England and Wales Court of Appeal (Civil Division) Decisions

IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT OF JUSTICE
QUEEN'S BENCH DIVISION
(Mr Justice Morison)

		Royal Courts of Justice Strand, London, WC2A 2LL Friday 20th July 2001

LORD JUSTICE POTTER:

INTRODUCTION

1. This is an appeal by the second defendant, Aeolian Shipping SA from an order of Morison J made on 4^th December 2000 whereby he granted summary judgment in favour of the respondents, ISS Machinery Services Limited, upon their claim and summarily dismissed the appellants' counter-claim. For convenience I shall refer to the appellants throughout this judgment as 'the defendants' and to the respondents as 'the claimant'.
2. The claimant sued under an agreement evidenced in writing ("the spares contract") for the supply by the claimant to the defendants of various replacement parts for a turbo-charger previously purchased from the claimant for installation in the defendants' vessel "Aeolian" ("the turbo-charger contract"). The claim was for the price of various of the parts supplied under the spares contract and for damages in respect of the defendants' refusal to take delivery of certain other parts. The defendants admitted that they had not paid the price and had refused delivery as alleged but pleaded, and sought to set-off, a counter-claim for damages for breach of a term as to the quality and durability of the turbo-charger said to be implied in the turbo-charger contract.

THE BACKGROUND FACTS

3. The turbo-charger had been supplied in September 1998. In October 1999 it suddenly failed, as a result of which the defendants had urgently to obtain replacement parts. They contacted the claimant to arrange for the Japanese manufacturers of the turbo-charger to inspect the damage and replace the damaged parts on the basis that the turbo-charger was still within its guarantee period and the problem was caused by a defect in the machinery itself. The defendants asserted that the turbo-charger failed because of its faulty design or construction for which the claimant was liable. The claimant, which is a Hong Kong company, had played no part in the manufacture of the turbo-charger but had simply acted as middleman in its supply. The claimant rejected the defendants' contentions, as did the Japanese manufacturers. There was an exchange of correspondence in which the claimant made clear to the defendants that the manufacturers denied liability and were not prepared to carry out an inspection without the defendants covering the cost and expenses. The claimant took the stance that, unless it received confirmation that the parts would be paid for, shipment would be suspended and the parts would not be supplied until such confirmation was received. At the time, the defendants' managers were being subjected to increasing pressure from the time charterers of the vessel who were complaining of its under-performance and resultant delays. The position was encapsulated by the statement of Mrs Niakaris the head of the defendants' spares department in a passage of his witness statement quoted by the judge as follows:

"I therefore called Mr Tanaki [of the claimants]. I told [him] we were very unhappy with the attitude of ISS and the manufacturers … and that given the long-standing relationship between owners and ISS that I expected that ISS would do more to assist us. I also told Mr Tanaki that the spares were only being requested as a result of defect in a turbo-charger which had only been fitted in the vessel [a] little over a year ago and was still, as far as the managers were concerned, under guarantee. Mr Tanaki said that he understood our problem and why the spare parts were being requested and that he sympathised with the managers' point of view. However, he said that the manufacturers were taking a tough line, that the problem with the turbo-charger was not their [the claimant's] responsibility and it was their [the manufacturers] decision, not the decision of ISS, that owners must pay for the spare parts. Mr Tanaki insisted that a confirmation must be sent by owners and without the confirmation requested the spare parts would not be shipped."

4. That position was maintained and, while maintaining their protest, the defendants confirmed the order.
5. Upon delivery of the spares, as already indicated, the defendants accepted delivery of part of the goods and rejected others; they also cancelled a second contract relating to the silencer for the turbo-charger.
6. Upon the defendants' continuing refusal to pay the invoice rendered by the claimant in respect of those spares which the defendants had accepted, the claimant threatened to arrest the vessel. As a result, and following 'without prejudice' correspondence which we have not seen, the defendants' P & I Club ("the Club") entered into an agreement (which I shall refer to as "the Undertaking") that, in consideration of the claimant refraining from exercising any power of arrest over the vessel or any other ship or asset of the defendants, the Club would pay the amount of any final judgement against or written agreement with the defendants in respect of the claim. The Undertaking defined the claim as the claim of the claimant

"For payment for goods and materials supplied to the ship for her use as referred to in your invoice number 278144 dated 27 October 1999 ("the Invoice")"

7. The relevant parts of the body of the Undertaking, which give rise to the principal issues in this appeal are as follows:

"In consideration of your refraining from arresting the Ship … we hereby undertake to pay to you forthwith upon your first demand such sums as may be adjudged to be due to you in respect of the Claim, interest thereon and costs from [the defendants] by a final judgement of the English High Court of Justice or by judgement on appeal therefrom …

And for the consideration aforesaid:

1. ....

2. We confirm that … [the defendants] … agree that the Claim shall be determined by reference to English law and shall be submitted to the exclusive jurisdiction of the English High Court of Justice. We hereby undertake to instruct English solicitors, within fourteen days of your written request to do so, to accept service of a claim Form or other initiating process on behalf of … [the defendants] .. and to require the said Solicitors to confirm to you that they are authorised to accept service on behalf of .. [the defendants]."

THE JUDGMENT BELOW

8. The judge dealt with the claim, correctly, upon the basis that, but for a potential set-off in respect of their counterclaim, the defendants had no defence to the claim, the spares having been ordered and delivered at agreed prices, there being no allegation that they were defective. He held (and there is no appeal from this finding) that Japanese law was the law originally applicable to the turbo-charger supply contract. He also held, as is not now disputed, that Japanese law would not imply into the supply contract any implied term of satisfactory quality or durability as pleaded in the counterclaim and that, in any event, the defendants' counterclaim was time-barred under Japanese law.
9. Having held that the law applicable to the turbo-charger contract was, on the face of it, Japanese law, on which basis the claim would be bound to fail, the judge went on to reject the defendants' contention that the wording of the Undertaking amounted to an express or implied variation that English law would govern not only the claim as defined but also the contract relied on in the counterclaim. He held that the Undertaking left the position unaffected. It referred simply to 'the claim', which was defined with precision, and did not apply to the counterclaim, save that it was implicit that English law would apply to define whether any counterclaim (if valid) amounted to a defence to the claim. Finally, he held that, even if the counterclaim might otherwise give rise to a defence by way of equitable set-off, the effect of the communications between the parties was to agree that the spare parts would only be supplied if they were paid for, and thus that any right of set-off was excluded by implication; alternatively the judge held that it would not in the circumstances be equitable for such set-off to be permitted.

THE GROUNDS OF APPEAL

10. The defendants contend that the judge was wrong to hold that the counterclaim was governed by Japanese law because they submit that Clause 2 of the Undertaking had the effect of making English law rather than Japanese law the law applicable to the turbo-charger contract. They submit that the judge gave too much weight to the fact that 'the Claim' as defined in the letter of undertaking referred solely to the spares contract and contained no reference to the original turbo-charger contract. It is submitted that the judge should have held that, because the claimant knew at all material times that the defendants were asserting that they had a defence by way of set-off of their counterclaim under the turbo-charger contract, any agreement governing the claim and (by implication) the question of whether or not a defence could be established must, on the true construction of the clause 'encompass the counterclaim' as it is put. Accordingly, it is submitted, the counterclaim, including the turbo-charger contract out of which it arose, is governed by English law.
11. Second, it is submitted that the judge was wrong to hold that the defendants had agreed to pay for the spares without any right of set-off, alternatively that it would be inequitable to permit a set-off in the circumstances of the case. It is submitted that (i) on the true construction of the correspondence the defendants had not agreed to pay without any set-off but had simply re-confirmed their order for the spares; (ii) alternatively, as the spares contract had been agreed on 14^th October 1999, the claimants were not entitled thereafter to threaten to suspend shipment in breach of contract unless the defendants agreed a new term as to payment without set-off. In such circumstances it would be unfair to deprive the defendants of their equitable right of set-off; (iii) alternatively any agreement to pay without set-off was unenforceable for want of consideration and/or was liable to be set aside on the grounds of economic duress.

THE UNDERTAKING

12. It is not in issue between the parties that the effect of the Undertaking was to refer the dispute as to the liability of the defendants for the price of the goods sold under the spares contract for decision by the English Courts according to English law. It is plain therefore that the question of whether there is a defence to the claim (by way of set-off or otherwise) is also a question to be determined by reference to English law. However, determining the defence to the claimant's claim under the spares contract by reference to English law involves applying English law including its rules of private international law: see Meridien BIAO –v- Bank of New York [1997] 1 Lloyd's Law Rep 437, in which Millett LJ made clear the position as follows:

"Whether there is a defence to a contractual claim governed by English law must depend upon English law, including of course, its rules of private international law. Accordingly, the questions whether the bank has a right of set-off … must depend upon English law, including any foreign law which English law regards as applicable."

13. The effect of the Undertaking falls to be considered in that light. The passage quoted also points up the fact that the important question is not one put broadly in the terms adopted by the notice of appeal, namely whether the counterclaim is governed by English law rather than Japanese law, but whether or not the agreement out of which the counterclaim arises is governed by English law. The distinction is, of course, vital, because it is accepted that Japanese law governs that contract and gives no remedy, subject only to the defendants' contention as to the true construction of the Undertaking.
14. In my view the judge was correct to conclude that the terms of the Undertaking were not effective to render English law the proper law of the turbo-charger contract. On the face of it, the turbo-charger contract was governed by Japanese law, being the country with which that contract was most closely connected within the meaning of Article 4 of the Rome Convention as enacted in English law by the Contracts (Applicable Law) Act 1990. That being so the position could only change if there could be spelt out of the Undertaking a subsequent (different) choice of law agreed between the parties. Under Article 3(2) of the Rome Convention:

"The parties may at any time agree to subject the contract to a law other than that which previously governed it, whether as a result of an earlier choice under this Article or of other provisions of this Convention."

However, under the provisions of Article 3(1):

"The choice must be expressed or demonstrated with reasonable certainty by the terms of the contract or the circumstances of the case."

15. That does not seem to me to be the position here. The Undertaking makes no reference whatsoever to the turbo-charger contract. If the parties had intended to change the proper law of the turbo-charger contract, they could expressly so have provided; however, they did not. There is certainly no room in my view for the implication of such a term under the principles of English law applicable to the implication of contract terms, whether on the basis of business efficacy or the 'officious bystander' test. As the judge himself observed (a) the claimant was not the manufacturer of the turbo-charger. If a counterclaim prima facie existed in relation to the turbo-charger, the claimant would not have wished the counterclaim to be decided according to English law when its own remedies over against the Japanese suppliers would depend on the rules of Japanese law. (b) If the claimant had adopted English law as the proper law of the turbo-charger contract it would have relinquished two complete defences under Japanese law in respect of the defendants' counterclaim. (c) In contrast, in relation to the spares contract, the application of English law was of no concern, since there was no suggestion that the defendants had done other than perform their obligations under those contracts in respect of which no breach was alleged, but merely a defence of set-off based on breach of the turbo-charger contract.
16. The circumstances which may be taken into account when deciding whether or not the parties have made an implied choice of law under Article 3 of the Rome Convention (whether by initial choice or subsequent change) range more widely in certain respects than the considerations ordinarily applicable to the implication of a term into a written agreement, in particular by reason to the reference in Article 3(1) to 'the circumstances of the case'. As stated in the Giuliano-Lagarde Report at p.17, the provision 'recognises the possibility that the court may, in the light of all the facts, find that the parties have made a real choice of law although this is not expressly stated in the contract', but that it 'does not permit the court to infer a choice of law that the parties might have made where they had no clear intention of making a choice'; see also the general discussion in Dicey & Morris: The Conflict of Laws (13^th ed), paras 32-089 – 32-097. In my view, none of the authorities there cited assists the defendants in the circumstances of this case. In this respect, I would add that it does not seem to me that the express provision for the exclusive jurisdiction of the English Courts over the claim as defined in the Undertaking can give rise to any inference that English law should govern the cross-claim. It begs the question raised rather than providing the answer.
17. The argument which has been advanced by Mr Davey for the defendants is that at the time of the Undertaking, the parties, i.e. the Club (acting both for itself and the claimants) on the one hand, and the defendants on the other hand, were well aware that the nature of the counterclaim relied on arose under a contract governed by Japanese law. Mr Davey submits that, adopting the approach to construction propounded by Lord Hoffman in Investors Compensation Scheme –v- West Bromwich Building Society [1998] 1 WLR 896 at 912-3, the court should hold that the parties must reasonably have contemplated and intended that they were providing in short form for all issues between the parties, including the question of law applicable to any counterclaim by the defendants under the turbo-charger contract, to be governed by English law. Mr Davey argues that, if parties agree to litigate in England under English law, they should not be taken to intend that it may yet be necessary to research into and adduce evidence of a foreign law for the purpose of deciding the dispute between them. As he put it, if any part of the dispute is to remain unaffected by the agreement it should be spelt out in clear terms; since it was not, a choice of English law is to be inferred in respect of the turbo-charger contract.
18. I do not accept that argument. We do not have before us any of the correspondence leading up to the giving of the Undertaking because both the parties regard it as having been conducted 'without prejudice'. Both parties accept, however, that a Club 'guarantee' of this kind is a common form of agreement entered into by the Club in a wide variety of circumstances, in the face of the need for urgent agreement and the issue of such 'guarantee' in order to avert the threat of arrest. In such circumstances, the focus is upon the claim in respect of which the Undertaking is being given and the need to make clear the Club's liability for any ultimate judgment and costs, and not upon the law applicable to any obligation (or tort) which may form the subject of a counterclaim in the prospective proceedings.. In this case the Club was concerned simply to give an undertaking which would ensure payment of the claim if and when it was adjudicated payable by the court in which the claimant sought to issue proceedings. No more than that was necessary or is, in my view, to be implied or inferred. If and so far as the Club was aware of the grounds on which the claim was resisted, the agreement for determination of the claim under English law was apt to include English rules of private international law and, in particular, the requirement that the law applicable to any contract impleaded before the English courts is to be decided upon the principles laid down in the Rome Convention. Accordingly, that is the basis upon which the claim falls to be adjudicated unless there is good reason to assume or infer a common intention of the parties to avoid that rule. In the light of the considerations highlighted by the judge (see paragraph 15 above) I see no basis for inferring such an intention and I would uphold the decision of the judge upon that ground.
19. That being so, it becomes unnecessary to deal with the other issues raised in the appeal. However, had it been so necessary, following careful perusal of the correspondence, I would have upheld the submission of the defendants that they successfully evaded the claimant's repeated requests for unqualified confirmation that they would pay for the spares regardless of their claim by way of set-off. It appears to me that the spares were eventually sent by the claimants in the hope and expectation of an assurance of payment which was never in fact given.
20. In those circumstances, I also differ from the conclusion of the judge that, assuming the defendants could demonstrate a right to recover damages under the turbo-charger contract, they should nonetheless be denied any right of equitable set-off in the action. Had a remedy existed under the turbo-charger contract, the circumstances were such that, in my view, the defendants could arguably have demonstrated a cross-claim 'flowing out of and inseparably connected with the dealings and transactions which gave rise to the subject matter of the claim', in circumstances in which it would have been unfair for the claimant to be paid without taking into account the defendants claim: see Bank of Boston Connecticut-v- European Grain and Shipping [1989] 1 AC 1056 at 1102 and other authorities as reviewed in Bim Kemi –v- Blackburn Chemicals Limited [2001] EWCA CIV 457.
21. Nonetheless, for the reasons stated in paragraph 17 above, I would dismiss the appeal.

MANCE LJ:

22. I found this at some points in the argument a nicely balanced case, but I have no doubt at the end of the day that the appeal must fail on the first and main point.
23. The claimants were well aware that the second defendants' continuing refusal to pay the claimant's invoice dated 27^th October 1999 for the replacement spares delivered in that month for the turbocharger which had been supplied to the defendants' vessel "Aeolian" by the claimants a little over a year previously was based upon the second defendants' contention that the delivery of such spares was only necessary because of a defect in the turbocharger supplied. The claimants, reflecting in this respect the attitude of the Japanese manufacturers from whom they in turn had obtained both the turbocharger and the spares, denied that there had been any relevant defect, refused to supply the spares free of charge and insisted on the second defendants' acknowledging (at the least) that the spares were being supplied under a commercial order. The claimants thus rendered invoice No. 278144 dated 27^th October 1999.
24. Both the supply of the original turbocharger and the supply of the spares were under contracts subject to Japanese law, as were the claimants' back-to-back orders with the manufacturers.
25. The claimants took steps to enforce their claim to payment under invoice No. 278144 in Spring 2000, by threatening to arrest either the Aeolian or another of the defendants' vessels. This threat was removed by the West of England undertaking, which reflects terms of agreement with the claimants to which not only the West of England but also the second defendants were in certain respects party. The undertaking starts by defining the claim as "For payment for goods and materials supplied to the Ship for her use as referred to in your invoice number 278144 dated 27 October 1999 ("the Invoice")". It expresses the consideration provided by the claimants as "refraining from arresting the Ship or any other ship or asset in the same ownership, associated ownership or management in respect of the Claim". In return the West of England agreed to pay forthwith upon first demand the amount of any final judgment against or written agreement with the defendants in respect of the claim. It also confirmed its authority to communicate the second defendants' agreement, firstly, "that the claim shall be determined by reference to English law and shall be subjected to the exclusive jurisdiction of the English High Court of Justice", and, secondly, that the second defendants would instruct English solicitors within 14 days of written request to accept service of a claim form.
26. The critical issue is whether the undertaking changes not just the proper law governing the claim, under invoice No. 278144, but also that covering the cross-claim by which the defendants seek to extinguish that claim. Under Article 3(1) of the Rome Convention, parties may select the law applicable to a part only of their contract, just as they may select the law governing the whole of their contract. Here, it is clear that the parties agreed that at least the claimants' claim to the price should be subject to English as opposed to the previous Japanese law. Did they agree that the cross-claim in respect of the previous turbocharger contract should likewise be subject to English law, instead of the previous Japanese law? The undertaking says nothing expressly about any cross-claim. If the defendants had subsequently thought of and sought to rely on a cross-claim other than that arising out of the turbocharger claim, I can see no basis on which the undertaking could be argued to have changed the proper law of that cross-claim. The strength of the defendants' case arises from the fact, mentioned at the outset of this judgment, that both parties must be taken to have had in mind that the defence would assert and rely as a set-off on breach of the turbocharger contract giving rise to the supplies to which the claim relates.
27. Article 3(2) of the Rome Convention allows parties at any time to agree to subject the contract (or any part of it) to a law other than that which previously governed it. The effect of article 3(1) is, however, that both an initial choice of a governing law and its change "must be expressed or demonstrated with reasonable certainty by the terms of the contract or the circumstances of the case". Under this article a choice of law may be demonstrated with reasonable certainty by inference, e.g. from other terms (such as an arbitration clause) or background circumstances (such as prior or other dealings): see the Guiliano-Lagarde Report p.17 and the examples given in it which are cited in Dicey & Morris's The Conflict of Laws (13^th ed.) Rule 173, paras. 32-089 to 32-097 and see also Egon Oldendorff v. Libera Corp. [1996] 1 Ll.R. 380, 389-390 per Clarke J (inference from an arbitration clause).
28. The claimants have sought to negative any such inference, by pointing out that a change to Japanese law would be most unfavourable to them, since it would deprive them of two complete answers to the cross-claim, namely that (i) Japanese law recognises no implied term as to satisfactory quality and (ii) Japanese law allows no claim for damages for any defect in goods supplied not discovered within 6 months of supply. However, there is no evidence that either of these answers was within the claimants' knowledge, still less the second defendants', in Spring 2000 when the undertaking was given, and it seems improbable that they were. Both are now put forward on the basis of written advice from Japanese lawyers dated 26^th July 2000. The specific effects of applying or not applying Japanese law cannot, I think, be regarded therefore as a relevant background circumstance, to be taken as having been within the parties' assumed knowledge, when construing the undertaking.
29. Circumstances that are, on the other hand, entitled in my view to some weight are the known facts that the claim was effectively undisputed, whereas the cross-claim would be bound to give rise to issues, at least of fact, and that the claimants could in the ordinary course be expected to wish to pass on any liability to the manufacturers under their own purchase contract which would be likely to be subject to Japanese law. They can to my mind be regarded as throwing some doubt on the likelihood that the claimants would readily change the law governing any cross-claim. But there are to my mind other more powerful considerations in play pointing in the same direction.
30. Save as summarised in this judgment, we have no real information about the context of the undertaking. The whole genesis and impetus of the undertaking was, however, the claimants' claim and the claimants' threat of an arrest of one of the second defendants' vessels in pursuit of that claim. The terms of the undertaking reflect agreements, obtained from and given by either the second defendants' Mutual Association or the second defendants themselves, designed to ward off that threat. In the same way, the undertaking records the second defendants' agreement, through the West of England, to English law and exclusive jurisdiction in respect of the claim. It was, in short, the claimants who were setting terms for the convenient pursuit of their claim. Nothing in the undertaking addresses any cross-claim specifically. Nothing in its context or terms indicates either that the claimants were seeking to regulate any cross-claim or that the second defendants were making, or were in any position to make, any demands in that connection.
31. I would add that the second defendants' agreement, at the claimants' request, to the exclusive jurisdiction of the English courts in respect of the claim cannot sensibly be viewed as extending to the cross-claim. This too suggests that their agreement to English law must likewise be confined to the claim. Further, any cross-claim advanced might (as happened) not merely match, but exceed the claim in amount.
32. No doubt the claimants, by seeking and obtaining agreement to English law and jurisdiction in respect of the claim, also agreed that the issue whether any cross-claim which the second defendants might be able to mount and pursue in the English courts could constitute a defence or set-off should be determined by English law. But that is a different matter from agreeing to the substance and validity of the cross-claim being determined by English law, when this was previously subject to Japanese law.
33. For these reasons, I agree that the undertaking cannot be regarded as having been intended to address, or change the proper law of, the cross-claim arising out of the turbocharger contract, even though all parties to the undertaking were aware that the second defendants would seek to set up that cross-claim. I too would therefore dismiss the appeal.

SIR MARTIN NOURSE: I agree.

ORDER: Appeal dismissed with costs. Application for permission to appeal to the House of Lords refused. (Order dopes not form part of approved Judgment)