Does a shipowner have to sell its ship in order to mitigate its loss?

by Reed Smith

Reed Smith

The greatly anticipated Supreme Court judgment on the New Flamenco is due to be heard later this year. The decision will address principles of mitigation and the assessment of damages for repudiatory breach of a time charterparty. In particular, it will consider whether an owner that sells its vessel following such a breach must give credit for any benefit flowing from such a sale.

A brief recap of the facts

By a charterparty on an NYPE form and subsequent addenda, the cruise ship, the New Flamenco was time chartered for a period of over five years from 2004. The Charterers redelivered the vessel in October 2007 but the Owners’ position was that the earliest redelivery date under the charterparty was in November 2009. The Owners treated the Charterers as being in anticipatory repudiatory breach and accepted such repudiation as terminating the charterparty. In late October 2007, the Owners entered into an MOA for the sale of the vessel for US$23,765,000.

The arbitrator found that the minimum redelivery date under the charterparty was in November 2009 and that the value of the vessel in November 2009 was US$7,000,000. The arbitrator further found that Owners’ sale of the vessel in October 2007 was caused by the Charterers’ early redelivery and was in reasonable mitigation of loss. It was not in dispute that there was no available market for a substitute charter at the time of the Charterers’ breach.

The arbitrator declared that the Charterers were entitled to a credit of US$16,765,000; the difference between the value of the vessel in October 2007 and November 2009. This would be set off against the Owners’ claim for damages. That is, the Charterers were entitled to a credit in the assessment of the Owners’ damages claim for the ‘benefit’ that accrued to the Owners by selling the vessel for more in October 2007 than what it would have been worth at the end of the charter period in November 2009.

The Owners appealed. A fundamental part of their appeal was that the benefit they had obtained was not sufficiently causally linked to the Charterers’ early redelivery such that it should be taken into account when assessing damages. The Owners argued that the capital value of a vessel is different in kind from the type of loss for which they were claiming (i.e. loss of an income stream).

On the Owners’ appeal to the High Court, Mr Justice Popplewell held that the Owners’ decision to sell the vessel was independent of the Charterers’ breach in redelivering the vessel two years early and, therefore, the difference in value could not be taken into account to reduce the loss recoverable. The Charterers successfully appealed to the Court of Appeal.

The law of damages and mitigation

The general rule for damages is that they should place the claimant in the same position that it would have been in if the contract had been properly performed. It is often said that the claimant has a ‘duty to mitigate’. Put another way, a claimant is not entitled to recover in respect of loss which could have reasonably been avoided. Moreover, if a claimant takes steps to mitigate and the loss is thereby avoided, the claimant cannot recover in respect of that avoided loss.

Court of Appeal Decision

Overturning the High Court decision at first instance, the Court of Appeal held that the owners of a vessel claiming damages for the repudiation of a time charterparty must give credit to the charterers for the ‘benefit’ accrued following the sale of the vessel. That is, the owners must give credit for the difference in value between when the vessel was sold and when it would have been sold had the charterers performed the contract. In the present case, there had been a finding of fact that the sale had been caused by the early redelivery of the vessel by the Charterers and that such sale was a reasonable mitigation of the Owners’ loss.

One of the key statements made by Lord Justice Longmore was that the assessment of damages should be based upon the following principle:

“[I]f a claimant adopts by way of mitigation a measure which arises out of the consequences of the breach and is in the ordinary course of business and such measure benefits the claimant, that benefit is normally to be brought into account in assessing the claimant's loss unless the measure is wholly independent of the relationship of the claimant and the defendant.”

The question then arises: does it follow that shipowners may be required to sell their vessel in mitigation of their loss? Put another way, if a charterer breaches the terms of a chaterparty by redelivering the vessel early, and there is no available market for re-chartering, are the owners required to realise the capital value of that asset rather than wait until the market recovers? Will the owners’ recovery be reduced if they choose not to sell the ship but instead to wait until the market recovers?

Lord Justice Longmore further stated that:

“The doctrine of mitigation may, indeed, sometimes require an owner to sell the vessel he has hired out to a hirer or a charterer if the relevant chattel is returned early.”

The tree or the fruit?

Should the capital value of an asset be used when determining the compensation a party may recover for being unable to obtain income? Does a shipowner have to consider selling its ship in order to mitigate loss following a wrongful early redelivery under a charterparty? The law on this subject is unclear and requires clarification.

As was argued on behalf of the Owners, the capital value of the vessel is different in kind from the loss recoverable for a charterer’s breach of a time charter; namely the loss of income. The former is the tree, whereas the latter is the fruit. If an owner decides that it wishes to retain the vessel, being its investment that will bear fruit in the future, will the owner receive less in damages for failing to mitigate?

What’s next?

The decision of the Court of Appeal has been appealed to the Supreme Court, which will readdress these issues. This will be heard between 21 and 24 November 2016.

Without a doubt, the Supreme Court’s judgment will be greatly anticipated by the shipping industry. If the Court upholds the decision made by the Court of Appeal it may have a significant impact on the way damages are assessed and the ‘reasonable’ steps shipowners will be required to take in order to mitigate their losses – even, ultimately, to sell their vessels.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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