Mutuality in action

“With us… all the conditions of a mutual contract are dependent on their counter parts, as a general rule, when they are of the substance of or material to the subject matter of the contract itself” (Turnbull v McLean & Co (1874) 1R 730).
Such has been said to be – and remain – “general principle” to be applied, at least, in the “operation” of the Scots law of contract (see below).

That is so whatever the nature of the contract, whether for the sale of heritage (Lloyds Bank v Bamberger 1993 SLT 595, where interest could only be demanded while the claiming party remained willing to perform his obligations), lease (Graham v Gordon (1842) 5D 1207), or, indeed, any other mercantile contract (Graham & Co v United Turkey Red Co Ltd 1922 SC 533, involving commission payable to an agent). Applying such principle is merely adopting the views of the institutional writers (Erskine, Institute, IV ii 86) and leading writers since (Gloag, Contract, chapter 23; McBryde, Contract, chapter 20).

Specifically, “in a mutual contract where one party seeks performance of the stipulations in his favour, he must show that he has given or tendered performance of his part of the contract. Every action on a mutual contract implies that the Pursuer either has performed, or is willing to perform, his part of the contract; and it is, therefore, always open to the Defender to say that under the contract a right arises also to him to demand performance of the contract before the Pursuer can insist in his action” (Johnston v Robertson (1861) 23D 646). It remains for that reason that a suing party in a contractual dispute should aver his own continuing willingness to perform the contract being founded on.

Classic application of this approach remains provided from the five-judge Inner House decision in Ramsay v Brand (1898) 25R 1212, where the builder departing from the terms of his contract lost the right to sue for the contract price. As the Lord President then concluded, “When contractors do not stick to their contracts they not only unmoor themselves from their contract rights, but they drift into much less certain and much less definite claims”. Without the ability to found on the contract, all that was considered left was a “right to the materials or a claim for recompense quantum lucratus the proprietor”.

In practice, of course, such are the detailed express terms in modern building contracts that strict application of such approach can usually be elided (see “Ramsay v Brand in the 21st Century – Superseding the Rule”, Scottish Law and Practice Quarterly, July 2002).

The application and the approach to be taken in relation to mutuality in contracts has been reviewed by an Extra Division in the context of a contract of partnership, resulting in the majority (2-1) decision of the court in Forster v Ferguson & Forster, Macfie & Alexander [2010] CSIH 38. That the ultimate decision was a majority one with substantive different approaches from Lords Clarke and Marnoch might suggest uncertainty as to the correct approach to be taken, but seems, rather, to have to be related to the specific terms of the partnership agreement in question and the actions taken by the respective parties in the circumstances.

Forster v Ferguson & Forster

The circumstances of this case might, properly, be said to have been “stark” in terms. The pursuer was the former partner in a continuing legal partnership whose partners were the defenders in the action. The pursuer had been convicted of a substantial series of charges of embezzlement and contraventions of the Bankruptcy (Scotland) Act 1985. In anticipation of that prosecution he had (albeit outwith the strict terms of the relative partnership agreement) resigned, which resignation itself was understandably not opposed by the defenders.

The partnership agreement provided for expulsion of a partner in the event of specified circumstances, including acting in such a way as to bring his name or the name of the partnership into disrepute or acting contrary to the agreement or to good faith between the partners. For subsequent purposes, the agreement (to the considerable surprise of at least Lord Marnoch) equated expulsion with retrial, whereupon the financial consequences specified upon retiral might be applied. Amongst those provisions was one that the retiring partner might elect to receive in lieu of any sum due to him in respect of the goodwill and work in progress of the partnership, “a pension for a period of 10 years, payable” to the extent specified.

In essence the pursuer sought payment under that provision, while the defenders withheld payment on grounds that there had been (admitted) material breach of the partnership contract by the pursuer which, applying mutuality, rendered this provision unenforceable.

Before the sheriff (Peebles), the pursuer’s claim was dismissed as “wholly unstatable”, on the view that the pursuer had been in material breach of his obligations and, applying the doctrine of mutuality, could not at the same time sue on that agreement.

On initial appeal before the sheriff principal, as the Division put it, “a different view was taken of matters”, focusing on the particular terms of the relative clauses of the partnership agreement, following which he held that the obligation to pay the pension was not to be regarded as a counterpart of any obligation not to defraud clients or breach the fiduciary duties owed to the pursuer’s former partners. On his analysis, the pursuer not having damaged the financial position of the firm, there was “no good reason” why the remaining partners should “receive a windfall represented by the pursuer’s capital” in the firm.

Not surprisingly, on further appeal, these issues have been before the Extra Division for review. For the defenders it was maintained that distinction had to be drawn between the pursuer’s property rights said to be due under his capital account, which it was conceded he was entitled to claim, and what was (only) his contractual right to receive the payments in pension provided for. Given the terms of the decision of the Lords in Hurst v Bryk [2002] 1 AC 185, and the underlying support for that approach in Scotland given in Gloag, such distinctions appear to be justified. The defenders argued that the sheriff principal had, rather, “conflated” these two separate and distinct types of situation. His view that there was no mutuality between the contractual obligations in question was said to have been “in error”.

Detailed reference was made to the analysis of mutuality offered in McBryde, para 20-47, under which mutuality was said to involve at least five ideas:

1. a party who is in breach of obligations cannot enforce performance by the other party;
2. the party who is not in breach may withhold performance until the other has performed or is seen to be willing to perform the counter stipulations;
3. the mutuality concept only applies if the obligations of the parties are the causes of one another or reciprocal undertakings;
4. the operation of the principle can be affected by the express terms of the contract; and
5. it may not be for every trifling breach that a party can withhold performance of part of the contract.

The obligation of good faith within the contract of partnership was said to be fundamental, citing Lindley & Banks on Partnership and the approach of the Inner House in Macari v Celtic Football and Athletic Co Ltd 1999 SC 655, where the implied obligation of trust and confidence in the contract of employment in question was said to have to be “seen as striking at the very root of the contractual relationship between the parties and that all the other obligations of the contract could be seen as the counterpart of that obligation”.
Seeking to justify the approach of the sheriff principal – but not supporting his approach in equiparating any rights of the pursuer from his capital account in the partnership with his right to pension under the contract – it was said for the pursuer (respondent) that the defence of “retention” could not be maintained where the only remedy properly available to the defenders (appellants) was rescission of the contract and/or damages; the right to retain performance, it was argued, only arose where there was continuing non-performance of a reciprocal obligation; and while contractual obligations were presumed to be reciprocal, that was only a presumption which could be rebutted by what the parties, on a proper construction of their agreement, had in fact agreed. There was (and could be) no dispute that there was an obligation of the utmost good faith within a partnership which “permeated the whole of that relationship”.
What was said was that the specific terms of the partnership agreement in question excluded there being any reliance on breach of such fundamental obligation to defeat entitlement thereunder. There was, it was said, clear intention to be drawn from the agreement that the remaining partners would be liable to make the pension payments demanded.

Applying the mutuality principle

In his substantive judgment (in favour of the appellants’ position), Lord Clarke rejected the respondent’s approach as to the correct application of the principle of mutuality of contract, which he regarded as “labouring under a fundamental mistake or classification” in equiparating retention with all the consequences of that application, as opposed to “seeing it for what it is, namely, an important example of how the principle of mutuality applies in a continuing contractual relationship”. Referring to “high authority on the general principles of the law of contract in Scotland”, with “first port of call” from Gloag, that criticism was set out.

As had been said by Lord President Rodger in Macari, the scope of this general principle was not to be restricted to its application in respect of the right of retention. As Lord Clarke saw it, “that principle has a vigour going beyond its application in relation to retention and, in particular, may be used by a party to a contract which has been broken materially by the other party to resist any claim for performance of any obligation on his part under the contract, even where the contract has been terminated”.

Support for that approach was provided from McBryde and the approach of Lord Cowie in Laurie v British Steel Corporation 1988 SLT 17 (which itself had been followed in the Lords in the circumstances of Myles v Wakefield MDC [1987] 1 AC 539).

Fundamental support was given by Lord Clarke to the approach of Lord Drummond Young in Hoult v Turpie 2004 SLT 308 where he accepted there to be a presumption that the whole of the obligations on one side of the contract are the counterparts of the obligations on the other side. For Lord Clarke the obligations under the contract were interdependent with, and conditional upon, the respondents’ obligations of utmost good faith, and that presumption had not been rebutted. This approach, as will be seen, was the fundamental one upon which Lord Marnoch reached somewhat different specific conclusions in this case.

The suggestion that the express terms of the agreement had excluded application of the mutuality of the obligation of good faith was roundly rejected. As Lord Clarke put it, “the importance of that obligation can hardly be overstated in the circumstances of such a relationship… the nature and extent of the respondent’s conduct was an extraordinarily serious breach of that obligation. For the respondent to avoid the consequences of such conduct, which the law would otherwise apply, would require… very clear wording, indeed, in the partnership agreement. To have that effect would require wording which made it clear that the other partners were abandoning their right to refuse to perform their obligations in the partnership agreement when faced with a material breach of contract striking at the very heart of the agreement between the parties… no such wording appears in the partnership agreement. Such a result should not be read into the contract as some kind of side-wind from a specific provision dealing with a specific matter (expulsion)… On any view of matters… it would be stretching the wording of that provision to suggest that its effect is wholly to subvert the effect of the principle of mutuality of obligations in the present situation which would otherwise arise as a matter of law”.

Discussing what the “innocent party” may be required to do when faced with material breach of contract on the part of the other party, it was noted that it was not necessary for there to be rescission of the contract before a defence from mutuality might follow (Laurie). Further (citing McBryde at 20-106), it was suggested that “it may be that the innocent party never need rescind”. Even where a party remains inactive, if sued he “has a good defence to the action. Rescission is not an inevitable consequence of a decision to found on a material breach”.

Standing the respondent’s admitted material breach of contract, the appellants were regarded by Lord Clarke as “entitled to point to that breach of contract as providing them with a shield against any claim brought by the respondent”, even after the parties’ relationship had otherwise clearly come to an end.

Cherry picking?

As already noted, however, although Lady Dorrian agreed with Lord Clarke to constitute the majority, Lord Marnoch offered a dissenting approach.

On his analysis the principle of mutuality was “essentially to do with the way contracts operate and, in particular, with when they can or cannot be enforced. It is not a principle to be used as an aid to the construction of what parties have agreed and, far less, as a means of implying terms into a contract”. He disputed the correctness of any approach as to “whether the parties have by clear express provisions rebutted some supposed meaning of the contractual provisions derived from the principle of mutuality”. He saw “no reason a priori to regard the complicated provisions of a contract of copartnery as being other than wholly interdependent and conditional upon each other”.

As he saw it, to be “cherry picking” certain provisions as being the supposed counterparts of a breach of good faith, and disapplying those but not others under the guise of mutuality, was not justified in that it would “undermine the principle of unity and indeed contradict the initial presumption of mutuality which is the interdependence of all material contractual provisions” (Macari; Hoult).

Following this approach, “acceptance of the interdependence principle” meant that “any deployment of a shield is quite inconsistent with the attempted enforcement of other parts of the contracts” (by the appellants). On this approach he was unable to agree with Lord Clarke that the particular clause on the consequences of retirement in relation to pension could be looked at as conferring a right exercisable in the case of determination of the respondent’s contractual relationship. For Lord Marnoch it was for the defenders to have rescinded the contract of partnership following the pursuer’s material breach of the obligation of good faith under that contract.

Regard, in his view, had further to be had to the express terms of that contract and the (claimed) deemed retirement of the pursuer; as he saw it the parties had “expressly foreseen a possible breach of good faith and, improbably or otherwise, decided to equate its consequences with those of retirement”. On that ground alone, he thought, the defenders could – and should – have treated the contract as having been repudiated and thus rescinded it.

Consequences

The mutuality principle being applicable across all contracts, of whatever type, guidance from the Forster decision could and should justifiably be invoked in other cases.

Specifically, in relation to partnership contracts, partner solicitors reading the judgments under consideration might, understandably, be expected to be looking at the terms of their own partnership agreements – assuming such written agreements exist! Review might, clearly, be justified in relation to powers of expulsion/entitlement to resignation and any financial consequences of either.

Remaining partners, faced with such difficult circumstances as arose here, would seem justified in:

1. adopting Lord Marnoch’s approach in making the soonest possible decision to rescind their contract on the available grounds; but, failing that,
2. withholding performance of their obligations on grounds of breach of the mutual obligations of the contract, applying the mutuality principle, as suggested by Lord Clarke.

On any view, of course, the difficulties as or when they arise which will be associated with such or similar circumstances – legal and otherwise – will have to be dealt with.