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|Judgments - Amoco (UK) Exploration Company etc. and Others v. Teesside Gas Transportation Ltd and v. Imperial Chemical Industries Plc and others (Consolidated Appeals)
HOUSE OF LORDS
Lord Bingham of Cornhill Lord Hoffmann Lord Hope of Craighead Lord Hobhouse of Wood-borough Lord Scott of Foscote
OPINIONS OF THE LORDS OF APPEAL FOR JUDGMENT
IN THE CAUSEAMOCO (U.K.) EXPLORATION COMPANY (A COMPANY INCORPORATED IN DELAWARE, USA) AND OTHERS (APPELLANTS) v. TEESSIDE GAS TRANSPORTATION LIMITED (RESPONDENTS) AMOCO (U.K.) EXPLORATION COMPANY (A COMPANY INCORPORATED IN DELAWARE, USA) AND OTHERS (APPELLANTS) v. IMPERIAL CHEMICAL INDUSTRIES PLC AND OTHERS (RESPONDENTS) (CONSOLIDATED APPEALS)
ON 4 APRIL 2001
 UKHL 18
LORD BINGHAM OF CORNHILL
1. For the reasons given by my noble and learned friends Lord Hoffmann, Lord Hope of Craighead and Lord Hobhouse, whose opinions I have had the opportunity to read in draft, I would allow these appeals.
2. The Central Area Transmission System ("CATS") is a 36 inch pipeline, 255 miles long, together with ancillary installations, which carries natural gas from various points in the Central Graben of the North Sea to Teeside. It was built by a consortium of four oil and gas exploration and development companies (who have been called "the CATS Parties") between 1990 and 1993 and is operated by one of them, Amoco (UK) Exploration Co ("the CATS Operator"). The first use of the pipeline was to carry gas from the Everest and adjacent Lomond field (also owned by the consortium companies) for delivery to a power station at Teeside. But its capacity was much larger than was necessary to carry the Everest/Lomond gas and the CATS Parties were in a position to offer spare capacity to others.
3. These appeals concern an agreement by which the CATS Parties agreed to allow a company called Teeside Gas Transportation Ltd ("TGTL"), (originally a joint venture between ICI and Enron Corporation of Texas but now a wholly owned subsidiary of Enron) to use part of the pipeline capacity. It was called the Capacity Reservation and Transportation Agreement ("CRTA") and was executed on 10 September 1990, before the pipeline had been built. By clause 3.1, the CATS Parties undertook to construct the system so as to be capable of carrying gas for TGTL by 1 April 1993. The agreement reserved to TGTL the right to deliver to the pipeline a defined quantity of gas which the CATS Parties would carry as part of a commingled flow to Teeside and there redeliver the appropriate share to the shore installations of TGTL. TGTL was to be entitled to use the capacity from a date on or after 1 April 1993 (defined in the agreement as "the Commencement Date") until 1 October 2018.
4. My Lords, the definition of the Commencement Date is central to the dispute in this case and I shall have to examine it later in some detail. For the present, however, it is sufficient to say that it was the date upon which the CATS Operator notified TGTL that certain conditions relating to the system had been satisfied. The significance of the Commencement Date was two-fold. First, by clause 6.1 the CATS Parties came under an obligation, subject to compliance by TGTL with various conditions, to accept and redeliver its gas:
Secondly, as from the Commencement Date TGTL came under an obligation in accordance with clause 7.4 to make quarterly "send-or-pay" payments, at the rate of about £8m a quarter, whether it used the capacity or not:
Enron and ICI agreed to guarantee the obligations of TGTL under the CRTA.
5. TGTL (or Enron) did not have any gas for delivery to the pipeline at the time when it entered into the CRTA. It was contemplated that it would acquire it later. On 26 March 1993 another subsidiary of Enron called Enron Europe Ltd ("EEL") entered into Gas Sales Agreements ("GSAs") with the owners of gas fields known as J-Block to buy their gas for a period expiring in 2011. The gas was expected to come on stream in late 1995 or early 1996. On 30 March 1993 the CATS parties notified TGTL that the conditions for the Commencement Date had been satisfied. The notification therefore took effect on 1 April 1993. Thus Enron appeared to be committed over a long period to fixed payments, negotiated at then prevailing rates, for the purchase of gas and the use of the pipeline. In respect of the pipeline, it would have to make send-or-pay payments for about three years before it could make any use of the reserved capacity.
6. In February 1994 the spot price of gas was 22p a therm. The combined cost to Enron of buying the gas under the 1993 GSAs and transporting it to Teeside under the CRTA was about 19p a therm. The agreements therefore appeared to be profitable. But by the middle of the following year the spot price had fallen below 10p a therm and remained depressed.
7. In these circumstances it is not surprising that Enron read the CRTA and GSAs with close attention to discover whether there was any means of escape. It focussed upon the definition of the "Commencement Date" in the CRTA, which had triggered TGTL's obligation to start making send-or-pay payments:
8. As will be seen, this definition incorporates a number of other defined expressions, some of which must be explained in order to make it intelligible. Under (a), the "CATS Approvals" meant "all necessary consents and approvals in a form and substance satisfactory to the CATS Parties for the construction, operation and use of the CATS System ." The construction of engineering works in the North Sea is heavily regulated by the Health and Safety Executive of the Department of Trade and Industry and approvals were necessary at various stages to enable the pipeline and ancillary works ("the CATS System") to be built and operated.
9. Condition (b) requires little explanation except to say that neither side suggested that the words "to the satisfaction of the CATS Parties" gave them an unfettered discretion as to what should be tested and what results should be treated as satisfactory. But there was some argument over whether it was enough that the CATS Parties should have acted in good faith or whether the testing and commissioning should have been to an objective standard which the agreement defined as "the standard of a Reasonable and Prudent Operator." I prefer the latter construction. But the point is only marginally relevant (for a reason I shall mention later) because TGTL accepts that condition (b) was satisfied when the CATS Operator notified 1 April 1993 as the Commencement Date.
10. Condition (c) contains a number of defined expressions but they do not need to be unpacked in any detail. The "CATS Transportation Facilities" meant the facilities to be constructed, owned and operated by the CATS Parties, described in some detail in Schedule 1. "The Transportation Service" meant the service of accepting, transporting and redelivering TGTL's gas. "Capacity Gas" meant TGTL's gas and "the Capacity Reservation Rate" fixed the quantity which it was entitled to have transported.
11. In February 1995 TGTL, which had already paid about £45m in send-or-pay payments, gave notice that it would not pay any more. It also asked for its previous payments to be refunded. The grounds were that, for various reasons, the conditions for the Commencement Date had not been satisfied. The main, and now the only surviving reason is that the CATS Transportation Facilities were not "available to perform the Transportation Service" within the meaning of condition (c) on 1 April 1993 or thereafter.
12. On 6 March 1995 the CATS Parties commenced proceedings claiming a declaration that TGTL was liable to make send-or-pay payments from 1 April 1993 and payment of arrears. They commenced separate proceedings against ICI and Enron as guarantors. After 1 April 1996 TGTL amended its defence to claim that not only was it not liable for any send-or-pay payments but that it was also entitled to cancel the whole agreement. This was because clause 2.4 (a) provided that if the Commencement Date had not occurred on or before 1 April 1996, TGTL should have the right to terminate. By the time the case came to trial, this date had passed and TGTL was claiming that there had not yet been a Commencement Date. The GSAs contained provisions which entitled Enron indirectly to terminate them if the CRTA came to an end. In separate proceedings tried with this action, Enron claimed to have exercised these rights as well.
13. When the action came before Langley J, TGTL was contending that there were four reasons why condition (c) had not been satisfied. First, the designated re-delivery point at Teeside had not been constructed. Secondly, the entry point at which TGTL proposed to tie in its pipeline from the J-Block fields was not in a fit state to receive it. Thirdly, the specification of the Everest/Lomond gas passing through the system, and with which TGTL's gas (if they had been delivering any) would have been commingled, meant that the CATS Parties would not have been able to redeliver TGTL's gas at the appropriate specification. Fourthly, there would have been too much mercury in the gas. Langley J heard evidence and argument on these matters over 38 days and in what the Court of Appeal rightly described as a masterly judgment, dismissed them all. He held on the facts that none of the alleged defects could be said to have made the Transportation Facilities "unavailable" to provide the Transportation Service.
14. TGTL (and ICI and Enron as its guarantors) appealed to the Court of Appeal on one ground only. That was the availability of the entry point, known as T6. The CATS Transportation Facilities which the CATS Parties had to make available included a number of "Entry Points" at which pipes carrying TGTL's gas could be tied in. TGTL had the right to nominate entry points at which the CATS Parties were then obliged to construct the necessary facilities. It had nominated T6. Clause 3.8 (a) provided that the entry points were to be owned by the CATS Parties and form part of the CATS Transportation Facilities.
15. The entry point constructed at T6 was in a form common in the industry. It consisted of a short spur of pipe ending in a blind flange which could be removed so that the incoming pipe could be tied in by a flange or weld. In order to be able to tie in while the pipeline was live with high pressure gas, as it was after the Everest/Lomond gas started to flow in May 1993, it was necessary to provide a valve assembly which could be closed to isolate the end of the spur from the pipeline. For greater safety, two large metal ball valves were installed in series, with outlet valves to enable the lengths of pipe (or "spools") between the valves and between the second valve and the terminal flange to be vented of gas when the valves were shut.
16. The T6 valves were installed in August 1992. The judge found that they had been designed, manufactured and installed according to best industry practice by reputable suppliers. They had been fully tested on shore and found to be working properly. Once installed, they were not tested again. The judge found this to be standard practice: first, because testing might damage the valves and secondly, because they would in any case have to be tested again before they were closed to enable a tie-in to take place.
17. In October 1994 the valves were inspected with a view to a tie-in about a year later. They were found to be leaking to an extent which would not then have allowed a tie-in to proceed. The judge found that they had probably been in the same state on 1 April 1993, when the notification of the Commencement Date had taken effect.
18. The rate of leakage caused some alarm and at first it was thought that the valves themselves might be defective. But tests at other entry points in the following month showed that similar valves were behaving in the same way and it was unlikely that they could all be defective. By December 1994 it was accepted that the most likely cause of the problem was insufficient differential pressure across the valves, which caused the heavy metal balls within the valves to float free of their seatings rather than being pressed hard against them. The solution was a rapid venting of the gas on the downstream side of each valve, enabling the upstream pressure to "shock" the ball against its seating. Onshore tests in the early months of 1995 tended to confirm this opinion. The suggested remedy was then applied off shore. Although leakage through the first ball valve still exceeded expectations, it worked sufficiently well to enable the leaking gas to be vented from the spool between the valves so that the tie-in could proceed. This took place in October 1995, well in advance of any gas being available from the J-Block fields.
19. The judge found that although the state of the valves on 1 April 1993 was not such as to permit a tie-on to have taken place on that day, that did not mean that the entry point was not "available to perform the Transportation Service" on that date. The words did not mean that the Transportation Service had to be available "at the push of a button." Clause 8(3)(a) of the agreement required TGTL to give the CATS Operator at least 100 days notice of the commencement of any tie-in works. The tie-in was the responsibility of TGTL or its contractors. The CRTA provided for a good deal of exchange of information and co-operation before a tie-in could take place. The parties would reasonably have expected that the entry point might require some fine-tuning before there could be a tie-in and the agreement provided for this to happen. There was nothing wrong with the valves or the construction of the entry point. They could be used without modification. All that was necessary was to devise procedures by which the valves could be properly shut. This did not prevent the entry point from being "available" within the meaning of condition (c).
20. The Court of Appeal disagreed with the judge's view of what was meant by "available". Tuckey LJ said that the words "are available" denoted an objective state of present facts, not a prospective one. The facilities were either available on 1 April 1993 or they were not. The judge had found that no tie-in could have taken place on that date and it followed that they were not available. The Court of Appeal therefore allowed the appeals. As it was common cause that the valves had been made to work adequately before a second precautionary Commencement Date notice was served on 31 May 1995, TGTL's success was not complete. It could not cancel the CRTA or Enron the GSAs. But the send-or-pay payments for which it and the guarantors have been held not liable amount to about £100m. Against those decisions the CATS Parties appeal to your Lordships' House.
21. My Lords, the argument has tended to concentrate on the state of affairs said to be denoted by the words "available to perform the Transportation Service". At one extreme was the submission of Mr Pollock QC, for the CATS Parties, that it meant only that the CATS Parties had not entered into a conflicting obligation to allow the reserved capacity to be used by someone else. The judge rejected this construction and it was not advanced in the Court of Appeal. Mr Sumption QC, for TGTL, said that it would be very odd to require the CATS Operator to make a formal declaration that the CATS Parties had not done something which would on any view be a fundamental breach of contract. I agree.
22. At the other extreme is the construction favoured by the Court of Appeal. This means that if it is found, perhaps some years after the notified Commencement Date, that the Transportation Facilities had then been suffering from some remediable defect which prevented their immediate use (apart from what the Court of Appeal called "minor problems") the notification will be retrospectively invalid. It seems to me very improbable that this is what rational businessmen could have intended.
23. The fact that the power to notify the Commencement Date is vested in the CATS Operator suggests that the parties contemplated, first, that the CATS Operator would be able to know at the time whether the conditions for notification had been satisfied or not and secondly, that the notification would give rise to definite commitments on the part of the CATS Parties and TGTL. TGTL would rely upon the Commencement Date notification to built their feeder pipeline from the J-Block fields and prepare to tie it in. It would be strange if the existence of an unknown defect in the pipeline enabled the CATS Parties to say that there had been no Commencement Date and that they therefore had no obligations under clause 6.1 to provide the Transportation Service. I do not think that in such a situation even the unqualified obligation under clause 3.1 to complete the pipeline by 1 April 1993 would provide TGTL with a remedy. If the CATS Parties were under no obligation to provide any Transportation Service, the failure to complete the pipeline would have caused TGTL no loss.
24. Likewise, the CATS Parties no doubt relied upon receiving the income stream from the send-or-pay payments from the time when the system had been completed and commissioned. It must have formed part of their financing arrangements. It would not be very businesslike to enter into an agreement which provided that if some remediable defect emerged at the time of a tie-in two or three years later, all the money would be repayable and the CRTA liable to cancellation.
25. Mr Sumption said that there is nothing unreasonable in a provision by which liability for the send-or-pay payments can be retrospectively invalidated by the emergence of a latent defect. It is simply a commercial allocation of the risk that there might be such a defect. The Court of Appeal agreed. But the construction for which Mr Sumption contends is not what is ordinarily meant by the allocation of risk. It usually means a term which provides that a loss which would otherwise fall to be borne by one party shall be borne by the other. A warranty in a contract of sale allocates to the seller the risk of losses which would otherwise fall upon the buyer. In the present case, however, there was no loss to be allocated. If there had been a loss, other terms of the contract like clauses 3.1 (the obligation of the CATS Parties to construct the system) and 7.5 (which provides for a reduction in send-or-pay payments when capacity is not available) would have come into play. The latent defect in T6 was simply an unforeseeable event which TGTL says entitles it to be relieved of the obligation to pay £100m. I think that Mr Pollock was right in saying that such a term would be more like a bet than a provision for the allocation of risk. Furthermore, the allocation of risk argument does not explain why it would be rational to deny TGTL a remedy for loss suffered because they were unable to tie in by reason of a defect which invalidated the Commencement Date.
26. Mr Sumption said that the availability of the Transportation Facilities from the Commencement Date was what TGTL had bargained for. If they were not in a state to be used, then TGTL was being denied the only consideration for which it was making send-or-pay payments. But this seems to me an unrealistic view of the commercial nature of the transaction. TGTL agreed to pay from the Commencement Date in order to reserve capacity for itself, to be used from whatever date it chose in accordance with the terms of the CRTA. It was not paying to avoid the disappointment of knowing that if it had chosen to tie in at some other date, it might not immediately have been able to do so.
27. The construction adopted by the judge makes more commercial sense, certainly on the facts as he found them, than either of the extremes so far considered. The only reason why I do not find it entirely satisfactory is that the judge thought it was important that there was nothing wrong with the valves. They could be made to work without modification. This suggests that he might have given a different answer if, by reason of some latent defect or supervening event unknown to the parties (like a trawler net snagging T6 between the time it was built in August 1992 and the Commencement Date on 1 April 1993) the valves were defective or broken and had to be replaced. But this would also produce the retrospective consequences which I have described and would in my view be equally irrational.
28. It would be possible to modify the judge's construction to cope with this difficulty. But I think that one should go back and examine the basic assumption that the words "the CATS Transportation Facilities are available to perform the Transportation Service" are intended to be descriptive of some state of affairs and that the problem is to identify just what that state of affairs is. It is true that conditions (a) and (b) plainly denote a state of affairs in which certain events have occurred; the CATS Approvals "have been obtained" and the CATS System "has been tested and commissioned". Condition (c) has the same (subject-predicate) grammatical structure and therefore it has been assumed that it also denotes a state of affairs, this time in the present tense. But this need not necessarily be the case.
29. One clue to the possibility that the words are not intended to denote a state of affairs is that the agreement does not elaborate on what that state of affairs might be. If that was intended to be its meaning, one would certainly have expected this agreement to say exactly what the CATS Parties had to do to comply. The CRTA covers 348 pages with detailed and careful drafting. More particularly, in clause 7.5 it uses the expression "capacity is not available" in a different context, to which I shall have to return later, and provides a three page definition of what for that purpose is meant by capacity not being available. One would therefore have thought that if £100m were going to turn on whether the Transportation Facilities could be said to be available, the agreement would have said precisely what that meant.
30. A second clue is the purpose that the definition of the Commencement Date was intended to serve. It is a defined expression for use in the substantive provisions of the agreement and, as I have already said, in those provisions it serves two main purposes. It defines the moment from which the CATS parties come under an obligation to provide the Transportation Service to TGTL under clause 6.1 and the moment from which TGTL is required by clause 7.4 to make send-or-pay payments. Thus the fixing of that Date imposes obligations upon both parties. The CATS Parties come under an absolute obligation (subject to a force majeure clause) to provide the Transportation Service, for breach of which they may be liable in damages, and TGTL come under an obligation to make the send-or-pay payments. But the CATS Operator must first decide that the Transportation Service is in a state in which the CATS Parties can accept the obligations imposed by agreement.
31. Reading the definition of the Commencement Date in this context, it becomes clear why there is no attempt to define the word "available." It is for the CATS Operator to decide whether the Transportation Service should be declared available or not. Conditions (a) and (b) provide TGTL (and no doubt its bankers) with objective assurances, in accordance with the standards of a "Reasonable and Prudent operator", as I have construed condition (b) to require, that the system has been lawfully built, tested and commissioned. But condition (c), despite its similar grammatical structure, is not in my opinion intended to be descriptive of any state of affairs at all. It is rather in the nature of a declaration which (assuming conditions (a) and (b) to be satisfied) triggers the Commencement Date. A notification that "the CATS Transportation Facilities are available" is simply a statement that the pipeline is open for business and that the CATS Parties accept liability from that date to provide the Transportation Service. In speech act theory, condition (c) is technically called a "performative" (see JL Austin, "Performative Utterances" in Philosophical Papers (3rd ed 1979) at pp 233-252). It does not describe anything; it does something, rather as the statement by the visiting celebrity at the village fete "This fete is now open" does not describe anything. The fete is open because she has declared it open.
32. Of course the making of such a declaration may imply a belief on the part of the maker that a certain state of affairs exists which enables it to be meaningfully made. In the present case, the notification that "the CATS Transportation Facilities are available" would imply a bona fide belief on the part of the CATS Operator that they were in a state which enabled the Transportation Facilities to be provided. The lack of such a bona fide belief might invalidate the notice. But there has never been any suggestion that the CATS Operator did not honestly believe that the Facilities could be provided in accordance with the contract.
33. This construction means that a Commencement Date notification can be validly given even though, on account of a latent defect or for some other reason unknown to the CATS Operator, it is in fact incapable of providing the Transportation Service. But when one looks at the CRTA as a whole, this does not seem to me at all unreasonable. It avoids what I have described as the irrational consequences of the construction adopted by the Court of Appeal. And it does not cause any difficulties for TGTL. Under clause 3.1 the CATS Parties were under an absolute obligation to cause the CATS Transportation Facilities to be constructed and capable of performing the Transportation Service. So far as a breach of this obligation causes TGTL any loss, it will have a claim in damages. Secondly, clause 7.5 provides for a reduction in send-or-pay payments if capacity is not "available" (as defined in clause 7.5(b)) for the provision of the Transportation Service. I shall have to consider the effect of this clause in a moment, but I think it is clear that it entitles TGTL to a reduction if the CATS Parties are unable or fail to redeliver some or all of its gas after its pipeline has been tied into the CATS system.