Robert Hildyard QC and Richard Hill, instructed by Messrs Ashurst LLP, for Dana Gas 

'''CONTRACT: JOINT VENTURE FOR GAS EXPLORATION: REPUDIATORY BREACH COMMITTED BY ONE PARTY: INNOCENT PARTY TERMINATED CONTRACT BASED ON WRONG BELIEF THAT CONTRACTUAL TERMINATION CLAUSE WAS TRIGGERED: WHETHER INNOCENT PARTY COULD JUSTIFY TERMINATION OF CONTRACT'''

'''Summary'''

Shell and Centurion entered into a contract for the joint exploration of natural gas in Egypt, under which the latter had to acquire all the interests in a concession which it jointly held with another company. Shell mistakenly thought that this was not done within the prescribed period, and issued a letter to terminate the contract under a termination clause in the contract. The High Court affirmed the holding of the arbitral tribunal that Shell’s letter evinced an unequivocal intention to terminate pursuant to the contractual termination clause. This precluded Shell from relying on the other repudiatory breach committed by Centurion to justify its termination of the contract. 

This note has been contributed by Ken To-ching Lee, LLB(Hons), PCLL (University of Hong Kong), BCL(Oxon) and barrister-at-law in Hong Kong.

'''Background'''

In 2005, Centurion Petroleum Corporation (Centurion) and CTIP Oil and Gas (CTIP) obtained concessions from the Egyptian Government for natural gas exploration along the Nile. Centurion held a 75% interest, and CTIP a 25% interest.

In March 2006, Centurion entered into a joint venture with the Shell Egypt companies (Shell) through a “Farm-In and LNG Co-operation Agreement” (“the FIA”). Under the FIA, Centurion agreed to obtain the relevant governmental approval, acquire the 25% interest held by CTIP, and assign a 50% interest in the concessions to Shell. Completion of this transaction was called “Closing” under the FIA, and this was supposed to take place 9 months after the FIA was entered into. Shell would pay an initial sum of US$15 million, and a further US$20 million upon the completion of drilling five wells.

Clause 3.1.8 of the FIA provided that if Closing did not occur within 9 months, Shell might elect to terminate the FIA by 30-day written notice, and Centurion did not have to refund any payments made by Shell.

Clause 3.1.9 of the FIA provided for the situation where Closing did not occur because Centurion failed to secure governmental approval for the acquisition of CTIP’s interests in the concession. In such case, even if Shell terminated the FIA pursuant to Clause 3.1.8, Centurion would nevertheless have to refund payments made by Shell.

Disputes arose on whether Centurion had breached the FIA by engaging in ‘sole risk’ drilling activities. It also denied that there had been a ‘change of control’ by reason of a third party acquiring its ultimate holding company – a factor which would have triggered for Shell certain pre-emption or assumption of control options. 

Matters came to a head in December 2006, when after the failure of negotiations, Shell wrote a letter (the Letter) to Centurion on 22 December stating that, as Closing did not occur within 9 months after the FIA was entered into, it was issuing a notice to elect to terminate the FIA. Shell further alleged that it received not received confirmation that Centurion had obtained consent from the Egyptian government for its acquisition of CTIP’s interests. It treated the acquisition of CTIP as not having been completed, and demanded that Centurion refund the payments it had made. 

However, in fact, when Shell sent out the Letter, it was mistaken in its belief that the CTIP acquisition had not been completed. It had overlooked that it had actually received the relevant documents from Centurion long before the Letter had been sent. 

Subsequent arbitration between the parties held that Shell was not entitled to invoke Clause 3.1.9, and Centurion was under no obligation to refund any payment to Shell. Although Centurion was in repudiatory breach of the FIA in other respects, the Letter could not be read to mean that Shell had accepted those repudiatory breaches. The effect of the Letter was only that Shell terminated the FIA in accordance with its Clause 3.1.8, and it had no right to damages or refund of sums paid.

Shell then obtained leave from Gloster J to appeal against the arbitral award: see [2009] EWHC 2097 (Comm), [2010] 1 Lloyd's Rep 109.

'''Judgment'''

Tomlinson J dismissed Shell’s appeal.

The issue before the Court was whether Shell could be regarded as having accepted Centurion’s repudiatory breach by the Letter.

Tomlinson J accepted that generally, even if a party gave the wrong reason for accepting a repudiatory breach and refusing to perform a contract, it might later justify its behaviour if there existed at that time in fact good reasons for refusal. There was no finding by the arbitral tribunal that the doctrines of waiver or estoppel operated to preclude Shell from relying on grounds other than those stated in the Letter, i.e. the repudiatory breach committed by Centurion in other respects. Thus, the only question was whether Shell was entitled to justify its termination of the FIA by reasons other than those stated in the Letter. 

In the present case, the exercise of Clause 3.1.8 was necessarily inconsistent with treating the FIA as being terminated by accepting a repudiatory breach. This was because Clause 3.1.8 was not triggered by breach. Further, different consequences followed if Shell exercised its right under Clause 3.1.8 of the FIA, and if it accepted Centurion’s repudiatory breach. Shell was entitled to refund of its payment under the latter, but not the former. Thus, Shell had to elect between these two options: Dalkia Services plc v Celtech International Ltd [2006] 1 Lloyd’s Rep 599 and Stocznia Gdynia SA v Gearbulk Holdings Ltd [2010] QB 27.

Although the Letter did not expressly refer to Clause 3.1.8, it could only be read as terminating the FIA pursuant to Clause 3.1.8. That clause was the only clause in the FIA that gave Shell the right “to elect to terminate”, which it purportedly exercised in the Letter. Further, the Letter referred to Clause 3.1.9 which was only applicable by its terms when Shell elected to terminate in accordance with Clause 3.1.8. Although a reasonable recipient would have realised that Shell was mistaken as to the applicability of Clause 3.1.9 in this case, this alone did not remove the clear effect of the Letter, which evinced Shell’s unequivocal intention to terminate under Clause 3.1.8. 

Shell could have served a notice which accepted the repudiatory breach as terminating the FIA, and alternatively, in case it was wrong in asserting the repudiatory breach, exercised the contractual right to terminate under Clauses 3.1.8 and/or 3.1.9. However, this was not done. 

Thus, reading the Letter in the context of the Decmber negotiations, a reasonable recipient would have thought Shell more concerned about having to spend more money in the FIA than in recovering compensation. The arbitral tribunal was right in holding that Shell did not accept Centurion’s repudiatory breach, and the appeal was dismissed.

'''Comment'''

This is yet another case after Stocznia Gdynia SA v Gearbulk Holdings Ltd [2010] QB 27, that touches on the interaction of contractual termination clauses and the right to terminate for repudiatory breach under the common law. In the Stocznia case, the Court of Appeal held that the right of the innocent party to terminate the contract for repudiatory breach coincided with the right conferred under a contractual termination clause in that case. So, a notice by the innocent party to accept the repudiation, and alternatively, in case repudiation was wrongly asserted, to terminate pursuant to contractual clause, was held to be effective. 

In the present case, Tomlinson J took this approach a step further by suggesting that Shell could have adopted an “alternative” termination notice as was adopted in the Stocznia case, even though the events triggering Clause 3.1.8 did not coincide with Centurion’s repudiatory breach. 

In general, adopting the “alternative” termination notice saves the innocent party to a contract some trouble in deciding whether the other party has committed a repudiatory breach – but only if the contract contains a termination clause that could be invoked as a fallback, should the decision turned out to be wrong.