FUDAMENTAL BREACH: HAS THE BABY GONE OUT WITH THE BATHWATER – BY MIKE WAGENER

Monday, July 19, 2004
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FUNDAMENTAL BREACH:  HAS THE BABY GONE OUT WITH   THE BATHWATER?
           
This article examines the genesis and demise of the doctrine of fundamental breach. It attempts to show that, properly understood, the doctrine of fundamental breach has value and should be retained: It evaluates persistent attempts to re-introduce the doctrine in order to defeat the package limitation contained in the Hague Rules and the Hague-Visby Rules and compares the law in this area in England and America.
 
ORIGINS
 
            The doctrine of deviation in ocean carriage has been recognized as the ancestor of the doctrine of fundamental breach. [i] Deviation was described in Joseph Thorley Ltd v Orchris Steamship Co [ii] as “a serious matter that changes the character of the contemplated voyage so essentially, that a shipowner that has been guilty of a deviation cannot be considered as having performed his part of the bill of lading contract but something fundamentally different (emphasis added);  and therefore he cannot claim the benefit of stipulations in his favour contained in the bill of lading.” [iii]
           
The true rationale of fundamental breach was affirmed by Lord Wright MR in  Hain Steamship Co. Ltd v Tate & Lyle Ltd [iv] as follows:  
 
[L]oss of the insurance is sometimes stated as the reason why deviation is treated so drastically under a contract of affreightment.  If that were all, the mischief might be remedied by means of the deviation clause which is so generally now found in policies.  But the reason is more fundamental and is the same principle in both contracts.  The adventure has been changed.  A contract entered into on the basis of the original adventure, is inapplicable to the new adventure. [v] (emphasis added).
To extract a principle of general application in the law of contract from these cases,  care should be taken not to lose sight of maritime deviation in its singular factual context:   every part of an ocean voyage is (or was when these early cases were decided)  fraught with unforeseeable danger.  In this light it was not unreasonable to clothe the shipper with the right to insist on the very strictest compliance with the agreed route.
            In time the principle enunciated by Lord Wright in the Hain case was broadened to include not only radical non-performance but also the breach of any material term of the contract.  The view was expressed that no matter how widely exempting clauses were drawn, they could only avail a party when he is carrying out the contract in its essential respects.[vi]  In U.G.S Finance, Ltd. v National Mortgage Bank of Greece,[vii]  Lord Denning MR found a new rationale for the doctrine of fundamental breach: 
 
The doctrine of “fundamental breach” is a recent introduction into our law.  It has been developed so as to get over an injustice of “standardised contracts”.  A trader undertakes to warehouse goods, or to carry them, to sell them or to let them on hire-purchase, and issues a printed form of contract which he gets the customer to sign: but somewhere on the form he inserts exemption clauses in which he purports to exempt himself from all liability.  No customer has any choice but to accept the form.  He must sign on the given line or go without a contract at all.  No customer - or not one in a thousand - ever reads the exemption clauses, and it is a fiction to suggest that he agrees to them.  So the Courts have held that they cannot be used by the trader so as to avoid the fundamental obligations which he has undertaken.[viii]
 
 
            THE TIDE BEGINS TO TURN
 
In the mid 1960’s Suisse Atlantique Société D’armement Maritime SA v NV Rotterdamsche Kolen Centrale [ix] was decided in the House of Lords.  On a careful analysis,  the speeches of the judges in Suisse Atlantique repudiated the broadened concept of fundamental breach but not its essence as formulated in Hain.
 
Suisse Atlantique was decided upon a consultative case.  The owners sued the charterers for damages for delay.   There was a demurrage clause.   Although the vessel was chartered for a fixed term of two years, freight was paid on consecutive voyages.  The owners contended that the charterers deliberately delayed the voyages to deprive them of freight which could have been earned on a number of  voyages.  The loss of freight was considerably more than the sum arrived at by applying the demurrage rate.  The court was asked to decide whether deliberate delay on the part of the charterers nullified the demurrage clause.
 
The pivotal fact in the case was that half way through the charter the owners repudiated the contract by reason of the delay but continued to make the vessel available for the remainder of the term of the contract.  The effect of this fact on the outcome of the case can be seen in all of the leading judgments.   The following statement in the speech of Lord Upjon will serve as an example:
[W]ith full knowledge of the all facts (the owners) elected to treat the contract as on foot until the expiry of the charter party by effluxion of time.  It is this feature which gives rise to the whole difficulty in this interesting case.  For it is common ground that, had the appellants (the owners) accepted the assumed repudiation and sailed away, thereby terminating the contract, none of its terms survived and damages for breach of contract would have been at large,  including damages for loss of profitable employment of the ship for the term of the charter party.[x] (emphasis added)
                       
Lord Wilberforce, far from sounding the death-knell for the doctrine of fundamental breach,[xi] affirmed it.  Referring to the demurrage clause he said as follows:
One may safely say that the parties cannot, in a contract, have contemplated that the clause should have so wide an ambit as in effect to deprive one party’s stipulations of all contractual force;  to do so would be to reduce the contract to a mere declaration of intent.[xii]… Since the contracting parties could hardly have been supposed to contemplate such a mis-performance, or to have provided against it without destroying the whole contractual substratum, (emphasis added) there is no difficulty here in holding exception clauses to be inapplicable.[xiii]
 
The fact overlooked by commentators[xiv] is that if the owners had sailed away in Suisse Atlantique they would have been able to rely on the doctrine of fundamental breach as expounded in Hain.
 
            PHOTO PRODUCTION v SECURICOR
 
Photo Production Ltd v Securicor Transport  Ltd [xv] is widely regarded as the case which  brought about the ultimate destruction of the doctrine of fundamental breach.  As in Suisse Atlantique, how the facts coloured the outcome has been ignored. 
 
In Photo Production, a security guard employed by the defendant company deliberately started a fire.  The fire destroyed the entire building which the defendant had been hired to look after.  In the leading judgment on the facts, Lord Wilberforce pointed out that there was no finding that the guard intended to burn down the entire premises.[xvi]  If there had been such a finding, the outcome of Photo Production could well have been different with important consequences for the legal perceptions of the doctrine of fundamental breach.
 
The problem under discussion is what to do when one party performs something wholly different from what has been undertaken.  Lord Diplock with his usual clarity of expression provided the following analysis in an earlier case, Hardwick Game Farm v The Suffolk Agricultural and Poultry Producers Association Ltd:[xvii]
 
When applied to this kind of event the expression ‘fundamental breach’ means a total failure by one party to perform a contract of the kind into which he has entered.  So far as it appears from the words and the conduct of the parties that they intended to enter into a contract of that kind an exception clause cannot be drafted in wide enough terms to cover this kind of event without either destroying the contract altogether or changing its character.  If it is wide enough to exempt one party from performance while binding another party to perform, the contract is either void for lack of consideration or transformed from a bilateral synallagmatic contract into a unilateral or ‘if’ contract in which one party undertakes a legal liability to perform acts if the other party performs other acts but the other party undertakes no legal liability to perform such other acts.  It would, I think, be conducive to clarity in the law of contract if the expression ‘fundamental breach’ were restricted to events of this kind, but in recent years it has been applied by this court to a much wider class of events than this (emphasis added).
 
Regardless of the terminology used, the phenomenon where a party delivers a performance entirely different from the one contracted for,  has to be dealt with by the law.  Such fundamental malperformance could never have been contemplated by the parties without destroying the foundation of the contract together with exemption and limitation clauses.  This insight, evident in Hardwick Game Farm was explicitly abandoned by Lord Diplock in Photo Production.[xviii]
 
In Photo Production, Lord Diplock exercising a powerful influence on the other members of the court, adopted a determinist approach which may be summarized as follows: commercial enterprises agree to deliver results and are free to determine between themselves the effect of the failure to produce such results; human waywardness in arriving at the agreed result should be left out of account and reserved for the law of tort.   On this model parties must be taken to contemplate the possibility of total failure of performance whether by design or accident and to make the necessary allowances for the risk by taking out insurance.  Lord Diplock’s developed thought on this point is found in his article ‘Conventions and morals – Limitation clauses in International Maritime Conventions’[xix]  Here insurance is the deus ex machina which eliminates personal responsibility as a factor to be taken into account in commerce. 
 
That this view is contrary to the expectations of the business community and legal orthodoxy is abundantly clear from the travaux preparatoires  to the Hague Rules.[xx]  It is also in stark contrast with what Lord Diplock said in Hong Kong Fir Shipping Co. Ltd v Kawasaki Kisen Kaisha Ltd: [xxi]  “[T]he fundamental legal and moral rule (is) that a man should not be allowed to take advantage of this own wrong”.[xxii]  In any event, the principle of subrogation in insurance law maintains and even reinforces the significance of personal responsibility.
 
THE TRAVAUX PREPARATOIRES
 
At the twelfth conference of the Association for the Reform and Codification of the Law of Nations held at Hamburg in August 1885,  reference was made to resolutions signed by the leading insurance companies of London, and all the insurance companies of New Zealand and Australia, formally protesting against the adoption of any bill of lading for general use which would release the shipowners from liability for the negligence of the master or crew.[xxiii]  At the same conference the following quotation from the “Montana” was read out:   “It cannot be permitted to stipulate for immunity for the negligence of its (the carrier’s) servants”;  [xxiv] Mr Justice Peabody added: 
 
It is a universal principle of law, and is the law of nature, that every man is responsible for his own acts, and that every man who acts by another, in effect acts by himself, is bound for the acts of the person he employs – bound for their diligence, their honesty and capability.  The carrier ought to be responsible, with very few exceptions, for that which he undertakes to do for the shipper, and this general rule was a very necessary one for the general interests of commerce.[xxv]
 
At the 30th conference of the Maritime Law Committee of the International Law Association at the Hague in 1921 the chairman, admiralty judge, Sir Henry Duke said to loud acclaim:
And now, gentlemen, I think it is within my province as chairman to remind you what is in question.  It is not insurance. (Hear, hear).  That is a separate business.  It is to secure that the shipowner does his duty in taking care of the goods (Hear, hear); [xxvi]
 
IS THE DOCTRINE OF FUNDAMENTAL BREACH REALLY DEAD?
 
In George Mitchell (Chesterhall) Ltd v Finney Lock Seeds Ltd [xxvii] merchants sold and delivered “autumn” cabbage seeds instead of “Dutch winter white” cabbage seeds with disastrous results for the buyer’s crop.  The House of Lords dubiously found that the product delivered was not wholly different from that ordered so that a limitation clause was held to apply at common law.  Fortunately, the buyer was able to rely on the reasonableness provision in the Sale of Goods Act, 1979. 
 
The interesting part of the speech of Lord Bridge of Harwich in which the other Law Lords (including Lord Diplock) concurred was that he expressly distinguished the facts of this case from the “peas and beans” or “chalk and cheese” cases.  (In Charter House Credit Co. Ltd v Tolly [xxviii] the example had been given of the delivery of three Suffolk Punch horses in place of a tractor).  Lord Bridge stated:
 
My Lords, it seems to me, that with all due deference, that the judgments of the trial judge and of Oliver LJ (in the Court of Appeal) on the common law issue come dangerously near to reintroducing by the backdoor the doctrine of “fundamental breach” which this House in the Photo Production case had so forcibly evicted by the front.  The judge discusses what I may call “peas and beans” or “chalk and cheese” cases, ie.  those in which it has been held that exemption clauses do not apply where there has been a contract to sell one thing, eg.  a motor car, and the seller has supplied quite another thing, eg.  a bicycle … in my opinion, this is not a “peas and beans” case at all.  The relevant condition applies to “seeds”.[xxix]
 
In Wibau Maschinefabric Hartman S.A. v Mackinnon Mackenzie & Co. (the “Chanda”) [xxx] the package limitation in the Hague Rules was held inapplicable to damage caused to unauthorized deck cargo.  Expressly disavowing reliance on the fundamental breach doctrine,  the package limitation was held not to apply on a proper “construction” of the bill of lading.  In arriving at his conclusion, Mr Justice Hirst, relied on the following quotation from Firestone Tyres v Vokins:[xxxi]
 
This is not a case of fundamental breach.  It is a question of construction.  Interpreting the contract as I find it to have been, I feel driven to the conclusion that none of these exemption clauses can be applied, because one has to treat the promise that no container would be shipped on deck as overriding any question of an exempting condition.  Otherwise, as I have already said, the promise would be illusory.  (emphasis added).
 
Davenport QC [xxxii] criticized the judgment in the Chandra of allowing the doctrine of fundamental breach in by the “side door”. The question arises whether the continued re-appearance of the doctrine is not an emphatic demonstration of the need for a reasoning tool to deal with the “peas and beans” cases.  To say the problem is one of “construction” is surely begging the question.
 
THE PACKAGE LIMITATION AND FUNDAMENTAL BREACH
 
Learned hand, the American Jurist said that the surest way of misinterpreting a document is to read it literally.  This caution is particularly appropriate in interpreting an international instrument representing a result of a compromise between many conflicting interests.[xxxiii]
 
The package limitation (rule 5(a) of article 4 of the Hague Rules) reads as follows:
 
Neither the carrier nor the ship shall in any event be or become liable for any loss or damage to or in connection with goods in an amount exceeding 100 pounds sterling per package or unit, or the equivalent of that sum in any other currency unless the nature and value of such goods have been declared by the shipper before shipment and inserted on the bill of lading …
 
In Daewoo Heavy Industries Ltd v Klipriver Shipping Ltd (the “Kapitan Petko Voivoda”) [xxxiv] the package limitation was held to apply to a claim for goods damaged as a result of unauthorized deck carriage.  Following the lead in the Happy Ranger, [xxxv] the Court of Appeal declined to place any restriction on the words “in any event”.  The possibility of a “peas and beans” situation was left out of account and the problem was treated as one of the “construction” of the contract.
 
To apply the package limitation to a flagrant breach of an undertaking to carry below deck must surely be unsatisfactory to anyone who denies that morals and personal responsibility can be excised from the law of contract.  The primary argument upon which the Court of Appeal based its decision and which emanated from  The Happy Ranger was that, by their nature, exemption and limitation clauses are formulated to deal with serious breaches of contract eg. unseaworthiness. 
 
Various degrees of seriousness of breach must be recognized even if this does require value judgments that may not always be consistent.  It is self evident that value judgments cannot be eliminated from the judicial process.  Taken to its logical conclusion the reasoning in the Kapitan Petko Voivoda would mean that if the shipper contracted for carriage of goods on vessel A and the carrier transported them on vessel B, the package limitation would apply to a claim for goods lost or damaged due to the unseaworthiness of vessel B.
 
The phrase “in any event” can be traced back to the model bill of lading prepared by the New York Produce Exchange and approved by the Liverpool Steamship Owners’ Association.  Clause 1 of the model bill read as follows:-
 
– It is also mutually agreed :  That the Carrier shall not be liable for gold, silver, bullion, specie, documents, jewellery, pictures, embroideries, perfumeries, works of art, silks, furs, china, porcelain, watches or clocks, or in any respect of, all for goods of any description whatever above the value of 20 dollars per cubic foot, and in no case is the carrier to be liable beyond 500 dollars per package, unless bills of lading are signed therefore where the value expressed and a special agreement is made. [xxxvi]  
 
Although “in no case” is closer to the French version of the Hague Rules, “en aucun cas”, it is just as susceptible to the wide interpretation given to the words “in any event” in The Happy Ranger and The Kapitan Petko Voivoda. That the wording has been in existence for more than a century with only three cases of any note holding them capable of applying to cases of unjustified deviation or fundamental breach in its original sense calls for a careful examination of their soundness.[xxxvii]
 
THE UNITED STATES OF AMERICA
                                   
In the United States of America, the overwhelming majority of cases have held that the package limitation is inapplicable to an unjustified deviation of which unauthorized deck cargo is treated as a manifestation.  The United States Courts of Appeals for the Second, Fifth and Ninth Circuits have held that the statutory phrase “in any event” does not alter the pre-COGSA rule proscribing limitation in the case of deviation.   The Fourth and Eleventh Circuits have indicated that they would adopt the same reasoning.[xxxviii]   Only the Seventh Circuit has held that an unreasonable deviation does not oust the package limitation. [xxxix]  The American locus classicus, Jones v The Flying Clipper[xl], expresses the orthodoxy of Hain as follows:
 
The underlying rationale of the controlling cases is that an unjustifiable deviation changes the character of the voyage so essentially as to amount to an entirely different venture from that contemplated by the parties.
 
In Jones the argument that the phrase “in any event”, was wide enough to defeat the package limitation was dealt with as follows:-
 
The carrier presses hard that according to the language of paragraph §1304 (5) the limitation of 500 Dollars per package is applicable “in any event” and thus liability may never be imposed beyond that amount.  It suggests that in the give and take which lead to the enactment of the Act, maximum liability was fixed and is controlling “in any event” except where the shipper declared the value of the goods and paid an increased freight charge.  The purpose of the 500 Dollar limitation in §1304 (5) was to prevent a stipulated value for cargo in a lesser amount and to do away with then current limits imposed by carriers, usually 100 Dollars or even a smaller sum.  Except for this change in the amount, the provision of the Act did not represent any basic departure from existing law.  Neither the Convention nor the Act contains any provision concerning the legal result of unjustifiable deviation.  There is nothing in the history of the Act to indicate that Congress by fixing the limitation at 500 Dollars intended to misplace the doctrine of unjustifiable deviation which was so firmly entrenched in maritime law.  Such a drastic change in the existing law, with its far-reaching consequences in the commercial and financial world would have been expressed in clear and unmistakable terms. [xli]  
 
The same conservative approach with regard to existing law and the Hague Rules was expressed by the House of Lords in the Muncaster Castle.[xlii]
 
THE EFFECT OF STATUTORY INCORPORATION
 
Does the incorporation of the Hague Rules in the United States’ Carriage of Goods by Sea Act, 1936 and the British Carriage of Goods by Sea Act, 1971 fortify the limitation clause against fundamental breach.  In Jones it was held that the statutory enactment made no material difference:
 
The distinction suggested between contractual and statutory limitation or exemption clauses is more apparent than real.  The fundamental character of the bill of lading is not changed by incorporation of the statutory provisions of the Act.  The bill of lading is the contract between the shipper and the carrier.  It defines the rights, duties, exemptions and limitations of the parties, whether imposed by statute or the result of voluntary agreement and when there is such a departure from the contract of carriage as to amount to an unjustifiable deviation, the bill of lading and all its terms go.  So, too, statutory limitation would be vitiated unless the Act specifically keeps it alive.[xliii]
 
THE HAGUE -VISBY AMENDMENT
 
The central argument of this article applies equally to the Hague-Visby Rules which have introduced rule 5 (e) into article IV which reads as follows:
 
Neither the carrier not the ship shall be entitled to the benefit of the limitation of liability provided for in this paragraph if it is proved that the damages resulted from an act or omission of the carrier done with intent to cause damage, or recklessly and with knowledge that damage would probably result.
 
It has been suggested that this addition provides the Hague-Visby Rules with its own built-in fundamental breach clause.[xliv]  Yet the clause, like rule 5(a), remains, part of the contract and cannot apply in the face of fundamental malperformance for the same reasons given.
 
CONCLUSION
 
In modern times deviations vary in degrees of seriousness and on container vessels, unauthorized deck cargo may assume less significance.  But these are factual enquiries and finding that a particular breach does not constitute performance entirely different from that contracted for should not be allowed to obscure the working principle expounded in this paper.
 

 
 
[i] Dockray “Deviation:  a doctrine all at sea?”  [2000] LMCLQ 76.

 
[ii] [1907] 1 K.B. 660. 
 

[iii] Joseph Thorley [1907] 1 KB 660 at 669.
 

[iv] [1936] 2 All ER 597.
 

[v] Hain Steamship Co. Ltd v Tate and Lyle Ltd [1936]  2 All ER 597 at 608.
 

[vi] Karsales (Harrow) v Wallis [1956] 2 All ER 866 at 869.
 

[vii] [1964] l Lloyd’s Rep 446.
 

[viii] U.G.S. Finance Ltd v National Mortgage Bank  & Greece [1964] 1 Lloyd’s Rep 446 at 450.
 

[ix] [1966] 2 All ER 61.
 

[x] Suisse Atlantique [1966] 2 All ER 61 at 84.
 

[xi] The metaphor employed by Lloyd LJ Kenya Railways v Antares Co Pte Ltd  (“The “Antares”) (Nos 1 & 2)
    [1987] 1 Lloyd’s Rep 424 at 429.
 

[xii] Suisse Atlantique [1966] 2 All ER 61 at 93.
 

[xiii] Suisse Atlantique [1966] 2 All ER 61.
 

[xiv] See for example Coote “The Second Rise & Fall of Fundamental Breach”  (1981) ALJ 788.
 

[xv] [1980] 1 All ER 556.
 

[xvi] Photo Production [1980] 1 All ER 556 at 559.
 

[xvii] [1966] 1 All ER 309 at 347.
 

[xviii] Photo Production [1980] 1 All ER 556 at 565.
 

[xix] Journal of Maritime Law  & Commerce Vol 1 no.4 at 525.
 

[xx] Reproduced by Sturley A legislative history of the Carriage of Goods By Sea Act in 3 volumes (Fred B  
    Rothman & Co. 1990) hereafter “Sturley”.
 

[xxi] [1962] 1 All ER 474.
 

[xxii] Hong Kong Fir [1962] 1 All ER 474 at 485.
 

[xxiii] Sturley vol 2  at  67 – 68.
 

[xxiv] Sturley vol 2 at 69.
 

[xxv] Sturley vol 2 at 95.
 

[xxvi] Sturley vol 1 at 303.
 

[xxvii] [1983] 2 All ER 737.
 

[xxviii] [1963] 2 All ER 432 at 442.
 

[xxix] George Mitchell [1983] 2 All ER 737 at  741.
 

[xxx] [1989] 2 Lloyd’s Rep 494.
 

[xxxi] [1951] 1 Lloyds Rep 32 at 39.
 

[xxxii] Davenport “Limits on the Hague Rules” (1989) 10 LQR 521.
 

[xxxiii] “To ascertain their meaning (referring to the Hague Rules) it is in my opinion necessary to pay particular
     regard to their history, origin and context” per Viscount Simonds in Riverside Meat Company (Pty) Ltd v
     Lancashire Shipping Company Ltd (“Muncaster Castle”) [1961] 1 Lloyd’s Rep 57 at 67.
 

[xxxiv] [2003] EWCA Civ. 451, [2003] 2 Lloyd’s Rep 1.
 

[xxxv] [2002] 2 Lloyd’s Rep 357.
 

[xxxvi] Read out at the Twelfth Conference of the Association of Reform and Codification of the Law of Nations 
    held at Hamburg in August 1885.  See Sturley vol 2 at 81.
 

[xxxvii] Three cases are:  The Happy Ranger, The Kapitan Petko Voivoda and Atlantic Mutual Insurance Co. v
    The Poseidon Schiffart, G.m.b.H. 313 F.2d 872,  (7th Cir 1963).
 

[xxxviii] Sturley “Handling the Cargo Case” 21 Tulane Maritime Law Journal 263 at 339.
 

[xxxix] Atlantic Mutual 313 F.2d 872.
 

[xl] Jones v The Flying Clipper  116 F. Supp 386.
 

[xli] Jones 116 F. Supp 386, 388.
 

[xlii] The “Muncaster Castle”  [1961] 1 Lloyd’s Rep 57.
 

[xliii] Jones 116 F.supp. 386, 388.

 
[xliv] Diamond QC “The Hague-Visby Rules” [1978] LMCLQ 225 at 244 and following.