Payment entitlement

It will come as little comfort to learn that the shipbuilding industry suffers its fair share of disputes on cost and time overrun. Judgments in connection with shipbuilding contracts have often provided important guidance in the law of contract generally, of direct relevance to construction contracts.

The case of Stocznia Gdanska -v- Latvian Shipping Company decided recently in the House of Lords provides an example.

The appeal to the House of Lords arose out of proceedings relating to six shipbuilding contracts, each for the construction of a single refrigerated vessel. Stocznia was a Polish shipbuilding yard which contracted to build the ships for Latvian Shipping. Under each of the contracts Stocznia undertook to design, build, complete and deliver the vessel, such that property would not pass to Latvian until delivery.

instalments

The price for each ship was between US$27.6 million and US$29 million. Provision was made in the contracts for the price to be paid in four instalments. Broadly speaking these were: (a) 5 per cent advance payment against a bank guarantee, (b) 20 per cent upon receipt of a notice of keel laying (this was defined as meaning that the first and second sections of the vessel's hull had been joined on the berth where the vessel was to be constructed, (c) 25 per cent upon notice of successful launching of the vessel, and, (d) the balance of 50 per cent upon delivery of the vessel.

Work began on vessels 1 and 2 in 1992 and the first instalments of 5 per cent of the price for all six vessels were duly paid. However by July 1993 agents for Latvian revealed that they had serious funding difficulties. By December 1993 they had informed Stocznia that taking delivery of the vessels might be impossible.

Whilst these discussions and exchanges were taking place, progress on vessels 1 and 2 had continued and in December 1993 the keel of the first vessel was laid and the corresponding notice issued.

Payment against that notice was not made and therefore Stocznia issued a notice rescinding the contract in accordance with its terms. The same happened three months later with vessel 2.

There then followed, to put it mildly, a series of controversial events which would stretch the imagination of even the most hardened construction industry commercial manager.

Stocznia decided to take advantage of the keels laid for vessels 1 and 2 in order to trigger the second instalments, first for vessels 3 and 4 and then for vessels 5 and 6. The purpose of Stocznia doing this was plainly to secure accrued rights to the second instalments for all four of these vessels, thereby putting itself in a stronger financial position than it would have been if it only had a right to claim damages.

simplicity

Stocznia's approach was one of astonishing simplicity. The keels which had originally been laid in connection with the contracts for vessels 1 and 2, were simply re-numbered for vessels 3 and 4 and fresh keel laying notices were then served.

To nobody's surprise, the second instalments for these vessels were not paid and accordingly Stocznia gave notice rescinding the contracts for these two vessels. Exactly the same procedure was then followed in respect of vessels 5 and 6, appropriating the same keels to the contracts for these two vessels and serving keel laying notices in respect of them.

Predictably, these instalments were not paid and again Stocznia gave notice of rescission of both contracts.

Space does not allow me to report the tortuous litigation route that then followed. However, in front of the House of Lords, the issues which had to be addressed included firstly, whether Stocznia had acquired accrued rights to the second instalments of the contract price in respect of vessels 3 to 6, and secondly, whether the right to be paid by instalments in any event fell away once Stocznia had given notice of rescission of contract.

On the first of these points, Counsel for Stocznia pointed out that what triggered the obligation to pay the instalment was not the keel laying as such, but the giving of a notice that the first and second sections of the hull had been joined on the relevant berth.

Their Lordships saw little merit in this argument. Lord Lloyd of Berwick noted: "My instinctive answer, and that which would I think be given by any fair-minded man, is "of course not." There only ever were two hulls, how can two hulls be made to serve the purpose of six contracts? The re-numbering of the hulls was an artifice to enable the plaintiffs to recover six keel laying instalments when they had only laid two keels."

Dealing with the second point, Counsel for Latvian argued that once the contract had been rescinded by Stocznia, it had no rights of common law to recover unpaid instalments of the contract price. Lord Goff of Chieveley held that this was contrary to principle, and he could find no contractual expression of an intention of the parties to this effect.

Stocznia were entitled to sue for the unpaid instalments in respect of vessels 1 and 2, notwithstanding that they had rescinded both those contracts.