Commercial Contracts Bulletin March 2018
CONTENTS Contents 3 5 7 8 10 Houseboats, entire agreement clauses and misrepresentation Sparks fly over implied terms Effective service of warranty claims: following notice provisions to the letter High Court provides further guidance on the meaning of ordinary course of business Tread lightly terminating - contractors may be due one more chance 2 Commercial Contracts Bulletin
HOUSEBOATS, ENTIRE AGREEMENT CLAUSES AND MISREPRESENTATION Houseboats, entire agreement clauses and misrepresentation In the joint cases of Djurberg (trading as Hampton Riviera) v Small and Johnstone v Djurberg (trading as Hampton Riviera) [unreported, Ch D, 1 Sept 2017], the High Court considered whether a seller could rely on an entire agreement clause in an attempt to exclude assurances the seller had made prior to its sale of houseboats. Facts Mr Myck Djurberg ( Mr Djurberg ), owner and manager of the Hampton Riviera boatyard and marina, negotiated the sale of two luxury houseboats, HRB3 and HRB4 (the Houseboats ): HRB3 to Oliver and Jennifer Small; and HRB4 to Fiona Johnstone and Louis Sydney (together, the Purchasers ). Although the contractual documents relating to the purchase of HRB3 and HRB4 differed in their commercial terms (the Contracts ), commonality arose in the misrepresentations claimed by the Purchasers. The Houseboats were purchased on the understanding that the purchase price included a 125-year mooring licence and the right to permanently moor at Hampton Riviera. However, Mr Djurberg failed to produce mooring licences and later claimed that the Houseboats were sold to the Purchasers without mooring rights. This, due to the sheer size of the Houseboats, rendered them worthless as there were no other moorings on the River Thames able to accommodate them. Consequently, the Purchasers brought a claim, and Mr Djurberg relied on the entire agreement clause included in the contractual documents. Mr Djurberg argued that as such a clause stated that the written terms contained in the respective agreements constituted the whole and entire agreement between the parties and, in particular, no warranty or representation was made or implied outside of each agreement, the Purchasers therefore could not claim misrepresentation. The Decision The Court held that Mr Djurberg was unable to rely on the entire agreement clause for the following reasons: 1. The Contracts did not constitute the entirety of the agreement reached between the Purchasers and Mr Djurberg The entire agreement clause did not cover the parties discussions. As the representations and promises as to the mooring at Hampton Riviera were not covered by either document but were basic to the parties bargain, the Court was unable to interpret the entire agreement clause as covering the representations made by Mr Djurberg in relation to mooring the Houseboats. 2. The entire agreement clause failed the reasonableness test Any clause seeking to restrict or exclude a party s liability for any misrepresentation made by that party must pass the reasonableness test outlined at section 11 of the Unfair Contract Terms Act 1977 ( UCTA ). Therefore, even if the entire agreement clause had effectively excluded liability for representations relating to the mooring of the Houseboats, the fact that Mr Djurberg was aware that the Purchasers were planning to make the Houseboats their primary residence meant that the entire agreement clause was unfair and unreasonable. As such, the Court found against Mr Djurberg, who was ordered to pay damages to the Purchasers for losses arising in connection with the misrepresentations (including mooring fees and a portion of the original purchase price of each Houseboat). 3
HOUSEBOATS, ENTIRE AGREEMENT CLAUSES AND MISREPRESENTATION Comment This case illustrates that it cannot be assumed that the inclusion of an entire agreement clause will effectively exclude all other terms. Accordingly, parties should note the following: 1. Care should be taken if a contract (which contains an entire agreement clause) relates to a specific part of a transaction and is not representative of the wider agreement. The courts will also take into account whether the terms a party is seeking to exclude are fundamental to the agreement in question. 2. It is necessary to have a clear and comprehensive contract that captures all the important aspects of the agreement. This will reduce uncertainty as well as the likelihood of requiring judicial involvement to interpret a contract. 3. When the reasonableness test in section 11 of UCTA applies, there is no wording that guarantees the effectiveness of the entire agreement clause. The court will consider the impact of the clause in each specific set of circumstances and decide on a case by case basis whether it is fair and reasonable for the clause to be upheld. 4 Commercial Contracts Bulletin
SPARKS FLY OVER IMPLIED TERMS Sparks fly over implied terms The Courts role in interpreting implied terms was recently revisited in Sparks v Biden [2017] EWHC 1994 (Ch), when the High Court implied an obligation to market and sell houses constructed as part of a residential property development within a reasonable time of being completed. Facts Mr Sparks (the Seller ) granted an option to Linkwood Consultants Ltd, the company of Mr Biden (the Buyer ), to purchase land for 600,000 plus overage (i.e. a clawback) on 9 June 2005 (the Option Agreement ). The Option Agreement required the Buyer to apply for and use all reasonable endeavours to obtain relevant planning permission within three years of the Option Agreement. If the planning permission was obtained then the Buyer would have one month to exercise the option to purchase. The Buyer was then required to proceed as soon as practicable to construct the residential housing development on the land. The overage mechanism was triggered when any of the new dwellings were sold. The Seller was entitled to receive around a third of the sale price for each dwelling, subject to: (i) the overage only arising where the sale proceeds were in excess of 600,000; and (ii) in any event, the Seller receiving a minimum of 700,000 in total by way of overage in addition to the 600,000 original purchase price. The overage obligation was contingent on the newly constructed dwellings being sold and the outstanding overage balance on the minimum 700,000 payment became due on sale of the final newly constructed dwelling. The parties entered into a supplemental agreement on 22 July 2008 which (i) extended the option period; (ii) reduced the purchase price of the land to 500,000; and (iii) altered the overage mechanism so that overage arose with sale proceeds exceeding 500,000. The Buyer exercised the option, obtained the relevant planning permission and constructed the residential development. Instead of selling the new dwellings, the Buyer let them on assured shorthold tenancies. The Buyer argued that there was no express term in the Option Agreement requiring him to sell any of the new dwellings and he was not obliged to do so. Instead he submitted that he had an unfettered discretion on selling. As such, he argued that the overage payment obligations could be delayed indefinitely by him not selling. The Seller, however, argued that interpreting the Option Agreement in such a way fundamentally undermined its working and underlying purpose. He submitted that a term should be implied, requiring the Buyer to sell each of the new dwellings within a reasonable time of their construction. Decision The Court implied a term into the Option Agreement requiring the Buyer to market and sell the newly constructed dwellings within a reasonable time period of the option being exercised, planning obtained and construction completed. The Court deemed that such an implied term was necessary for business efficacy, which involves a value judgment, and without such a term the contract would lack practical and/or commercial coherence. In the Court s opinion, the implication of a clause requiring the development to be sold and, as such, for overage to be payable, was also suggested by the Buyer being obliged to: 1. use all reasonable endeavours to obtain planning permission for the residential development; 2. proceed as soon as practicable to construct the residential development; and 3. pay overage. 5
SPARKS FLY OVER IMPLIED TERMS The Court considered the obligations in (1) and (2) above were made with a view to realisation of the development s value and the Seller s entitlement to overage. Otherwise, it would be difficult to see the interest of the parties in such obligations. The Court did not view the Seller s suggestion that the implied term be premised on reasonable time as imprecise or unclear. A degree of discretion to exactly when to sell would allow the Buyer to take account of various relevant factors including market conditions. The Court made an order for specific performance of the agreement with the implied term but adjourned the working out of such order to the Master, allowing the parties to focus on each residential housing in sufficient detail. Comment The case is a useful reminder of the Court s willingness to imply terms into a contract for business efficacy, practicality and commercial coherence. Precision and clarity are essential when implying terms to express the full intentions of the parties. Overage or clawback mechanisms are difficult to draft and involve many variables and unknowns. The drafting used in this Option Agreement suggests that the Buyer would want to sell quickly in order to realise his capital investment quickly. Notwithstanding the decision in this case, as we have seen through recent developments, the Courts are typically reluctant to intervene to imply terms into a contract. Therefore, parties should apply careful forethought to the agreement and its potential outcomes prior to execution, ensuring express terms are sufficiently certain, match their intentions and will withstand later scrutiny. 6 Commercial Contracts Bulletin
EFFECTIVE SERVICE OF WARRANTY CLAIMS: FOLLOWING NOTICE PROVISIONS TO THE LETTER Effective service of warranty claims: following notice provisions to the letter In Zayo Group International Ltd v Ainger and others [2017] EWHC 2542 (Comm), the High Court took a strict interpretation of a contractual notice provision in order to promote certainty and common business sense. Facts The case concerns a share purchase agreement ( SPA ) by which Zayo Group International Ltd ( Zayo ) purchased a company from seven management vendors and a private equity fund (the Vendors ). After the sale, Zayo brought several warranty claims and served them by courier on the very last day on which the notice could be served in accordance with the SPA. Upon arriving at the address with the notice of claim for service of Ms Jaggard (one of the Vendors), the courier was informed that Ms Jaggard had moved and no longer lived at the address. The courier did not leave the notice of claim at the address for service, instead he chose to deliver it to one of the other Vendors who had already received the notice. Ms Jaggard did become aware of the warranty claims, although not through service of the notice of claim to the address set out in the SPA. The key questions for the Court were whether there was effective service on Ms Jaggard, and whether the management sellers were therefore liable for the warranty claims. Decision The judge looked at the express language and provisions of the notice clause, following the approach taken in Rainy Sky SA v Kookmin Bank [2011] UKSC 50 that the Court should consider which construction of the clause is more consistent with business common sense. He found that under the SPA, notice is served by delivering the notice to the address (as opposed to personal service on the individual) where the notice is left. This could also have been achieved by posting it through the letter box, pushing it under the door or leaving it with a person at the address. The judge recognised that valid service might therefore not bring the notice of claim to the relevant individual. The notice clause provided for an alternative address as may be notified in writing from time to time. The judge held that this was purely permissive in other words, the fact that Ms Jaggard did not notify a change of address was not a breach of the notice clause. It was also irrelevant that Ms Jaggard became aware of the warranty claims through other means. This had significant consequences for Zayo. The judge held that under the SPA, a failure to notify all of the Vendors meant that none of them were liable for the warranty claims. The issue concerning notice was seen to be a knock-out blow, rendering all other issues academic. Comment This judgment emphasises the importance of following contractual notice provisions with utmost care. Even if the notice of claim had never been personally served on Ms Jaggard, valid notice would have been given if the notice had been left at the address for service. Before serving notice on a counterparty, consider the following aspects of the contractual notice clause: Is notice served by delivering the notice to the address, or by personally serving the notice on the individual? If the notice clause provides for an alternative address, must this be notified to the other parties, or is it a permissive option for the party changing address for service? Where possible, it is preferable to serve notice with time to spare before the notice period expires as this may allow time for the notice to be re-issued should problems arise with the initial service. 7
HIGH COURT PROVIDES FURTHER GUIDANCE ON THE MEANING OF ORDINARY COURSE OF BUSINESS High Court provides further guidance on the meaning of ordinary course of business In Koza Ltd & Anor v Akcil & Others [2017] EWHC 2889 (Ch), the High Court provided much-needed guidance on the interpretation of the phrase in the ordinary and proper course of business, and concluded that fees paid to public relations consultants and in respect of a director s remuneration fell within that definition. Facts Koza Limited ( Koza ), a company incorporated in England and Wales, became embroiled in criminal proceedings in Turkey as part of the Koza Group which was accused by Turkish authorities of financing terrorism. In that context, a dispute arose in 2015 in respect of a general meeting called by Koza. Following on from that dispute, an English court of first instance issued an order in 2016 which, amongst other things, provided that Koza should not, until further order or full trial, dispose of, deal with or diminish the value of any funds belonging to [it] or held to [its] order other than in the ordinary and proper course of business (the Undertaking ). Koza later applied to the Court to vary the order and approve three expenditures to: (i) finance arbitration proceedings on behalf of Koza s parent company; (ii) retain a firm of public relations consultants; and (iii) pay for the services of its CEO by way of remuneration. Decision The Court considered a number of factors in assessing whether the relevant expenses were in the ordinary and proper course of business, and in particular asked the following: Would an objective observer, with knowledge of Koza, its memorandum of association and its business, view the proposed expenditure as being made in the ordinary and proper course of its business? On the proper interpretation of the Undertaking, did the parties intend the proposed expenditure to fall within the ordinary and proper course of Koza s business? Does the unprecedented and exceptional nature of an expense preclude it from being regarded as one made in the ordinary and proper course of business? Does the proposed expenditure give rise to a breach by Koza s directors of their fiduciary duties? The Court went on to assess each of the three proposed expenditures in turn, in light of the principles set out above. The Court quickly concluded that the fees paid by Koza to the public relations consultants and to its director were in the ordinary and proper course of business, having regard particularly to the reasonable nature of those expenses and the value for money they delivered. In respect of the costs associated with the proposed arbitration proceedings, whilst the Court affirmed that funding such proceedings could in theory fall within the definition of ordinary and proper course of business, it assessed the merits of the underlying dispute and concluded that expending those costs would not be within Koza s ordinary and proper course of business. The Court pointed in particular to the facts that other sources of funding had not been explored properly, and that funding the proceedings may be in breach of the directors fiduciary duties (having regard to the limited prospects of success). Comment This judgment provides additional guidance on the meaning of ordinary course of business, and whilst the Court s decision related to the language used in a bespoke court order, its conclusions can be applied to other types of documents such as commercial contracts and freezing orders. 8 Commercial Contracts Bulletin
HIGH COURT PROVIDES FURTHER GUIDANCE ON THE MEANING OF ORDINARY COURSE OF BUSINESS The following principles can be drawn from this decision: 1. Whether an expenditure is within the ordinary and proper course of business must be assessed objectively having regard to the specificities of the company and its business. 2. The fact that an expenditure is unprecedented and/ or exceptional does not preclude it from being in the ordinary course of business. 3. An expenditure that would cause the company s directors to breach their fiduciary duties will normally be outside of the ordinary course of business. By assessing the merits of the proposed arbitration proceedings in great detail, the Court also demonstrated that whether an expenditure is within the ordinary course of business is a question of facts and shall be assessed on a case-by-case basis. 9
TREAD LIGHTLY TERMINATING CONTRACTORS MAY BE DUE ONE MORE CHANCE Tread lightly terminating contractors may be due one more chance In Interserve Construction Ltd v Hitachi Zosen Inova AG [2017] (TCC), Jefford J in the Technology and Construction Court (TCC) highlighted that a contractor must be given the opportunity to remedy its breach before its employment was terminated. Facts The defendant, Hitachi Zosen Inova ( HZI ), was a contractor who entered into a design and build subcontract with the claimant, Interserve Construction Limited ( ICL ). On 7 July 2015, HZI issued a termination notice to ICL which listed a number of events that justified the immediate termination of their contract, stating that it was relying on the termination clauses 43.1 and 43.1A (as set out below): 43.1 If [any relevant termination events occur] then, subject to sub-clause, 43.1A ( ) the purchaser may forthwith by notice terminate the employment. 43.1A may (at its absolute discretion) notify the Contractor of the default and if the Contractor fails to commence and diligently pursue the rectification of the default within a period of seven (7) Days terminate the employment of the Contractor under the Contract. HZI also stated in the notice that it would not exercise its discretion to provide ICL with an opportunity to rectify the alleged defaults under clause 43.1A. ICL sought a Civil Procedure Rules (CPR) Part 8 declaration that these two clauses together should be read in a way that ensures HZI must first give notice to terminate under 43.1A, and thereafter wait until the seven-day rectification period has expired before actually terminating. Decision Jefford J found for ICL and followed Wood v Capita [2017] UKSC 24 which held that the textual approach of the objective meaning of the words was appropriate as the contract was a complex commercial document which had been carefully negotiated by two sophisticated commercial parties. Accordingly, the words subject to clearly indicated that the right to terminate was limited to a situation where clause 43.1A had first been effected. Jefford J also found that clause 43.1A s reference to absolute discretion did not make the seven-day period optional. Rather, the proper construction of the words meant that if HZI had failed to give notice to terminate, it would not be taken to mean that no default existed or any breach was waived. Comment The Court s interpretation relied heavily on the way in which similar terms were used elsewhere in the contract between the two parties. As such, this case is a good reminder that when drafting, lawyers should keep in mind that the Courts will not review contractual terms in isolation and that a contract that contains inconsistent provisions may produce unexpected outcomes. Parties should note that where a terminating event does occur, if the terminating party s absolute discretion to terminate has been limited by a term in the contract, then that party is bound by that limitation (as was the case here). A contracting party s particular right cannot be at its absolute discretion as well as subject to a different term in the contract without one of those phrases giving way. More generally, parties should adopt a cautious approach when terminating a contract, ensuring that the relevant notices are issued and the termination procedure specified in the contract is carefully followed. 10 Commercial Contracts Bulletin
KEY CONTACTS Key contacts Carina Healy Partner, Technology and Media T +44 141 304 6032 E carina.healy@cms-cmno.com Gemma Lampert Partner, Litigation & Arbitration T +44 131 200 7548 E gemma.lampert@cms-cmno.com Jennifer Barr Senior Associate, Technology and Media T +44 141 304 6233 E jennifer.barr@cms-cmno.com 11
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