Elite Underlay Limited v Eco Rubber Industries Limited
[2018] NZHC 571
•29 March 2018
IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY
I TE KŌTI MATUA O AOTEAROA TĀMAKI MAKAURAU ROHE
CIV-2017-404-001871
[2018] NZHC 571
IN THE MATTER of an appeal against the decision of the District Court at Auckland BETWEEN
ELITE UNDERLAY LIMITED
Applicant
AND
ECO RUBBER INDUSTRIES LIMITED
Respondent
Hearing: 5 December 2017 Appearances:
M D Branch for Applicant
M C Donovan for Respondent
Judgment:
29 March 2018
JUDGMENT OF COURTNEY J
This judgment was delivered by Justice Courtney on 29 March 2018 at 10.30 am
pursuant to R 11.5 of the High Court Rules Registrar / Deputy Registrar Date……………………….
ELITE UNDERLAY LTD v ECO RUBBER INDUSTRIES LTD [2018] NZHC 571 [29 March 2018]
Introduction
[1] In 2013 Elite Underlay Ltd (Elite) had a business in Hamilton manufacturing carpet underlay using recycled rubber crumb from the tyre industry. It agreed to sell the business to Eco Rubber Industries Ltd (Eco Rubber). Under the contract, Elite was to continue managing the business. Eco Rubber was to pay Elite $3,000 plus GST per month for management services for the first 36 months and $4,000 plus GST per month thereafter. This arrangement could only be terminated by agreement or by Eco Rubber if Elite was negligent in managing the business.
[2] Two months after the contract was entered into, the oven used to manufacture the underlay was badly damaged by fire. Some repairs were undertaken but before they were completed Eco Rubber decided to cease production altogether. It dismantled the oven, moved it into storage and stopped paying the management fee. Elite sued for the management fees due from the first month of non-payment to 1 July 2015 ($44,850) and a declaration as to Eco Rubber’s liability to pay $4,000 plus GST until 31 October 2023.
[3] Judge B A Gibson found that the management fee was only payable while there was an operation that needed to be managed, and the contract did not require Eco Rubber to continue paying the management fee once production had ceased. Elite appeals. It says that the Judge wrongly interpreted the contract as a result of:
(a)failing to consider the issue of termination;
(b)wrongly treating Elite’s bargaining position as a relevant consideration in the interpretation of the contract and, in doing so, making factual findings that were not supportable on the evidence;
(c)relying on inadmissible evidence of the parties’ subjective intentions;
(d)failing to take into account evidence of clauses deleted from drafts of the contract;
(e)failing to apply the contra proferentem rule against Eco Rubber; and
(f)failing to consider the commercial absurdity resulting from the construction contended for by Eco Rubber.
Factual background
Elite’s history
[4] Prior to 2013, Elite’s director and shareholder, Surindar Nanua, had some years’ experience in the manufacture of rubber underlay using recycled rubber. In 2009, he became involved with two companies, Pinnacle Underlay Ltd and Impacta- phonic Ltd (together Pinnacle), which produced carpet underlay from recycled rubber. Mr Nanua also owned the intellectual property associated with the manufacturing process and was paid by Pinnacle for it.
[5] Pinnacle did not succeed. The two directors wanted to concentrate on their other businesses. Mr Nanua’s ownership of the intellectual property prevented a sale of the business. The other shareholders refused to pay the lease, which Mr Nanua had guaranteed. In early 2013, the plant was closed temporarily pending resolution of safety issues identified by the Department of Labour.
[6] Mr Nanua decided to establish a new business. He incorporated Elite in May 2013. Superior Turf & Sports Ltd (now called Super Turf Ltd) requested a price list for underlay to use underneath artificial grass. Mr Nanua and Mr Brett Jenkins, a director of Super Turf Ltd, discussed the manufacture of high-density underlay best suited for safety surfacing that would comply with fall height requirements.
[7] Mr Nanua set about attending to the issues identified by the Department of Labour inspectors and Elite commenced production in July 2013. It spent some
$20,000 on new equipment suitable for manufacturing the higher density shock pads that Super Turf Ltd was looking for, undertook tests and discussed the results with Mr Jenkins and Super Turf Ltd’s other director, Mr Byron Ballan.
Eco Rubber buys Elite’s business
[8] Mr Jenkins and Mr Ballan had been finding it difficult to source suitable underlay and proposed acquiring Elite to ensure a reliable and economic supply of
first-grade rubber underlay. After some weeks of negotiation, the parties entered into the agreement that is the subject of this appeal. The agreement was drafted by Mr Ballan, with input from Mr Nanua. Neither party obtained legal advice, though Mr Nanua did discuss the sale with his accountant.
[9] Eco Rubber was the named purchaser under the agreement, which was recorded as being for the “purchase of the assets and business of Elite Underlay Ltd”. The relevant clauses were:
From the 1st of November 2013, being date of takeover, Eco Rubber Industries (ERIL) will be responsible for all legitimate running and purchase expenses relating to the business of Elite Underlay Ltd (EUL), except for interest and repayment obligations to the ANZ Bank or any other creditor of EUL that relates prior to the 1st of November 2013.
…
·EUL and ERIL acknowledge the assets and business of EUL are being sold as a going concern for GST purposes. …
·ERIL’s obligations include taking over the Lease of the premises at 47 Northway Street and ERIL will endeavour to provide alternative security in order to release [Mr Nanua] from his personal guarantee over the Lease.
·From the 1st of November, production will directed to producing the 10mm thick, 1.5 meters (sic) wide, 20 meters (sic) long rolls of 1st grade rubber matting currently manufactured by EUL or as otherwise directed by ERIL. Any direction by ERIL to change production will not disadvantage EUL in regards any payments due to it.
·When appropriate, as agreed between EUL and ERIL, EUL will use its resources, including the ANZ overdraft facility, to buy any equipment necessary to achieve a second mixer, when required to increase monthly production towards 10,000 square meters [sic].
·For the first 36 months after the 1st of November, ERIL will pay EUL a fee of $3,000 plus GST per month, to manage staff, manage the production, document the manufacturing process and train new staff as required.
·After 36 months ERIL will pay EUL $4,000 plus GST per month, plus a management bonus of 20 cents per square meter [sic] for 1st grade product over 5,000 square metres in a month.
·This arrangement will continue until it is mutually agreed that it should cease, or earlier if in ERIL’s reasonable opinion, EUL has been negligent in its management responsibilities and EUL having been advised in writing of ERIL’s reasonable concerns, EUL fails to
address the concerns to ERIL’s reasonable satisfaction, within 30 days.
For 36 months after the 1st of November ERIL will make a Lease to Own payment for all the assets of the business of EUL including any Intellectual Property. The monthly Lease to Own payment will be $1,000 plus GST, regardless of production volumes, and 65 cents plus GST for every square meter [sic] of 1st grade product produced in a month.
·EUL will advise their Insurance Company that from the 1st of November, ERIL has a ‘financial interest’ in the business and insured assets of EUL.
…
·In addition to monthly Lease to Own payments for the assets of the business of EUL, a monthly royalty is payable by ERIL to EUL, or as directed to an entity or person of EUL’s choice, or any other associated entities where the EUL’s intellectual property is used. The monthly royalty is 20 cents plus GST for every square meter [sic] of 1st grade product produced from 1st November 2013, for a period of 10 years. Monthly proof of production quantities are to be provided to EUL, should EUL cease to manage the business.
…
·All parties to this Agreement (and any associated entities) agree that for a period of 10 years, after the 1st of November, they will not set up, manage or direct any business to compete with any party named in this Agreement either directly or indirectly, nor disclose any information to 3rd parties regarding the business or intellectual property of ERIL, EUL or Surindar Nanua as it relates to ERIL and EUL, without the express approval of ERIL or EUL as the case may be.
·Notwithstanding any other clause in this Agreement, all parties must agree in writing that for this Agreement to cease or be changed, that those changes must be noted accordingly and signed by all parties to the Agreement. …
(emphasis added)
[10] Elite’s case centred on the three italicised clauses. Together they were referred to in submissions as “the Management Agreement”. For convenience, I use the same expression.
A fire destroys the oven
[11] In January 2014, there was a fire at the factory in Hamilton. The oven used to manufacture the rubber underlay was seriously damaged and production had to cease.
Elite made a claim on its insurance policy. A valuation obtained for this purpose put the market value of the plant (including oven, controls, cooling and extraction units) on a going concern basis at $408,000. The insurer paid Elite $392,500. Elite paid
$340,000 of that to Eco Rubber. Mr Nanua’s explanation for not paying the full amount was unclear but was not an issue in the appeal.
[12] It is obvious from the level of the insurer’s payment compared to the pre-fire valuation that the insurer treated the claim as a total loss, which would be consistent with two opinions provided at the time of the fire. The Electric Furnace Co Ltd inspected the oven on the day of the fire and considered that the damage was:
… [e]xtensive to the whole oven system to the point of requiring total re-build not only of the oven and conveyor but because of the internal and external distortion of the combustion chamber by the recirculated heat during the fire, the fans will have been severely stressed and we simply would not re-use.
[13] It recommended replacement of the oven, conveyor system, combustion chambers and associated recirculating fans and burner equipment and controls. Jonassen Industrial Projects Ltd inspected the oven a few weeks later. Its report of 31 January 2014 recorded extensive distortion and damage to the equipment and advised that:
… this unit is no longer serviceable and … it would not be practical to undertake the necessary remedial works to restore the unit to a condition compatible with a fully effective and compliant curing oven.
[14] The valuer’s report put the replacement cost of the plant at $1.2m. It was obvious that there would be a shortfall payment of the insurance monies. Nevertheless, Eco Rubber decided to repair the oven. Mr Nanua supervised the restoration work. Mr Ballan gave evidence that the following work was done under Mr Nanua’s direction: removal of insulation panels, fabrication of new insulation panels which were riveted together and then onto the frame, reduction in the height of the oven chamber and increase to its length, construction of inspection doors, painting, and re-conditioning of burners.
[15] That work completed the repairs to the physical body of the oven. A July 2014 valuation put the indemnity value (on an ‘in situ’ basis) of the heating chamber and oven at $900,000. That suggests that the work that was undertaken to re-build the
oven was reasonably successful. By then, approximately $200,000 had been spent. But other work was still needed before production could resume: replacement of the electrical wiring, controls for all driving motors and the conveyor system, the rubber matting handling system and a fire safety system.
[16] On Mr Ballan’s evidence, even if that additional work had been done, the process for mixing rubber and adhesive would still have needed substantial improvement. He described the pre-fire operation as a “cottage industry” style and considered that it needed to be more efficient. There were, clearly, discussions between Mr Nanua and the directors of Eco Rubber about whether it was preferable to move the manufacturing to Eco Rubber’s factory in Auckland. It is apparent from an email that Mr Jenkins sent to Mr Ballan and Mr Nanua that Eco Rubber was very concerned about the location of the premises and rate of (presumably pre-fire) production.
[17] In April 2014, Eco Rubber’s directors indicated that they did not want the oven fully fixed and re-assembled because it may yet be moved, though no decision had yet been made. By July 2014, however, the valuer undertaking a fresh valuation referred to Mr Ballan having informed him that the plant was to be re-located to Auckland.
[18] In August 2014, Mr Nanua rendered invoices for July, including the $3,000 per month plus GST for management fees. Mr Ballan responded, suggesting that, given that there was nothing further to manage, Mr Nanua simply be paid on an hourly basis for whatever work was still required. According to Mr Ballan, Mr Nanua was then away on holiday in September and October but still rendered management fee invoices, which Eco Rubber declined to pay. Eco Rubber continued to pay the “lease to own” payments of $1,000 per month plus GST.
[19] In November 2014, the oven was cut into sections and moved into storage in Auckland. In November 2016, Eco Rubber listed the oven for sale on Trade Me with no success. Two months later, in December 2016, it received $540,000 of a $600,000
grant to refurbish the oven.1 Notwithstanding the additional money received for the purposes of refurbishing the oven, it appears that no further work was done and production has not re-commenced. The present market value of the oven on an “as is” basis is minimal, about $3,000.
The case in the District Court
[20] Elite’s case was advanced on the basis that the Management Agreement had never been cancelled and Eco Rubber was therefore obliged to continue paying the management fees until the agreement was validly terminated. In opening submissions, Elite’s counsel framed the issue to be determined as “whether [Eco Rubber] could terminate the Management Agreement (which requires monthly ongoing payments) on the basis that it has unilaterally decided to cease production, thereby removing Elite’s ability to manage production”.
[21] Eco Rubber maintained that the management fees were payable only if management services were actually being provided. In opening, Eco Rubber’s counsel expressed the issue as whether, on a proper interpretation, the parties must have intended for the management fee to remain payable even where no management services were provided.
[22] It was also part of Elite’s case that the agreement was structured to require a smaller payment for the business assets to reduce Eco Rubber’s tax liability, with the management fees effectively representing part of the overall price. Eco Rubber rejected this, maintaining that the management fees related solely to management of the business, which neither of the directors of Eco Rubber wanted to undertake.
[23] The Judge framed the issues as being “whether the parties intended their contract to mean that management fees remained payable even when no management services were able to be provided and whether the management fees formed part of the purchase price for the agreement”. He did not identify the rights of termination as an issue, though did address the termination provision later in the judgment.
1 This evidence was not before the District Court Judge but was the subject of an application to adduce further evidence for the purposes of the appeal. Despite initial opposition, the evidence was ultimately adduced without objection.
[24] The Judge found that the oven probably represented virtually the whole value of the business and was worth in excess of $300,000 at the time of the agreement, but only because it was being operated on an ongoing basis. There is no challenge to that finding. But the Judge rejected Elite’s argument that the management fee formed part of the purchase price and was payable whether the business needed to be managed or not. He considered that the contract only provided for a purchase price of $36,000 plus GST. He did not accept that this would produce a commercially absurd result, characterising the agreement as a bad bargain that reflected Elite’s weak bargaining position:2
While Mr Nanua may have had an asset worth $300,000 as at October 2013 its value depended on its continued use and production. He was not able to achieve an outright sale to the defendant and he accepted a contract where payment to the plaintiff company was partly based on production and partly based on the management fees it could obtain from the production, as well as the lease to buy payments. The fact that a contract appears unduly favourable to one of the parties is not a sufficient reason for supposing that it does not mean what it actually says it means; Chartbrook Ltd v Persimmon Homes Ltd and the weakness of Mr Nanua’s negotiating position on behalf of the plaintiff provides a clear reason why he was not able to obtain a contract more favourable to the plaintiff.
The real issue is whether the parties intended their contract to mean that management fees remained payable even when no management services were able to be provided and whether the management fees formed part of the purchase price for the agreement.
[25] The Judge considered that for Elite to succeed in its interpretation, it would need to show that the wording of the contract was ambiguous, which it was not. He then addressed the issue of termination:3
The fact that the contract may well have been commercially disadvantageous to the plaintiff does not seem to me to be of any moment if the contract was freely negotiated and the words are capable of clear unambiguous meaning. Here, the plaintiff asserts that management fees remined payable even after the services for which the management fees were paid had ceased. The fee of
$3,000 plus GST per month, payable for the first 36 months, clearly related to the management of staff, production and the manufacturing process. While there was a termination provision that provision concerned failure on the part of the plaintiff to carry out its management responsibilities. It did not cover the absence of those responsibilities because the defendant, which was operating the business, determined for business operational reasons that it was no longer feasible to carry on.
2 Elite Underlay Limited v Eco Rubber Industries Limited [2017] NZDC 1334 at [29]–[30].
3 Elite Underlay Limited v Eco Rubber Industries Limited, above n 2, at [32]–[33].
I accept the defendant’s submission that the termination provision … assumed management services were still required and were being carried on by the plaintiff but had to be unsatisfactory before the provision could be invoked in the sense that the plaintiff had to be negligent or the parties agreed that the plaintiff no longer wished to manage the production. There is no provision in the agreement requiring agreement on the basis that the defendant no longer wishes to carry out production and I do not see that can be implied into the agreement. Such a term is not reasonable or necessary or “go without saying” for the agreement to operate according to the test in BP Refinery (Western Port) Pty Limited v Shire of Hastings …
(emphasis added)
[26] The Judge then considered and rejected the application of the contra proferentem rule and concluded:4
The plaintiff also argued that the management fee was part of the purchase price because it defied commercial common sense for it not to be. That argument essentially revolved around the sense of the plaintiff agreeing to sell an asset worth $300,000 or more for $36,000 plus GST paid over 36 months. The agreement, however, was clear that the lease to own payments amounted to the purchase price for the business. That provision … noted that the lease to own payment was for all the assets of the business including intellectual property. There is no ambiguity. The words bear only one meaning. This was, as events subsequently revealed, no more than a bad bargain made by reason of the agreement reached between the parties failing to include the clause which the plaintiff needed to protect itself from the unforeseen eventuality of the fire and the defendant subsequently determining, as it was entitled to, to cease production … .
[27] Because of his finding that management fees were tied to the provision of management services in respect of the first clause, the Judge did not consider it necessary to consider whether fees after 36 months were required to be paid even if no management services were provided.
Appeal
The issue of termination
[28] Elite argued that the Judge failed to address the issue of termination as it had been advanced at trial, namely that Eco Rubber was not entitled to terminate the Management Agreement by unilaterally deciding to cease production, thereby removing any need for management services.
4 Elite Underlay Limited v Eco Rubber Industries Limited, above n 2, at [40].
[29] It is apparent that the Judge treated the termination provision as not applying where production had ceased as a result of Eco Rubber’s unilateral operational decision. In doing so he failed to consider the effect of that provision and, in particular, failed to address Elite’s claim that Eco Rubber could not avoid its contractual responsibilities through a unilateral decision made for operational reasons.
[30] This ground of appeal is made out. In and of itself, it justifies a fresh consideration of the interpretation of the contract. For completeness, however, I deal with the other grounds of appeal first.
Factual findings regarding the strength of Elite’s bargaining position
[31] The Judge made the following findings which, presumably, he regarded as relevant context for the agreement:5
Moreover, Messrs Ballan and Jennings held the stronger position in the negotiations. Not only were they unable, or unwilling, to part with a lump sum to achieve an outright sale but they were aware the plaintiff company was in financial difficulties with a creditor, Advance Adhesives, about to take steps against the plaintiff. They also saw a GST return from the plaintiff, which was disclosed in the course of negotiation, and which indicated $200,000 of claimed expenses but no sales. Mr Ballan said that after going to the plaintiff’s premises it did not seem to him that the business was highly successful.
[32] Mr Branch, for Elite, submitted that there was no basis for the finding that Advance Adhesives was a creditor of Elite. Mr Ballan had accepted in cross- examination that the debt was owed by Pinnacle but asserted that Mr Nanua had guaranteed the debt. The allegation had not been put to Mr Nanua. There was, clearly, no evidential basis for the Judge’s finding that Advance Adhesives was about to take steps against Elite in relation to an outstanding debt. That was an error.
[33] The evidence about the GST return arose for the first time in Mr Ballan’s cross- examination. Mr Ballan did say that he would be able to produce the GST return but never did. Mr Donovan, for Eco Rubber, argued that the Judge was entitled to accept Mr Ballan’s evidence that he had seen a GST return for Elite that showed significant expenses even if it were not put in evidence and that it had been open to Elite, if it
5 Elite Underlay Ltd v Eco Rubber Industries Ltd, above n 2, at [27].
wished to contest the finding, to have adduced further evidence disclosing all of its GST returns in the 12 months leading up to the date of agreement.
[34] There was an insufficient evidential basis for the Judge’s finding. Elite’s GST returns for the periods August/September 2013 and October/November 2013 were produced at trial and put to Mr Ballan in cross-examination. Neither showed $200,000 worth of expenses. Mr Ballan accepted in cross-examination that Elite had not been trading in July 2013. Indeed, toward the end of that part of his cross-examination Mr Ballan gave an answer that suggested the possibility that the GST form he recalled seeing might have related to Pinnacle.
[35] Mr Donovan argued that there was, nevertheless, sufficient evidence that Elite was in a weak financial position and therefore a weak bargaining position prior to entering into the contract so that the errors in relation to the Advance Adhesives debt and GST debt would not have materially affected the position. He pointed to the general circumstances that existed for Elite at the time, including the fact that Elite was only $12,000 away from reaching its $50,000 credit limit on its overdraft and was on a cash-only basis with suppliers.
[36] I accept that the overall tenor of the evidence was that Elite was not in a strong financial position. However, attributing the Advance Adhesives and GST debts to Elite made the picture much more serious. It affected the way Elite’s bargaining position appeared, which was a factor the Judge took into account in his interpretation of the contract. These errors, coupled with the other errors I have identified, justify a fresh consideration of Elite’s position.
Evidence of the parties’ subjective intentions
[37] A substantial amount of evidence was given by both Mr Nanua and Mr Ballan about the negotiations and their respective intentions. Elite complains that the Judge wrongly took into account the subjective intentions of Mr Ballan and Mr Jenkins in finding that:6
6 Elite Underlay Ltd v Eco Rubber Industries Ltd, above n 2, at [34].
I am satisfied that Messrs Ballan and Jennings, negotiating on behalf of the defendant, never intended the payment provisions of the contract, other than the lease to own for the assets, to be anything other than production based and for the plaintiff to actually exercise a role in managing the production while it was a continuing operation. There was no intention on their part to guarantee payments to the plaintiff irrespective of whether the business continued save only the payment for the assets.
[38] In the District Court, Elite had argued that the fact that Mr Jenkins did not give evidence should have given rise to an adverse inference. That no doubt explains Mr Donovan’s perception that this ground of appeal was directed towards the fact that the Judge made a finding as to Mr Jenkins’ intention when Mr Jenkins had not given evidence. In fact, this ground of appeal is not concerned with the fact that Mr Jenkins did not give evidence but, rather, the fact that the Judge made a finding as to what his and Mr Ballan’s subjective intentions were.
[39] Evidence of subjective intentions may be relevant, and therefore admissible, to establish the background knowledge needed to properly understand the context in which the contract was entered into, or to prove that the parties intended a particular meaning to be ascribed to certain words.7 But the interpretation of a contract is an objective exercise and evidence of statements of subjective intent are inadmissible in the search for the meaning of a contract. In Vector Gas Ltd v Bay of Plenty Energy Ltd although divergent views were expressed on this point, the position as stated by Tipping J has been adopted in subsequent cases:8
Evidence is not relevant if it does no more than tend to prove what individual parties subjectively intended or understood their words to mean, or what their negotiating stance was at any particular time.
…
The common law focuses strongly on the agreement in its final form as representing the ultimate consensus of the parties. Hence it is regarded as irrelevant how the parties reached that consensus. To inquire into that process would not be consistent with an objective inquiry into the meaning of a document which is generally designed to be the sole record of the final agreement.
7 Vector Gas Ltd v Bay of Plenty Energy Ltd [2010] NZSC 5, [2010] 2 NZLR 444; i-Health Ltd v i- Soft NZ Ltd [2012] 1 NZLR 379, [2011] NZCA 575 at [21]–[24].
8 Vector Gas Ltd v Bay of Plenty Energy Ltd, above n 7, at [19]–[20].
[40] The Judge’s finding appears to have been reached without analysis of the terms of the contract as a whole, and is expressed as a finding of the actual intentions held by Eco Rubber’s directors, contrary to the orthodox approach to contractual interpretation. I find that the Judge erred in this aspect of his decision.
Deleted phrases from drafts
[41] The Judge referred in his decision to the contents of the pre-contractual drafts, but not to the fact that two drafts had contained the phrase “or pro rata for periods not worked”, which was not carried through to the final version. Mr Branch submitted that the drafts were admissible to show that the parties had considered and rejected the “no pay no work” model and that the Judge erred in not taking them into account. I do not accept this submission. As I have already discussed, evidence of pre- contractual negotiations, which includes drafts of the contract ultimately entered into, are not admissible to interpret that contract.
Failing to apply the contra proferentem rule
[42] Mr Branch had argued in the District Court (and before me) that it was Mr Ballan, on behalf of Eco Rubber, who drafted the agreement and that, as a result, any ambiguity in the wording was to be resolved against Eco Rubber.
[43] The Judge took the view that the contract was not ambiguous and, in any event, that the rule applied only where one party is responsible for the drafting of the agreement. In this case he was satisfied that both parties contributed to the drafting process.9 The Judge correctly stated and applied the law on this point.
[44] The evidence shows that both Mr Ballan and Mr Nanua were involved in the wording of the agreement. Mr Nanua even obtained accounting advice on it. The fact that Mr Ballan was the person who physically prepared the document is of no moment.
9 Relying on Victor Hydraulics v Engineering Dynamics Ltd [1996] 2 NZLR 235 (HC).
Commercial absurdity
[45] As a result of errors identified above, I intend to consider the question of interpretation of the contract afresh. Whether the Judge was right to reject Elite’s submission that Eco Rubber’s interpretation would lead to a commercially absurd result depends on the proper interpretation of the contract. Since I am about to embark on that exercise it is unnecessary to consider this point.
Was Eco Rubber entitled to terminate the Management Agreement by unilaterally ceasing production?
The issue
[46] Elite’s case on appeal was that the contract, as a whole, evinced an intention that the management fees formed part of the overall purchase price and would continue as provided for unless the agreement were terminated in accordance with the termination provision (which it was not) or, alternatively, at the expiration of 10 years.
[47] Eco Rubber’s position was that, on a proper interpretation of the Management Agreement, it was entitled to cease production unilaterally and, in doing so, bring its obligations under the Management Agreement to an end.
The relevant principles
[48] Mr Branch relied on the Court of Appeal’s decision in Vickery v Waitaki International Ltd for the proposition that where one party’s rights are dependent on the continued performance of another’s obligations then, absent a right of termination, the latter must either continue to perform its obligations or find itself in breach of the contract and face liability for damages.10
[49] Vickery involved a contract for (among other things) the operation of a cafeteria by the plaintiff, Mr Vickery, at the Longburn Freezing Works. An employment dispute led to the freezing works being closed. This led to Mr Vickery having to close the cafeteria because there were no workers. However, the contract was not formally
10 Vickery v Waitaki International Ltd [1992] 2 NZLR 58 (CA).
cancelled. Mr Vickery sued the owner of the freezing works, asserting that it could not close the freezing works without placing itself in breach of its obligations under the contract. He was unsuccessful at first instance in relation to the catering aspect of the contract.
[50] However, allowing the appeal, the Court of Appeal drew on the following statement of Coburn CJ in Stirling v Maitland:11
… if a party enters into an arrangement which can only take effect by the continuance of a certain exiting state of circumstances, there is an implied engagement on his part that he shall do nothing of his own motion to put an end to that state of circumstances, under which alone the arrangement can be operative.
[51]Having considered the terms of the contract as a whole, Cooke P in Vickery
said:12
Considering cumulatively the features and provisions of the agreement just traversed and having regard to the whole purpose of the agreement, I come without much difficulty to the conclusion that to close the works was a breach of the company’s contract with the plaintiff. It was implicit in the contract that the company would provide a workforce. Of course the company remained free to close the works, for whatever commercial or other reasons seemed good for it, but as it not uncommonly the case a closure could be and in this instance was in breach of contractual obligations, giving rise to liability in damages. No doubt the company would have been free to make changes in employee numbers or even temporary closures of the works without incurring a liability to the plaintiff. Questions of degree could arise there too in determining the fair operation of the agreement; but no question of degree complicates the present case, since the meat works were never re-opened in the last two years and four months of the contract yet on the evidence the plaintiff remained ready and willing to perform his part by re-opening the cafeteria.
[52] Mr Donovan sought to distinguish Vickery on the basis that it was a case involving the implication of a term into a contract, and because Elite’s case in the District Court had not been advanced on that basis it could not advance such an argument now. Mr Donovan also argued that Vickery was distinguishable on the basis that the closure of the freezing works was entirely a matter within the control of the owner of the plant, whereas the cessation of production in this case was caused by a fire.
11 Stirling v Maitland (1864) 5 B&S 840 (KB) at 852.
12 Vickery v Waitaki International Ltd, above n 10, at 65.
[53] Mr Branch expressly disavowed reliance on any implied term. He argued, correctly, that Vickery did not depend on the implication of a new term but merely the proper interpretation of the contract. It is perfectly clear that in Vickery the Court came to its view on the basis of the express terms of the contract. Cooke P expressly likened the case to that of Re Premier Products Ltd in which contractors engaged by a company that subsequently went into voluntary liquidation were held to have a continuing benefit under the contract and the company a continuing obligation to perform. The Court of Appeal in Re Premier Products Ltd specifically stated that its decision was based on the express terms of the contract, read as a whole.13
[54] Likewise, Richardson J, agreeing with Cooke P in Vickery, made it clear that the outcome was based on the interpretation of the express terms of the contract rather than the implication of any new term:14
It became clear early in the argument of the appeal that the crucial issue was whether it was implicit in the terms of the agreement entered into that the company undertook to operate the Longburn Freezing Works and maintain a workforce there who could be expected to patronise the appellant’s catering facilities over the period of the contract. It was not a matter of implying a further term so as to give business efficacy to the contract. That type of implied term does not arise for consideration where, as here, the question is answered as a matter of the true construction of the express terms of the contract.
[55] Nor do I accept that Vickery is to be distinguished by the fact that damage to the oven by fire was the backdrop to Eco Rubber’s decision to cease production. Although Mr Donovan’s language is suggestive of frustration, Eco Rubber did not advance frustration as an issue either in the District Court or on appeal, save obliquely in its effort to distinguish Vickery. Even if it had been raised as an issue, I would not have accepted that the circumstances could have amounted to frustration so as to relieve Eco Rubber of its obligations because (as I discuss later) I am satisfied that these parties intended the contract to continue even in the event of a fire such as the one that occurred.15
13 Re Premier Products Ltd [1965] NZLR 50.
14 Vickery v Waitaki International Ltd, above n 10, at 65.
15 See Planet Kids v Auckland Council [2013] NZSC 147, [2014] 1 NZLR 149 at [50] – [51] as to determination of whether an event has frustrated a contract.
[56] Recently, in Wallace v Herron, the Court of Appeal referred to the “doctrinally ambivalent” nature of “a generally implied obligation by a contracting party not to impede another from achieving a condition on which depends some contractually provided-for outcome or benefit”.16 It was considering the assertion of an implied term to that effect, noting the decisions in Vickery (based on the express terms of the contract),17 Singh v Potters Park Property Ltd (based on an implied term)18 and Rod Milner Motors Ltd v Attorney-General (decided “by implication from the express terms of the contract” or alternatively as an implied term required for business efficacy).19 Kós P, delivering the reasons for the Court, said:20
An alternative analysis of the rule is that it is simply remedial. That is, it is a rule that bars a claimant (in the broadest sense) from asserting and taking advantage of its own wrong. That approach commended itself to Lord Ellenborough in Rede v Farr, there describing a “universal principle of law, that a party shall never take advantage of his own wrong.21 The same approach appealed to Lords Finlay LC and Shaw in New Zealand Shipping Co Ltd, although Lords Atkinson and Wrenbury appeared to reach the same result by a process of construction.22 Similarly, Lord Atkin in Southern Foundries (1926) Ltd v Shirlaw expressed the principle as a positive rule of law of contract that conduct which amounts to bringing about the impossibility of performance is itself a breach.23 There is a philosophical linkage also to the rule against self-induced frustration. That is, the rule that a contracting party may not rely on frustration for which it is responsible.
[57] Although the idea of considering the issue more broadly, in the terms posited by Kós P, is attractive, the case was not argued on that basis. In any event, I consider that, properly interpreted, the contract does not permit Eco Rubber to bring its obligations under the Management Agreement to an end by unilaterally ceasing production so it is unnecessary to go further than the express terms of the contract.
Interpretation of the Management Agreement
[58]For convenience, I repeat the clauses comprising the Management Agreement:
16 Wallace v Herron [2017] NZCA 346 at [49], citing Singh v Potters Park Property Ltd [2015] NZCA 146.
17 Vickery v Waitaki International Ltd, above n 10.
18 Singh v Potters Park Property Ltd, above n 16.
19 Rod Milner Motors Ltd v Attorney-General [1999] 2 NZLR 568 (CA).
20 Wallace v Herron, above n 16, at [52].
21 Rede v Farr (1817) 6 M&S 121, 105 ER 1188 at 1189.
22 New Zealand Shipping Co Ltd v Société des Ateliers at Chantiers de France [1919] AC 1 (HL).
23 Southern Foundries (1926) Ltd v Shirlaw [1940] AC 701 (HL) at 717.
For the first 36 months after the 1st of November, ERIL will pay EUL a fee of
$3,000 plus GST per month to manage staff, manage the production, document the manufacturing process and train new staff as required.
After 36 months ERIL will pay EUL $4,000 plus GST per month, plus a management bonus of 20 cents per square meter [sic] for 1st grade product over 5,000 square metres in a month.
This arrangement will continue until it is mutually agreed that it should cease, or earlier if in ERIL’s reasonable opinion, EUL has been negligent in its management responsibilities and EUL having been advised in writing of ERIL’s reasonable concerns, EUL fails to address the concerns to ERIL’s reasonable satisfaction, within 30 days.
[59] I start with the plain meaning of the termination clause in the Management Agreement. The first clause specifies management services and is limited to 36 months. The second clause makes no mention of management services and has no end date. But it does refer to a “management” bonus, suggesting that payment, not just of the bonus but also of the $4,000 plus GST per month, is tied to Elite’s management services. In my view, the “arrangement” referred to in the third clause is a reference to the provisions of both the first and second clauses. Both are therefore subject to the termination provision contained in the third clause.
[60] The termination provision in the Management Agreement is clear: the parties can agree to terminate it any time or Eco Rubber may terminate for negligence on Elite’s part.24 On a plain reading, Eco Rubber had no right to terminate the Management Agreement unilaterally. The agreement does not impose a specific obligation on Eco Rubber to continue production but failing to do so would inevitably lead to the termination of the Management Agreement other than on the permitted grounds because it would deprive Elite of the opportunity to manage the business. Allowing Eco Rubber to unilaterally cease production would therefore be contrary to the plain wording of the contract and inconsistent with the parties’ intentions evident from the factual context of the contract.
24 There is a general termination provision at the end of the contract that permits termination only by agreement between the parties. Whilst a contract of indefinite duration is possible (se e.g. Bobux Marketing Limited v Raynor Marketing Limited CA 245/00 3 October 2001) I think it likely that, given the 10-year term of the non-compete clause and obligation to pay royalties in relation to the intellectual property for 10 10 years this provision would have been amenable to an implied term permitting termination on reasonable notice after the expiration of 10 years (see Ward Equipment Limited v Preston [2017] NZCA 444). The issue does not, however, arise for consideration in this case.
[61] First, Eco Rubber bought Elite’s business as a going concern. Although the contract specified that it was being purchased as a going concern “for GST purposes”, the contract recorded at the outset that Eco Rubber was buying the “assets and business of Elite” and the other terms of the contract and the surrounding circumstances make it clear that the purchase was intended to be of a going concern. Eco Rubber’s sole purpose in purchasing the assets and business was to ensure a reliable supply of underlay, an objective that could only have been achieved through the acquisition of Elite as a going concern. Eco Rubber was to take over the lease and all the operating expenses. The contract specified the nature of the product to be manufactured and even required Elite to purchase a second mixer to increase production. Payment of royalties for use of the intellectual property was tied to production. All these factors are consistent only with an intention that the business would continue to operate for the benefit of both parties.
[62] Secondly, the parties understood that the value of the plant lay (as the Judge found) in the fact that it was part of the going concern and, in that form, was worth in excess of $300,000. The totality of the payments anticipated in the first 36 months correlated with this value. In his submissions, Mr Donovan said that, had the fire not occurred and had production continued at the rate of a minimum of 5,000 square metres per month, the first 36 months would have seen a total payment to Elite of
$381,000, made up of $153,000 in “lease to own” payments, $120,000 in royalties and
$108,000 in management fees. This correlation is unlikely to have been mere coincidence.
[63] Thirdly, the contract required Eco Rubber to pay a royalty for the use of the intellectual property for a period of 10 years, even if Elite ceased to provide the management services. The contract was drafted to include the intellectual property as an asset of Elite rather than Mr Nanua, but the royalty payment was to be made to “an entity or person of [Elite’s] choice” so the agreement was clearly intended to be enforceable by and against Mr Nanua, as the owner of the intellectual property. Another clause prohibited the parties competing with one another without agreement or from disclosing information about the intellectual property without agreement for a period of 10 years.
[64] Fourthly, the contract required Elite to advise its insurer that Eco Rubber had a financial interest in the assets and business and required Eco Rubber to pay the normal outgoings, which included the insurance premium. The parties clearly turned their minds to the risk of fire, but they did not provide that the contract would come to an end if the plant were destroyed by fire. They did not provide that the insurance monies would be divided between them according to the extent of their respective interests. The only reasonable inference is that they wished to keep the plant insured to provide a fund for reinstatement in the event of physical loss or damage.
[65] Fifthly, although Eco Rubber was the financially stronger party in terms of a negotiating position, Elite was not in an entirely weak position. Eco Rubber needed Mr Nanua to operate the business; neither Mr Ballan nor Mr Jenkins (both of whom were based in Auckland) wanted to become involved in running the business and, on the evidence, there was no-one else available to could do so. Further, Eco Rubber could not operate the business without the intellectual property, which Mr Nanua owned. These factors meant that Elite did have a reasonable position from which to negotiate.
[66] Sixthly, the contract included the following clause that is consistent with an intention that production would continue for Elite’s benefit.
From the 1st of November, production will be directed to producing the 10mm thick, 1.5m wide, 20 meters (sic) long rolls of 1st grade rubber matting currently manufactured by EUL or as otherwise directed by ERIL. Any direction by ERIL to change production will not disadvantage EUL in regards any payments due to it.
(emphasis added)
[67] Looked at overall, I find that the purpose and effect of the contract was to create a comprehensive arrangement that conferred benefits and imposed obligations on the parties for a period of (at least) 10 years. Eco Rubber, which was seeking security of supply, would acquire the business it needed, together with a manager and the rights to the intellectual property necessary to manufacture the product. It could spread the cost of acquisition over several years. It would not face competition from Mr Nanua for a period of 10 years. It had control of the lease. Its interest was noted on the insurance policy, thereby creating a fund for reinstatement in the event of damage.
Elite had promised to spend part of its purchase price on a second mixer to increase production.
[68] Although Elite did not receive the security of a lump sum purchase price, it was assured of an ongoing income stream through the “lease to own” payments, management fees and royalties. It was obliged to continue managing the plant and could not compete with Eco Rubber nor use the intellectual property for a period of 10 years. But it would continue to receive royalty payments even if it ceased to manage the plant and its management of the plant could only be terminated in limited circumstances.
[69] In these circumstances, the contract did not permit Eco Rubber to unilaterally decide to cease production. Unless Elite was negligent in its management services (which was never asserted) or Eco Rubber secured Elite’s agreement to end the contract (which it did not), Eco Rubber was obliged to continue production. Of course, operational requirements sometimes mean that businesses cease to trade for reasons that suit their owners. But, as Cooke P pointed out in Vickery, this may still amount to a breach of contractual obligations. So it is in this case. Eco Rubber undertook to continue production for at least 10 years for what, at the outset, had seemed to be for the benefit of it and Elite. Its subsequent perception that its interests would be better served by not doing so did not entitle it to deprive Elite of the benefits that flowed to Elite from ongoing production. Eco Rubber’s unilateral cessation of production was a breach of the contract.
Quantum
[70] Elite is entitled to damages. The usual measure in a case such as this is expectation damages. There are, however, some difficulties in quantifying the damages.
[71] The amount due under the first clause in the Management Agreement should, save for one aspect, be reasonably easy to quantify, being the difference between the monthly payments payable for the 36-month period and the payments actually made. Assessing the loss resulting from the breach of the second clause of the Management Agreement is more difficult because Elite’s loss is that of the income expected over a
period of 10 years. The GST exclusive amount of that loss would, on its face, be
$480,000. But reduced to a lump sum, the present-day value of that figure is likely to be less. This aspect was not addressed in submissions. It may require further evidence.
[72] In relation to both aspects of the Management Agreement, there is a potential issue over GST. Eco Rubber’s obligation to pay the management fees plus GST arose in the context of a going concern in which Elite’s receipt of the fees would have attracted GST. That is no longer the case. This issue was not addressed and may require accounting evidence.
[73] In these circumstances, the best approach is to allow counsel to consider whether they wish to adduce further evidence and to make submissions on the issues I have raised.
Result
[74] The appeal is allowed. The decision of the District Court is set aside and judgment is entered for Elite on liability. The question of quantum is left for further evidence and submissions. I direct that a telephone conference be arranged for the purposes of discussing the next step towards addressing this aspect.
[75] Finally, the question of costs. The Judge awarded increased costs against Elite and Elite appeals that decision. However, consequent on my conclusion on the liability appeal, I set aside the award of costs in the District Court. There is no need to consider the specific grounds of the costs appeal. I invite counsel to file memoranda as to costs for both the District Court proceedings and the present appeal:
(a)On behalf of Elite within 10 working days of the date of this judgment;
(b)On behalf of Eco Rubber within a further 10 working days; and
(c)On behalf of Elite in reply within a further seven days.
P Courtney J
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