Dyco Hotels Pty Ltd v Laundy Hotels (Quarry) Pty Ltd [2021] NSWSC 504

Have you been to The Quarryman’s Hotel at Pyrmont?

Recently, the NSW Supreme Court considered whether the purchaser, who had signed a contract to buy The Quarryman’s Hotel in Pyrmont and the associated business assets, could escape the contract when the government introduced COVID restrictions before settlement. [1]

This case examined the legal principle of ‘frustration’ of contract, which allows a contracting party to terminate if an unexpected supervening event occurs.  Despite having a serious effect on the business, the Court ruled that the Public Health Orders did not constitute legal frustration.

As a result, the purchaser was obliged to proceed.  This proved very costly for the almost-purchaser ($900,000 in damages alone).  It demonstrates how using a well-drafted contract – that is tailored to manage the transaction at hand – can avoid costly and unhappy litigation by elucidating flexible exit provisions for the purchaser.

Background

In January 2020, Dyco contracted to buy the hotel and business assets from Laundy, the seller.  The parties signed a contract for sale for $11,250,000, with a 5% deposit ($562,500) paid upon exchange. The parties used a standard Law Society/Real Estate Institute form of contract for the sale and purchase of land, augmented with additional clauses about the sale of the business.

During the 56 day settlement period, Public Health Orders were announced and implemented, and the pub industry was hit hard.  The Pyrmont hotel was compelled to modify its business operations, relying for a period on take-away business only.

At settlement, Dyco, the buyer, claimed that the contract was frustrated.  This was said to be  because the Public Health Orders had prevented the business from operating in the usual and ordinary manner, an obligation set out in the contract.

The seller issued a Notice to Complete.  Dyco staunchly defended its position that the contract was frustrated.  The seller then issued a Notice to Terminate for breach.  Dyco sued for return of its deposit.  Laundy counter-claimed for breach of contract and recovery of damages for loss of bargain.

Legal frustration

The law recognises frustration when a supervening event, that occurs after a contract is entered into, significantly changes the nature of the agreement.  A frustrated contract is automatically terminated.

The legal definition of frustration under common law is slightly nebulous.  Common principles are that:

• neither party is at fault;
• the supervening event must not have been reasonably contemplated by the parties at the time;
• the effect of the event must be to change the nature of the parties’ obligations and rights, or render performance impossible, or not what was intended. It is insufficient for the consequence of the event to be merely increased cost or onorousness.[2]

The Contractual Obligations

The court decided that the contract was not legally frustrated, and that Dyco had breached its contractual obligations by failing to proceed with the purchase.  Dyco was required to pay Laundy the assessed amount of damages ($900,000, which was the difference between the value of the contract price and the value of the hotel assets on the day of termination).  Small consolation that the deposit went towards paying damages…

First, the Court considered whether the (standard) provision that the business be carried on “in the usual and ordinary course as regards its nature, scope and manner” should be construed as carrying on in a lawful manner only.  Unsurprisingly, the Court took the latter construction.[3]

In its reasoning, the Court noted that contractual provisions required that the business declare itself to have previously and currently operated in a lawful manner (for example, appropriate licences, no pending litigation, etc).  The Court also pointed that operating in an illegal fashion would be detrimental to the goodwill of the business, and therefore would breach other contractual provisions.

The defendant showed that it was able to, and did, carry on its business within the limits of policy-compliance and commercial considerations.  The Court accepted that in so doing, the business preserved goodwill, and that the Public Health Orders did not cause the defendant (seller) to breach the provisions.

Was the contract frustrated?

Did the circumstances render the contractual obligations “radically different” from that which was undertaken by contract?[4]  Hardship, inconvenience or material loss are in themselves insufficient to frustrate a contract.

In considering whether the contract was frustrated, the Court posed the questions:

1. Was the contract, on its true construction, “wide enough to apply to the new situation”?[5] and
2. Was there:
   1. a fundamental commercial difference between the actual and contemplated performance of the contract; or
   2. a fundamentally different situation for which the parties made no provision?[6]

The essential purpose of the contract: wide enough to apply

The Court decided that the essential purpose of the contract was the sale and purchase of the business assets for the agreed price.  The obligations to carry on the business were important, but were “ancillary”.[7]

The commercial changes: not fundamentally different enough to cause (legal) frustration

The value of the hotel had fallen by about $1 million (as noted, “a considerable amount, but … less than 9% of the purchase price”).[8]

Unfortunately for the purchaser, the contract did not provide any warranties about present or future financial performance.[9]  The Court noted that the buyers had been willing to take on the inherent risks of the financial performance of the business.[10]

The change in situation, although not anticipated, did not fundamentally change the nature of the agreement

The Court noted that all the parties were familiar with the high legal and regulatory environment of the hotel and gaming industry.[11] Although the Public Health Orders were not anticipated, the parties knew the industry was subject to regulatory oversight and licencing reviews.

Further, the Public Health Orders were temporary.

The Takeaway Messages

It is hard not to feel the purchaser was unlucky in this case.  While the Public Health Orders did not meet the legal threshold for frustration, there’s no doubt that the sale business (and many others) were dramatically affected by them.

This case highlights the importance of using a well-drafted contract in higher value transactions.  In this case, the outcome could have been very different if:

• the buyer had obtained promises in the contract as to the present and future income of the business; and/or
• the contract had included a properly thought out and tailored Material Adverse Change or Material Adverse Effect clause (“MAC” or “MAE” clauses), which allowed the purchaser to terminate if revenues or profits fell below agreed levels.

Keypoint Law advises buyers and sellers in relation to all aspects of business sale transactions, including these issues.  Please contact us if you would like more information.

 

[1] Dyco Hotels Pty Ltd v Laundy Hotels (Quarry) Pty Ltd [2021] NSWSC 504.

[2] For example, the Suez Canal has spawned past cases when its closure caused loss of profit to charter parties.  In the 1981 case National Carriers Ltd v Panalpina (Northern) Ltd, the English Courts noted that it was still possible for ships to continue the charter, albeit a longer, more expensive route.  The contract was therefore not legally frustrated.

[3] The judgment includes some beautifully worded quotes on the issue of legality:

From a case in 1906:  “The proper rule for the construction of such an agreement is laid down in Sheppard’s Touchstone: “That if the words may have a double intendment, and the one standeth with the law, and the other is against law, that it be taken in that sense which is agreeable to law” (at 81);  and a more recent (2001) quote, less majestic but drily succinct: “Unless driven to such an outcome by intractable language, such a construction should be rejected having regard to the principle that, where the words of a contract are capable of two meanings, one lawful and the other unlawful, the former construction should be preferred.” (at 82).

[4] At 90.

[5] At 100.

[6] At 100.

[7] At 105

[8] At 109.

[9] At 110.

[10] At 106.

[11] At 78.