In Cathay Pacific Airways Limited v Lufthansa Technik AG [2020] EWHC 1789 (Ch) John Kimbell QC, sitting as a Deputy High Court Judge in the Chancery Division, decided a dispute under a long-term contract for the maintenance, repair and overhaul of aircraft engines ("the Contract"). The ten-year term of the Contract expired in May 2018, and Lufthansa sought payment of US$35.8m due in End of Term Charges thereunder. Cathay agreed that this sum was due but sought to set off sums including US$42.9m as a reconciliation under Schedule 13 to the Contract.

Entitlement to the Schedule 13 reconciliation depended on the valid exercise of an express option in the Contract to remove engines from the "Flight Hours Service Program" ("FHSP") prior to expiry of the Contract Term ("the Option"). Under the terms of the Contract, and due to factors such as the anticipated timings of shop visits, if the engines were removed from the FHSP before the Contract ended this would trigger a financial reconciliation in respect of each engine under Schedule 13 and result in a significant credit to Cathay. Cathay exercised the Option in respect of all of the engines covered by the Contract before the Contract term expired. The Option was therefore exercised for commercial reasons, and the engines were still used in Cathay's fleet.

Lufthansa argued that the Option was not validly exercised, primarily because:

(i) on true construction, or by necessary implication, the Option only applied if Cathay were to remove engines from their fleet for operational reasons;

(ii) the Option was subject to a limitation that it may not be exercised in an arbitrary, capricious and/or unreasonable manner (see Braganza v BP Shipping[2015] UKSC 17 and Socimer International Bank v Standard Bank London [2008] 1 Lloyd's Rep. 558);

(iii) the Contract was a relational contract and therefore subject to a general good faith limitation, so that the Option could only be exercised in a way that would be regarded as commercially acceptable by reasonable and honest people.

Operational Purpose

The exercise of the Option was not restricted to removal of engines from the fleet for operational reasons. The language used was unambiguous and granted a unilateral option, albeit potentially a price would be paid for its exercise under Schedule 13. The Option operated as a partial termination because the engine(s) would be withdrawn from the FHSP only. The Contract would otherwise continue and would govern e.g. other work requested by Cathay and End of Term Charges.

Socimer/Braganza Implied Term

There was no implied term to the effect that the Option could not be exercised in an arbitrary, capricious or unreasonable way. A Socimer/Braganza limitation was more likely to be implied in the case of a contractual discretion to choose between a range of options, taking into account the interests of both parties, rather than in respect of a simple decision whether or not to exercise an absolute contractual right. The Option was far closer to the latter because it operated as a partial termination clause and did not involve the assessment by one party of whether a particular state of affairs existed. In any event, Cathay had not acted arbitrarily, capriciously or unreasonably. Its decision was a commercially sensible one.

Relational Contract

Although the Contract envisaged a great deal of communication and co-operation between the parties over a long period, it was not a "relational contract" and there was no implied term that the Option could only be exercised in good faith.

A term of good faith may be implied in a relational contract as a matter of law subject to any contrary express term. This applies where the parties have not only entered into a long-term collaborative relationship involving trust and confidence, but have also not specified (or have been unable to specify) in detail the terms governing their relationship. By contrast, the Contract was not a joint venture and the terms of the parties' relationship were set out with precision. A term requiring mutual good faith could also be implied as a matter of fact, but the usual tests for implied terms must be met i.e. whether, at the time the contract was made, a reasonable reader of it would consider the term to be so obvious as to go without saying, or the term is necessary for business efficacy. However, the overall character of the contract is an important consideration, including whether it would be characterised as relational.

In the present case, a reasonable reader of the Contract would infer that the parties had given careful consideration to its terms, and a mutual obligation of good faith was not obviously intended. Nor was any such obligation necessary to give business efficacy to the Contract. The Contract was not a relational contract and was not dependent on the parties' good faith of the parties. Cathay's main obligation was to pay sums due under the Contract, and the key thing was that maintenance work was carried out to the required standards. There was no trust and confidence going beyond matters agreed in the Contract.

Even a good faith obligation was to be implied, it would not apply to Cathay's exercise of the Option. The Option was intended to be for Cathay's benefit and in deciding whether and when to exercise it Cathay was entitled to focus on its own commercial interests. In any event, at all times Cathay acted in good faith. They believed that they had the benefit of a unilateral option to remove engines from the FHSP for commercial reasons.

Result

The outcome of the case was that Cathay's claim succeeded in the sum of US$9.7 million.

Commentary

The decision provides useful guidance on the exercise of contractual options in commercial contracts. Much turned on the particular terms in issue, but of broader interest is the finding that the Contract was not a "relational contract". As the Judge correctly pointed out, an engine maintenance contract is a standard commercial contract and is not an obvious candidate for the implication of a good faith obligation, even though in this sector it is usual for suppliers and airlines to work closely together.

As the Judge held, the financial consequences of Cathay's exercise of the Option followed from the agreed terms of the Contract, including the pre-agreed figures and formulae set out in Schedule 13 for any number of flight hours. The process of contractual interpretation could not be used to rectify Lufthansa's failure to think through the financial consequences of the Option. The Contract was between sophisticated commercial parties and drafted with the assistance of experienced law firms on both sides. In those circumstances, it is inevitably more difficult to argue that, effectively, something has been "left out" or that a "linguistic mistake" has been made. If the Option was intended to be restricted, it would have been easy to insert e.g. a maximum number of engines to which it could be applied. Therefore, if it is sought to constrain the exercise of contractual options, this should be negotiated upfront.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Ms Stephanie Barrett
Quadrant Chambers
Quadrant House
10 Fleet Street
London
EC4Y 1AU
UK

© Mondaq Ltd, 2020 - Tel. +44 (0)20 8544 8300 - http://www.mondaq.com, source Business Briefing