Implications of an Option Agreement

The author considers the case of Teekay Tankers Ltd (a company incorporated in the Marshall Islands) v STX Offshore & Shipbuilding Co Ltd (a company incorporated in the Republic of Korea). The Commercial Court has considered the dispute between the claimant buyer of the new-build vessels and the defendant shipbuilder in relation to an option agreement they entered into. The court decided that the shipbuilder succeeded in its defence that the option agreement was void for uncertainty.

What should Commercial lawyers take note of?

The option agreement which was central to this case stated (emphasis added in italics) that:

‘[4.1] The Delivery Dates for each [of the] Optional Vessels shall be mutually agreed upon at the time of [buyers’] declaration of the relevant option;

The court considered the italicised words, including:

• the law on certainty and agreements to agree, including the non-exhaustive ‘Rix/Chadwick principles’ set out in Mamidoil-Jetoil Greek Petroleum and BJ Aviation;
• principles concerning implying terms into an agreement (applying principles from Marks and Spencer plc v BNP Paribas) – the court considered the business efficacy test and concluded a term saving the option agreement could not be implied despite the fact that both parties appeared to have intended the option to be legally binding;
• effect of ‘best efforts’ – the court found it is well established that there is a crucial distinction between agreeing to use best efforts or best endeavours to achieve a particular result, and agreeing to use best efforts or best endeavours to reach agreement upon an essential term in a contract; the best effort obligation was no more than ‘aspirational’ in this case.

The court also considered a number of other issues including: repudiation, privity of interest, disclosure of confidential information by litigants, renunciation, quantum, and estoppel/abuse of process, which are not reported on in this In Brief.

Whilst this case was decided based on settled authorities it is a useful reminder of the importance of certainty and that the courts will not always save an agreement which is too uncertain, even if the parties may have intended for that agreement to be legally binding. If the agreement had not been void for uncertainty the total damages payable would have amounted to US$116,920,000.

What was this case about?

The case dealt with the dispute between the buyer and the shipbuilder under an option agreement. The option agreement was for the buyer to have options to order three additional sets of up to four vessels. The option agreement was part of a package of shipbuilding contracts, where the shipbuilding contracts had gone through arbitrations with arbitral awards given against the shipbuilder for repudiation of the shipbuilding contracts.

The buyer claimed in the present case that the shipbuilder repudiated the option agreement and that the buyer was entitled to terminate the agreement and claim damages as compensation. The shipbuilder denied liability, disputed quantum, and advanced a counterclaim against the buyer for breaches of the confidentiality of the arbitrations.

What did the court decide?

The option agreement in question was too uncertain and it was void.

The background and context showed an intention for the option agreement to be binding and enforceable. However the court held that was not sufficient since if parties have intended to leave some essential matter to be agreed between them in future, on the basis that either party will remain free to agree or disagree about that matter, then there is no bargain which the courts can enforce.

Implied terms

The buyer argued that the option agreement was sufficiently certain because the court could imply various terms into that agreement to make it so. The court noted that it should strive to give effect to the parties’ intention that their bargain should be enforceable.

The first of those implied terms (STX offer date alleged term) was dismissed as failing the ‘officious bystander’ test and as ‘an example of a term fashioned with the benefit of hindsight’.

The judge therefore considered the other suggested implied term (reasonable date alleged term, in summary that the Delivery Date in respect of each Optional Vessel was to be an objectively reasonable date (having regard to STX’s obligation to use its best efforts to provide delivery dates within 2016 or 2017 as appropriate), to be determined by the court if not agreed).

The shipbuilder raised a number of objections, including that the identification of a delivery date was integral and that the parties’ interests might diverge, and the judge noted:

‘…while I must strive to find an implied term which will save the option agreement, I can only do this consistently with established principles for the implication of terms. If I am driven to the conclusion that the parties must be taken to have intended that either would remain free to agree or disagree about a proposed delivery date as its own perceived interest might dictate, there is no room for an implied term that in the absence of agreement the matter shall be determined by reference to an objective criterion of reasonableness.’

The court found it is well established that there is a crucial distinction between agreeing to use best efforts or best endeavours to achieve a particular result, and agreeing to use best efforts or best endeavours to reach agreement upon an essential term in a contract. The buyer sought to bring itself within the first category by characterising the shipbuilder’s best efforts obligation as an obligation to provide the initial proposal for delivery date within a specified period, but the judge could see no basis for thinking that the relevant clause required one party or the other to provide the initial proposal. The judge found that the use of ‘best efforts’ was part of a process of seeking to agree upon an essential term and very different from valid and enforceable obligations to use best efforts to achieve a result.

In the case of MRI, Eder J (in a decision upheld by the Court of Appeal) held that the contractual provisions in question, properly construed, implicitly provided for the charges and the shipping schedule to be reasonable. The judge drew some crucial distinctions from the case of MRI, including:

• in commodity contracts of the type involved in MRI the subject matter (a shipping schedule) in respect of which terms were to be implied was essentially a matter of routine; and
• in MRI, the dispute arose in a context where shipping schedules had been agreed in each of the two previous years.

The judge stated:

‘The circumstances of MRI fall within Potter LJ’s observation that the court is frequently willing to resort to a standard of reasonableness when determining matters which are readily assessable by reference to the market. By contrast the present case falls clearly within Potter LJ’s description of a “one off” case in which no criteria have been specified and there may be a variety of considerations which might legitimately operate in the minds of the parties in relation to their ability or willingness to agree upon a specific date.’

Having reviewed related authorities, the judge further commented:

‘It is not clear to me how “best efforts” or “reasonableness” can provide the court with a criterion enabling the parties’ conflicting wishes to be reconciled…the parties’ wishes and interests are irreconcilable, and only by their agreement can the problem be resolved.’

He concluded that:

‘…that the best efforts obligation in the option agreement is… no more than “aspirational”. Similarly I conclude that, to the extent indicated above, STX’s submissions on the reasonable date alleged term are sound. Striving to the utmost, I cannot hold that this alleged term was an implicit part of the option agreement.’

On the basis that the option agreement was too uncertain, then there was no question of any award of damages to the buyer. However, if those conclusions has been incorrect, then the court would have held that the shipbuilder was liable to the buyer because it would had been entitled to terminate the option agreement by reason of the shipbuilder’s renunciation of that agreement (lest that conclusion be wrong the judge dealt with the parties’ submissions on quantum of damages in some detail).

The shipbuilder’s counterclaim for breaches of confidentiality of arbitrations were also dismissed.
Source: 9 Stone Buildings