Pacific Products Pty Ltd v Howard - [2005] SASC 290

SUPREME COURT OF SOUTH AUSTRALIA
(Magistrates Appeals: Civil)
PACIFIC PRODUCTS PTY LTD v HOWARD
Judgment of The Honourable Justice Bleby
8 August 2005
CONTRACTS - GENERAL CONTRACTUAL PRINCIPLES - CONSTRUCTION AND INTERPRETATION OF CONTRACTS - IMPLIED TERMS - DURATION OF CONTRACT
Oral agreement for distribution of grocery products - Silent as to termination - Implied term that agreement terminable on reasonable notice - Whether finding that reasonable notice of 12 months was justified - Whether Magistrate took irrelevant matters into account and failed to take relevant matters into account in assessing reasonable notice - Discussion of matters relevant to fixing of reasonable notice - Appeal allowed - Reasonable notice fixed at 10 months
Crawford Fitting Co v Sydney Valve and Fittings Pty Ltd (1988) 14 NSWLR 438, applied.

PACIFIC PRODUCTS PTY LTD v HOWARD
[2005] SASC 290
Magistrates Appeal: Civil
BLEBY J:
Introduction

The appellant is a manufacturer and wholesaler of supermarket products based in Sydney. The respondent was the sole broker and distributor of the appellant’s products to independent supermarkets in South Australia and the Northern Territory.
The brokerage and distribution agreements were both concluded verbally. The Magistrate found that they were separate agreements. There was some written evidence as to the terms agreed to, particularly in relation to the brokerage agreement. That agreement could be terminated on one month’s notice. However, all that is relevant for present purposes is that the distribution agreement (“the agreement”) gave the respondent the exclusive right to distribute the appellant’s products to independent supermarkets in South Australia and the Northern Territory and was silent as to termination.
The parties accept that the agreement could be terminated on reasonable notice. They have also agreed to a set amount of loss said to have been incurred by the respondent, being the figure of $1,585.00 per month for which notice was not but which should have been given. Not all these issues were agreed at trial. However, on appeal the sole issue was the period of time which should constitute reasonable notice in the circumstances. The Magistrate found that reasonable notice would amount to 12 months, to commence from August 2003. The appellant contended that it should be no more than six months.
The facts
The business relationship between the parties lasted approximately seven years, from late 1996 until mid August 2003, the agreement having commenced early in 1997. In June 2003 the appellant purported to notify the respondent of the appellant’s intention to terminate the distribution agreement by seeking to negotiate a variation to the existing agreement. However, the respondent refused to accept the termination or any variation and continued to distribute the appellant’s products until August 2003. By letter dated 14 August 2003 to the respondent’s solicitors, received on 21 August, the appellant’s solicitors gave formal notice of termination of both agreements with effect from 31 August 2003.
The reason for the termination was that the appellant had entered into an arrangement with a national distributor, Metcash Trading Limited (“Metcash”), to distribute four of the appellant’s major lines in New South Wales, Victoria, Queensland and South Australia. The appellant had sought to renegotiate the distribution agreement with the respondent. The respondent refused to agree to the variation, with the consequence that both agreements were terminated.
As was found by the Magistrate, the respondent’s role as distributor involved him committing himself financially to six month marketing plans. The Magistrate found, and the evidence shows that the plans were negotiated in advance in a period of some months before the marketing plan was scheduled to commence. Precisely how far in advance of the commencement of the marketing plan this negotiation generally began was not clear. Nor was it clear at what stage in a particular marketing plan the formal notice of termination was given.
The respondent increased the annual turnover of the appellant’s products in South Australia and the Northern Territory from effectively zero at the beginning of the relationship, to $20,000.00 in the first year and $60,000.00 by the final year. Sales of the appellant’s products constituted 23.4% of the respondent’s overall business.
There was also no evidence as to how long it would take the respondent, if he were able to at all, to replace the appellant’s products with other products for distribution. The Magistrate found that the market was dynamic and was subject to changes in methods of distribution, and that finding replacement business was not assured.
The Magistrate also found that negotiations between the appellant and Metcash commenced in June 2002, with the reaching of a consensus in November 2002 for implementation in July 2003.
The respondent negotiated his transport arrangements at 12 monthly intervals. These arrangements involved both storage and transportation of the relevant goods, but were based upon the volume of goods handled. If nothing was required to be distributed, nothing was paid. It was the rates which were negotiated annually.
The Magistrate’s reasons
In deciding that 12 months notice of termination of the agreement was reasonable, the Magistrate referred to two passages from the judgment of McHugh JA in Crawford Fitting Co v Sydney Valve and Fittings Pty Ltd[1] to which reference is made below.
[1] (1988) 14 NSWLR 438
Her Honour recited the fact that the respondent built up the market for the appellant’s products over almost seven years, that he was committed to six month marketing plans, that he had built up revenue from sale of the appellant’s products to $60,000 per year, that the respondent’s sales of the appellant’s products constituted 23.4% of the respondent’s business, that the negotiation of the respondent’s transport arrangements were conducted 12 monthly, and referred to the impact of the loss on the need for warehousing and sales staff. It was against those factors that the Magistrate fixed the period of 12 calendar months as reasonable notice for the termination of the agreement.
Consideration of the appeal
Both parties agreed that resolution of the appeal depended on the correct application of the decision in Crawford Fitting.[2] Crawford Fitting involved the termination upon reasonable notice of two exclusive distribution agreements, one in New South Wales and one in Victoria, which had been in place for 14 and 12 years respectively. The manufacturer claimed six months was a reasonable period of notice. The distributors disagreed, as did the trial judge who construed reasonable notice in the circumstances to be two years. The manufacturer appealed and was, by a majority decision of the New South Wales Court of Appeal, successful in persuading the Court that six months was a reasonable period of notice.
[2] Ibid
The first part of McHugh JA’s judgment (with which Priestley JA agreed) is devoted to whether the position adopted by courts in the United States to separate the question of the reasonable length of a contract from the reasonable period of notice for termination should be adopted here. His Honour approved of that approach, finding it proper that in certain open-ended contracts, such as where a distribution business was to be built up from nothing, there was to be implied a term that they should remain in force for a reasonable time soon after they were entered into. As turned out to be the case in Crawford Fitting, that is not an issue that need be addressed in the present circumstances. As the parties were in business together for close to seven years, if such a term was implied in this contract, the reasonable time had passed, and it was not in dispute that the agreement was now terminable upon reasonable notice. However, it will be necessary to touch briefly on this aspect when discussing compensation for extraordinary expenditure or effort within the scope of the agreement.
The first principle espoused in Crawford Fitting[3] of direct relevance to this appeal is that where a contract is terminable upon reasonable notice, the reasonableness of the period of notice must reflect the circumstances in existence at the time that the notice is given. That is, the whole of the relationship between the parties as it currently stands must be considered, not simply what would have been contemplated by the parties at the time of contracting. Hence, in considering reasonable notice, the court must look to the relationship between the appellant and respondent as it was in mid 2003. There is no suggestion that the Magistrate did other than that.
[3] Ibid at 444D and 454D
The second principle relates to the matters to be taken into consideration in determining what constitutes reasonable notice. It is summarised in the following frequently cited passage from McHugh JA’s judgment:[4]
When a contract is terminable upon reasonable notice, the period of notice must be sufficiently long to enable the recipient to deploy his labour and equipment in alternative employment, to carry out his commitments, to bring current negotiations to fruition and to wind up the association in a businesslike manner.
[4] Ibid at 444D
When viewed standing alone, this passage may suggest a focus on the circumstances of the recipient of the notice, in this case the respondent. However it is apparent from McHugh JA’s later comments[5] that it is necessary that the period of notice serve the interests of both parties. His Honour expanded on the factors to be taken into consideration and concluded:[6]
The chief purpose of a notice for a reasonable period, therefore, is to enable the parties to bring to an end in an orderly way a relationship which, ex hypothesi, has existed for a reasonable period so that they will have a reasonable opportunity to enter into alternative arrangements and to wind up matters which arise out of their relationship. Matters to be wound up will include carrying out existing commitments, bringing current negotiations to fruition, and, where appropriate, obtaining the fruits of any extraordinary expenditure and effort carried out within the scope of the agreement.
[5] Ibid at 450F
[6] Ibid at 448E
McHugh JA went to some length to explain what is meant by “extraordinary expenditure and effort”. Although His Honour noted that it could relate to hefty outlays by one party at the beginning of a relationship, in those circumstances the question would be whether there was an implied term that the contract be of a reasonable length.[7] Extraordinary expenditure and effort however, is not confined to the initial stages of the contract.[8] This is especially so where additional expenditure is incurred with the apparent authority of the other party. An example might be a once-off, intense and expensive marketing campaign designed to boost sales. It must be something outside of the ordinary day-to-day expenditure and effort required as a matter of course under the agreement. His Honour observed:[9]
The expenditure of money or effort is simply part of the ordinary cost of doing business. Once the business has existed for a reasonable period, the inability to profit from such work or expenditure is part of the business risk the… distributor takes in entering into an agreement which is terminable at any time.
[7] Ibid at 450B
[8] Ibid at 446A, 448C
[9] Ibid at 448D
McHugh JA also addressed the evidence in Crawford Fitting that the distributors in that case had expended much time, effort and hard work in building up substantial businesses over many years, but found that “their efforts and expenditure were no greater than was expected or demanded when they entered into the agreements”.[10]
[10] Ibid at 449G-450A
In this case there was no evidence that the respondent, in the period leading up to the purported notice of termination, had expended extra funds or effort outside of the normal course of running the distribution business. His efforts in building up the business over the course of almost seven years, whilst admirable, cannot be classed as “extraordinary effort or expenditure” as discussed in Crawford Fitting. As such, the period of notice in this case will not refect any amount of time for the recovery of the fruits of “extraordinary effort or expenditure”.
That said, contrary to the argument of the appellant, it is not apparent that the Magistrate made such an allowance in determining the period of 12 months. She made no finding that the respondent had contributed extraordinary effort or expenditure in that sense. Rather, she used the extent of the market of the appellant’s products built up by the respondent as an indicator of the time which she considered he would need to replace that share of his business which he had lost. But that is not a proper indicator of an appropriate period of notice either.
McHugh JA said in Crawford Fitting:[11]
(T)he prospect of obtaining profits in the future is not a relevant factor to be taken into account except so far as it is consequential upon the incurring of extraordinary expenditure or effort within the scope of the agreement.
[11] Ibid at 448D, and see also 451B
His Honour found that the purpose of the notice period was not simply to allow the distributor to continue to make profits during that time. There can be no attempt to compensate the respondent for his work over the years by allowing for an arbitrary period of profits to be recovered. This is not the role of the notice period.
Nor is the purpose of the notice period to allow the distributor to replace the whole of their lost business. As McHugh JA pointed out[12], it is to be expected that the distributor will not do as well in the first years of his or her new business as they did immediately prior to the termination. However, the notice period must give the respondent some opportunity to “deploy his labour and equipment in alternative employment”.[13]
[12] Ibid at 453B-C
[13] Ibid at 444D
The appellant complained that the notice fixed by the Magistrate was based, at least in part, on the time taken to obtain replacement of the business lost. I consider that there is some force in this argument. The Magistrate did not suggest that the lost business would be entirely replaced in that time, but it was a factor, and an irrelevant one, which bore on the Magistrate’s assessment of the appropriate length of notice.
In my opinion there are two other errors apparent in the Magistrate’s reasons. The first is that the Magistrate seems to have regarded as a relevant factor in fixing the period of notice the fact that negotiations had commenced between the appellant and Metcash in June 2002, being 12 months before the appellant first approached the respondent seeking a variation to the contract. The implication from the Magistrate’s reasons is that the opportunity was there for the appellant to give a greater period of notice, which it had consciously refrained from doing. That is not a relevant consideration in determining what was reasonable between the parties. At best it merely indicates that, if the reasonable period of notice was in fact 12 months, the appellant was not prevented from giving that notice to expire at the time when the contract in fact was terminated. However, the failure to give notice during that period cannot, in itself, be relevant to the determination of what is reasonable notice. The relevance of and weight to be given to the negotiations between the appellant and Metcash are discussed later in these reasons.
The second error is that, in discussing the various factors said to be relevant to the assessment of the period of notice, all factors listed by the Magistrate were considered from the point of view of the respondent and whether it was reasonable in the light of his own commitments and expectations. While it is true that in one part of his judgment in Crawford Fitting McHugh JA refers to the period of notice being sufficiently long to enable the recipient to deploy his labour and equipment in alternative employment, to carry out his commitments, to bring current negotiations to fruition and to wind up the association in a businesslike manner[14], he also makes it clear[15] that it is the interests of both parties which must be considered. That appears to be lacking in the Magistrate’s consideration of what is reasonable notice.
[14] Ibid at 444
[15] Ibid at 448
It follows that the Magistrate, having taken irrelevant considerations into account and not having taken relevant considerations into account in determining the appropriate period of notice, this Court must make its own assessment of what is reasonable in the circumstances. That may or may not accord with the period fixed by the Magistrate.
Reasonable notice
I consider that there are four factors evident in the present case which should weigh in the determination of what period of notice would be reasonable.
The first is the six month promotional cycle. The appellant has argued strenuously that the period of notice should reflect this cycle. Indeed it appears from the evidence that many organisational and logistical aspects of the distributorship are tied up with these cycles. To use the expression set out in Crawford Fitting, the notice period must be long enough for the parties to carry out existing commitments and bring current negotiations to fruition. This includes the commitments and negotiations inherent in each six month cycle. For this reason the appellant was bound to concede, as it did, that the notice must be at least six months. However, the evidence showed that there was a necessary period of negotiation preceding the implementation of each six month promotion. On the evidence, the extent of that additional period is uncertain, but in my opinion, some recognition must be given to that additional period.
The second relevant factor is the time it took for the appellant to negotiate its new arrangements. The actual period of such negotiations will not necessarily be conclusive. Nevertheless, it is a strong indicator of the period necessary for at least one party to negotiate satisfactory alternative arrangements. On the findings of the Magistrate the negotiations between the appellant and Metcash commenced in June 2002, and that a consensus was reached in November 2002 for implementation in July 2003. Thus, it seems that, while the negotiations themselves did not take 12 months, external factors may have combined with the negotiations to require a lead time of that order. Once again, this period is not conclusive, and if the negotiations had commenced at some other time of the year, the total period may have been shorter. However, it would indicate that, from the appellant’s own point of view, a period well in excess of six months is not unreasonable in order to negotiate an alternative arrangement.
The third and fourth factors which should be considered are the nature of the relationship between the parties and of the industry in which they operated. Although, as I have indicated, it is wrong to attempt to compensate either party for the loss of a long-standing arrangement, the matters outlined in Crawford Fitting must be considered in the context of the particular circumstances of the parties. At the time of the notice being given, how did these factors affect the ability of the parties to make alternative arrangements and extract themselves as smoothly as possible from their association? The respondent had no doubt relied, in part, on the longstanding relationship with the appellant in entering into arrangements with third parties for storage and transport of the appellant’s products. Counsel for the respondent submitted that such arrangements were generally entered into based on periods of 12 months, particularly contracts for freight services. That may well be so. However, there is no suggestion in the evidence in this case that the respondent was committed to a 12 month lease of warehouse premises or use of other facilities which he could now no longer use. The freight and distribution arrangements that he had in place were paid for according to usage. All that was negotiated each 12 months were the relevant rates that he would be charged for the services that he used. Those arrangements cannot therefore be regarded as weighing heavily in the balance.

With the loss of a major client there may well be the need to retrench employees unless immediate replacements can be found for the loss of business. In some cases there may be ongoing servicing of loans for capital purposes no longer able fully to be utilised, although these latter expenses would appear to be taken account of in the agreement between the parties in this case of the monthly loss incurred by the respondent. The respondent’s profit and loss statement does not suggest that there were any significant ongoing expenses thrown away which would require particular consideration affecting the period of reasonable notice of termination.
Taking into account all the relevant considerations, in my opinion an appropriate period of notice of termination would be 10 months, and I determine accordingly.
Other Matters Raised by the Parties
There were several arguments put by both sides which I do not consider relevant to the determination of reasonable notice.
First, the comparative bargaining power of parties is not an issue relevant to the appropriate period of notice save to the extent that it may be reflected in the time taken to rearrange one’s affairs in an orderly manner. In any event, it does not seem that either party in this case was especially vulnerable to such influences.
Secondly, the reason for the appellant’s decision to change distributors, and whether or not it was forced to do so as the result of a tendency towards national distribution in the industry, is also irrelevant to the period of notice. The notice period is not a punishment for wrongful termination. Neither can the interests of one party in pursuing a particular policy being adopted by others in the industry be allowed to dominate the reasonable requirements of the other party. The predominant consideration is the orderly termination of the business relationship from the point of view of both sides. However, as I have already observed, the appellant began negotiations for national distribution in June 2002. It was not precluded from giving the period of notice that I have determined to expire in August 2003 if it wished.
The respondent’s arguments as to the history of the appellant’s dealings with Davids, its previous distributor, the reduction in the number of products being sold in South Australia and the Northern Territory as a result of the change to Metcash, and the fact that the Magistrate found that a shift to national distribution was not in the contemplation of either party at the time of contracting, are also irrelevant as far as notice in concerned. The course that the parties initially expected the relationship to take might be relevant to a consideration as to the minimum reasonable length of the contract but this is not the question in dispute. What was contemplated in mid 2003 as to national distribution is irrelevant, because the reason for the breakdown of the relationship does not affect the period of notice.
The appellant argued that too long a notice period would unfairly exclude it from participating in the national distribution system. This was not in fact the case as it was able to enter the national market immediately by reason of its breach of the agreement with the respondent, and was in a position to have avoided the breach if it wished.
Finally, the fact that the respondent, until the appellant’s breach, had the benefit of an exclusive right to distribute the appellant’s products is irrelevant to notice. The fact that the respondent would immediately cease to reap the rewards of the agreement, and that the new distributor would inherit the benefits of an existing market are not relevant considerations either. These factors reflect the simple reality of the type of agreement entered into by the parties. The purpose of the notice period is not to reward or compensate the parties for their prior contributions. As McHugh JA noted[16] in Crawford Fitting, the distributors always carried the risk that one day the manufacturer might cease to engage them as distributors.
[16] At 453C
Conclusion
The appeal should be allowed and the order of the Magistrate on the respondent’s claim should be set aside, with an appropriate order being made based on an entitlement to 10 months notice of termination from 21 August 2003, the date when notice of termination was received by the respondent’s solicitors.
I will hear the parties as to the precise terms of any order that should be made as to the costs of the appeal and whether, in the circumstances, the Magistrate’s order for double costs under Rule 53 of the Magistrates Court Rules should stand.