In a recent decision, the High Court has considered the proper construction of a common pre-completion obligation in sale agreements to "carry on the business in the usual and ordinary course as regards its nature, scope and manner".
In a recent decision, the High Court has considered the proper construction of a common pre-completion obligation in sale agreements to "carry on the business in the usual and ordinary course as regards its nature, scope and manner" in the context of COVID-19 restrictions. In this article, we consider the issues explored by the decision of Laundy Hotels (Quarry) Pty Limited v Dyco Hotels Pty Limited.1
- In March this year, the High Court handed down its decision in Laundy v Dyco, a case which concerned a contract for the sale of a hotel during COVID-19, and held that, despite the operation of the business being restricted by a public health order, the Vendor was still “ready, willing and able to complete” its contractual obligations as the Vendor was only obliged to carry on the business to the extent that doing so was lawful.
- The meaning of the pre-completion obligation to "carry on the business in the usual and ordinary course" is not only dynamic and subject to change according to circumstances, but is also to be qualified as being “in accordance with law” where this is consistent with the context of the agreement as a whole.
- This case serves as an important reminder of the primacy of contractual terms. In particular, it highlights the need for sale agreements to expressly deal with the risk of changes in law where the target is a regulated business or asset.
- Parties cannot always rely on the doctrine of frustration to avoid completion in circumstances where the performance of contractual obligations is affected by newly imposed laws or regulations.
CONTEXT: COVID-19 AND BUYER’S REGRET
The COVID-19 pandemic brought into focus the ways in which sale agreements deal with (or fail to do so) changes in the legal and regulatory landscape, including in the context of what it means to be carrying on a business in the ordinary and usual course. The impact of the pandemic on business conditions and markets naturally saw purchasers seeking to minimise their loss by looking for ways to avoid completion under sale agreements entered into prior to COVID-19. As such, this resulted in some purchasers critically reviewing whether or not there had been failures by vendors to comply with the contractual pre-completion obligation to carry on a business in the ordinary course. The case of Laundy v Dyco is one such example where this issue was examined.
On 31 January 2020, Laundy Hotels (Vendor) and Dyco Hotels (Purchaser) entered into a contract for the sale of the Quarrymans Hotel. The contract also included the sale of the associated hotel licence (being a specified hotel licence under the Liquor Act 2007 (NSW) (Licence) and nine Gaming Machine Entitlements allocated to that Licence) as well as the business (being the hotel business trading as the Quarryman's Hotel which operated pursuant to the Licence).
Completion was scheduled to occur on 30 March 2020 and 31 March 2020 (the separate dates being to account for the separate sales of the Quarrymans Hotel itself and the Licence, and the other sale being for the remaining assets, such as goodwill, plant and equipment and business records).
Key terms of the contract
- Pre-completion conduct: Importantly, the contract provided that, from the execution date until completion “the Vendor must carry on the Business in the usual and ordinary course as regards its nature, scope and manner…" (clause 50.1).2
- Warranties: The contract excluded warranties by the Vendor, including any warranty as to the "present and future financial or income return to be derived from the Property or the Business" (clause 38.1(b)(iv)). Further, the contract relevantly provided that the Vendor gave no representation or warranties about "future matters, including the future financial position or performance of the Business" (clause 55.2(a)).3
On 23 March 2020, before completion was due to occur, the operation of the business was restricted by a public health order in response to COVID-19, which provided that pubs (meaning licensed premises under the Liquor Act 2007 (NSW)) could only be open for takeaway. This order applied to the Quarrymans Hotel. As such, the hotel shifted to a takeaway-only operation.
The Purchaser subsequently informed the Vendor that it would not complete the contract as the Vendor was not ready, willing and able to complete the contract. The Purchaser also asserted that the contract had been frustrated.
In response, the Vendor served a notice stating that it was, in fact, ready, willing and able to perform its contractual obligations and called upon the Purchaser to complete the contract. The Purchaser commenced proceedings seeking declaratory relief to the effect that the contract had been frustrated or alternatively that the Vendor was not entitled to issue the notice to complete.
Supreme Court of New South Wales4
In the Supreme Court of New South Wales, the primary judge (Darke J) held that the contract had not been frustrated. Darke J concluded that the pre-completion obligation in clause 50.1, properly construed, required the Vendor to “carry on the Business in the usual and ordinary course” as far as it remained possible to do so in accordance with law.
Court of Appeal5
On appeal to the Court of Appeal of the Supreme Court of New South Wales, the Purchaser alleged that the primary judge misconstrued clause 50.1 and ought to have held that, by virtue of the public health order coming into effect, the Vendor was unable to comply with clause 50.1 and was not ready, willing and able to complete the contract.
A majority of the Court of Appeal (Bathurst CJ and Brereton JA agreeing, Basten JA in dissent) allowed the appeal and set aside the orders of the primary judge. Bathurst CJ concluded that clause 50.1 was not to be construed as if the Vendor's obligation to “carry on the Business in the usual and ordinary course as regards its nature, scope and manner” was limited to the extent permitted by law.
However, in dissent, Basten JA determined that the obligation in clause 50.1 only required the Vendor to “carry on the Business in the usual and ordinary course as regards its nature, scope and manner” as permitted by law. Accordingly, the Vendor was not in breach of clause 50.1 by virtue of complying with the public health order.
On 8 March 2023, the High Court unanimously allowed the Vendor’s appeal and reinstated the decision of the Supreme Court.
Ultimately, the case turned on the proper construction of the contract and, in particular, the pre-completion obligation in clause 50.1. The High Court held that the Vendor was complying with clause 50.1 at the time of completion. The fact that the public health order prevented the Vendor from carrying on the business in the same way as it had prior to the execution date did not mean that the Vendor was in breach of the requirement to “carry on the Business in the usual and ordinary course”. This obligation on the Vendor was to carry on the business to the extent that doing so was lawful (and there was no obligation, nor could there have been an obligation, imposed on the Vendor to carry on the business unlawfully).
The High Court identified a number of relevant factors in reaching its decision. While this case was in the context of COVID-19, the High Court’s reasoning has important implications for how the terms of sale agreements are to be interpreted more generally. In addition to the key outcome that the words “carrying on a business” in a sale agreement are generally to be interpreted as incorporating an “inherent requirement to do so in accordance with law”,6 parties should also be aware of the following factors when negotiating terms.
Back to basics: objective test in contractual interpretation and primacy of contract
First, the High Court reiterated that the terms of a commercial contract are to be understood objectively, by what a reasonable businessperson would have understood them to mean.
In this case, a reasonable businessperson in the position of the parties would have understood the relevant pre-completion clause to mean that from the date of the contract until completion, the Vendor was required to carry on the business “in the usual and ordinary course” in accordance with law. This was in part due to the fact that one of the warranties stated that, as at the completion date, the Licence would not be subject to any conditions “other than any condition already imposed on the Licence or automatically imposed by virtue of the Liquor Act and the Regulations under that act from time to time”,7 which the High Court construed as an express acknowledgment that the requirements for the lawful operation of the business were variable.
This serves as an important reminder of not only the primacy of the contract, but also that the terms of a contract as a whole are relevant to contractual interpretation. As the High Court observed, the “Vendor's warranties…expose that the regulatory environment within which the Business operated was dynamic.”8 Accordingly, parties that are at risk of changes to the legal and regulatory landscape should take care to ensure that sale agreements expressly deal with such risk. A key takeaway for vendors in this respect is to be aware of the common pre-completion obligation to conduct the business in a manner that is “consistent with past practice”. To avoid any doubt as to the vendor’s ability to comply with changes in laws and regulations, while also satisfying its obligations under the contract, it is important that the terms clearly state that any such pre-completion restriction is subject to a proviso that allows the vendor (and the target business) to appropriately respond to such changes.
Frustration is not always the answer
Further, parties cannot simply rely on the doctrine of frustration in circumstances where the business or asset being sold is affected by newly imposed laws or regulations, particularly where compliance with legislative requirements can clearly be inferred from the “nature, scope and manner” of the business and the commercial construct of the agreement as a whole.
Nor can parties rely on the doctrine of implied terms to impose an obligation on another party where the terms of a contract can be understood by virtue of the principles outlined above. As the High Court noted, the “past, current, and anticipated future lawfulness of the operation of the Business was objectively essential and a commercial necessity to the parties”.9
Warranties are reflective of the parties’ intention
The warranties given can also be used to interpret the true subject matter of a sale contract and, importantly, the risk allocation between the parties. In this case, the Vendor did not warrant that the value of the assets being sold would remain the same between the contract date and completion and the warranties given by the Vendor specifically excluded the “present and future financial or income return to be derived from the Property or the Business”.10 The High Court pointed to these factors as reinforcement that the subject matter of the contract was the business (as opposed to the value of the assets), as well as the fact that the Vendor did not accept the risk of the value of the assets reducing between signing and completion.
Accordingly, if there is concern with respect to the value of a business or asset and who bares the risk of this prior to completion, then it is important that this is dealt with in the contract. Not only will it be important to ensure that adequate warranties are included, but also that the terms of the contract are clear as to who bares this risk in circumstances where the value of such business or asset changes (for example, through a change in law or material adverse change (MAC) provision). In practice, if a purchaser is seeking an ability to avoid completion of an acquisition in circumstances where the target is materially impacted by changes to the legal landscape or other such events, then ultimately a MAC provision (either by way of condition precedent or termination right) is required.11
Meaning of “in the usual and ordinary course”
Finally, the High Court noted that the phrase “in the usual and ordinary course” ultimately incorporates a requirement of lawfulness. This was particularly relevant in this case due to the Licence and the legislative scheme by which the Licence was controlled. As such, these words were said to reflect the commercial reality that ongoing legal compliance was essential to the business. However, this nonetheless has a broad application for regulated businesses or assets.
-  HCA 6 (Laundy v Dyco).
-  HCA 6, .
-  HCA 6, .
- Dyco Hotels Pty Ltd v Laundy Hotels (Quarry) Pty Ltd  NSWSC 504.
- Dyco Hotels Pty Ltd & Ors v Laundy Hotels (Quarry) Pty Ltd  NSWCA 332; (2021) 396 ALR 340.
-  HCA 6, .
-  HCA 6, .
-  HCA 6, .
-  HCA 6, .
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- For further commentary on MAC conditions in the context of COVID-19, see our article “COVID-19: Pressure Points: Material Adverse Change conditions take centre stage (Australia)”.