Dyco v Laundy | The Pub Appeal

Have you been back to the Quarryman Hotel at Pyrmont?  The Court of Appeal has!

Avid readers with long memories may recall our 2021 case note on the Dyco v Laundy trial.[1]  Dyco, the buyer of the Quarryman Hotel at Pyrmont, tried to get out of the sale when the business lost value following the introduction of COVID-19 Public Health Orders just days before completion was due.  At the trial, Dyco unsuccessfully argued that the deal had been legally frustrated by the introduction of the Public Health Orders, which largely shut down the pub industry’s operations. [2]

Dyco was more successful in its recent appeal, with a 2-1 split decision in the buyer’s favour, and a resultant return of its deposit.[3]  The appeal did not contest the legal decision at trial that the contract was not frustrated.  Instead, Dyco, the buyer, argued that Laundy, the seller, was not entitled to enforce completion because the seller was not ready to complete.  This was because the recently introduced Public Health Orders meant the seller was not conducting the business in the usual and ordinary course as required under the contract.  As a result, the seller was not entitled to terminate the contract because Dyco the buyer had refused to complete.

This highlights a common issue in contracts for the sale and purchase of businesses, namely, in what circumstances a party can exit during the completion period.  We recommend such contracts include clear and measurable metrics rather than general statements of the kind in this case.  For example, we think it is best practice to state that one or more parties can exit if the business fails to meet agreed financial targets during the completion period, suffers loss of a material asset, a key regulatory licensing permit or key customers.

The inclusion of such clauses removes ambiguity and the potential for dispute in such cases.

 

The Appeal Issues

The appeal was argued on quite technical legal issues.  Those issues were:

1. Implied terms

The trial decision rested on the interpretation that the obligation (set out in clause 50.1) requiring the business be conducted “in the usual and ordinary course” during the completion period was limited to carrying on the business according to the law.  On appeal, the question was whether this clause should be read with an implied term that the obligation was to the extent permitted by law.  The majority decision was that the clause should not be read with such an implied term.  The legal reasoning is discussed later in this report.  Notably, the drafting of the contract was important in reaching this conclusion.

2. Risk

The default position under common law is that the buyer assumes risk upon exchange of contract.  However, the contract can expressly reverse the common law position, as it did in this case.  The contract expressly stated that the risk remained with the seller until completion.  This provision was relevant in the judges’ (majority) reasoning that an implied term should not be read into clause 50.1, because an implied term would reallocate the risk of legal or regulatory change during the completion period back to the buyer.

3. Severability

Was clause 50.1 severable?  On appeal, the Court noted the provision was not severable.  The Public Health Orders were temporary, and the severability clause did not operate to enable temporary severance.

4. Temporary Illegality

When illegality is temporary, the relevant obligation is suspended rather than discharged.  Temporary illegality is therefore an excuse for non-performance but does not discharge the contract.

5. Wrongful termination

Laundy the seller had issued a Notice to Complete while it was operating under severely curtailed business conditions due to the Public Health Orders.  When Dyco failed to comply with that Notice, Laundy terminated the contract.

The Court found that the Notice to Complete was invalidly issued, as Laundy was at that time legally unable to comply with its obligation to run the business in the usual and ordinary course.  Dyco was not required to complete while the seller could not comply with its contractual obligations.  Laundy had wrongfully terminated and in so doing had repudiated the contract.  On that basis, Dyco was legally entitled to terminate the contract.

6. Conditions Precedent

Justice Basten, in a dissenting judgement, noted that if the obligation to conduct the business in the usual and ordinary course had been set out as a condition precedent to the sale, then the buyer would have been legally entitled to terminate the contract.

 

Construction | Implied Terms

The legal principles…

The Court reviewed the legal principles in interpreting a disputed clause.  Fundamentally, the courts pose the question:  what would a reasonable person understand this clause to mean?

To answer this question, the courts examine (1) the language used in the contract and in other transaction documents,[4] (2) the surrounding circumstances, and (3) the primary purpose of the clause.

 

In this case…

The reasonable person test is perhaps hard to pin down.  The position taken at trial and in the appeal minority judgement, was that the parties understood that a business in the hotel industry operated within the confines of law, regulations, and licensing conditions.  However, the majority decision of the Court of Appeal differed.

The majority decision noted that the language of the disputed clause referred to the ‘nature, scope and manner’ of how the business was carried on.  A reasonable person would perceive that these factors were indisputably modified under the Public Health Orders, and that the business being conducted under the Public Health Orders (ie limited takeaway, closed hotel premises) was substantially different from the business that the buyer agreed to purchase.

Other provisions in the contract provided context for how the parties intended the disputed clause to operate.  For example, because another clause expressly referred to licencing conditions imposed by law and regulations from time to time,[5] the absence of an express term qualifying the legal limits of the obligation in clause 50.1 was presumed intentional.[6]   Further, the contract provided a mechanism to vary the obligations under clause 50.1, by written agreement from the buyer.  (This mechanism had not been activated.)  As previously discussed, the Court also observed that reading an implied term into clause 50.1 was contrary to the intention of the contract’s risk allocation provision.

Other clauses in the transaction documents emphasized the importance of the ongoing conduct of business to the agreement.  These were:

• the warranties that the licence must permit trading activities;[7] and
• the lease agreement’s requirement that the premises must be kept open during usual trading hours.[8]

Additionally, the Court considered how clause 50.1 operated to achieve its primary purpose, which was to preserve goodwill.  The majority view was that under the restricted operating circumstances at the time of completion, the hotel was not a ‘going concern’, and the assets (goodwill, plant and equipment, and licencing and gaming machine entitlements) would be of negligible benefit to the buyer unless the hotel was operational.[9]

 

Severability

In principle…

The legal test for whether invalid promises are severable is ‘whether they are so connected with the others as to form an indivisible whole which cannot be taken to pieces without altering its nature’.[10]  A clause will only be severable if its absence does not substantially change the balance of the contract.

              In this case…

The Court felt that clause 50.1 was not severable as it was integral to the agreement that the business transferred at completion was a going concern.

Further, the Court pointed out that the severability clause did not apply to temporary illegality.  It did not enable a temporary severance, and it would be inappropriately advantageous to the seller if clause 50.1 remained severed after the Public Health Orders ceased.

Although often considered a boilerplate clause, the drafting of the severability clause may become important.  In this case, the severability clause required that a court declaration be obtained, and technically neither party applied for a court order.

 

Temporary Illegality

This case led to an interesting examination of previous cases, many involving citizens of warring countries unable to enforce contracts under altered regulatory and legal circumstances.  The common law principle relevant to this case is relatively clear:  when frustration does not apply, temporary illegality suspends but does not terminate contractual obligations.

Supervening illegality (as opposed to illegality at the outset of an agreement) may trigger various legal responses according to the circumstances:  there may be no effect; the contract may be frustrated; the obligations of both parties may be unenforceable; or, as in this case, one party’s obligations may be unenforceable, but the contract stands.  In this case, the seller was not entitled to compel completion, nor was the buyer entitled to terminate because Laundy was unable to perform its contractual obligation.  A subsequent legal error (wrongful termination) by the seller was the legal basis on which the buyer terminated.

 

Wrongful termination and repudiation

Wrongful termination is a surprisingly common error.  A party that wrongfully terminates is considered to have abandoned its obligations under the contract (often referred to as repudiation), and the other party is legally entitled to terminate the contract.

In this case, both parties argued that they had the legal right to terminate based on wrongful termination by the other party.  The buyer Dyco argued its case successfully.

Dyco argued that Laundy had invalidly issued a Notice to Complete, because at the time of issue Laundy was not ready, willing or able to complete.  Due to the recently introduced Public Health Orders, Laundy was conducting the business in a way that contravened its obligation under clause 50.1.  Laundy was not breaching its contract, as supervening illegality excused its non-performance of this obligation, and Dyco had no legal right to terminate at that stage.  However, Laundy’s subsequent termination in response to Dyco’s failure to complete was wrongful and amounted to repudiation.  On that basis, Dyco was entitled to terminate the contract.  The Court of Appeal agreed.

In contrast, Laundy argued that Dyco had wrongfully claimed in correspondence between the parties’ solicitors that the contract was frustrated and had wrongfully sought declaratory relief on the invalid basis of frustration.  Laundy argued that this amounted to a repudiation of the contract by Dyco, and Laundy was entitled to terminate the contract.

The Court of Appeal did not agree.   It observed that although Dyco took a wrong view of the contract in respect of claiming it was frustrated, Dyco had accepted the authoritative decision of the Court that there had been no frustration.

When can a party issue a Notice to Complete?  The legal rule is that a party can issue a Notice to Complete before performing all its obligations, provided it can fulfil those obligations by the completion date.   A party may not issue a Notice to Complete while it is in default of obligations that should already have been done.

 

Lessons:

This interesting case was an early indication of how agreements affected by regulatory and legal changes during the COVID-19 pandemic might be treated legally.  (Note that the legal response in any case would depend on the circumstances.)

The case highlights the importance of

1. good drafting; and
2. experienced legal advice.

When unanticipated events occur, a well drafted document will set out the parties’ positions unambiguously and save significant time and money.  In this case, the court construed the intended meaning of a disputed obligation clause by considering the contract in its entirety.  A risk allocation provision was ultimately very important in the decision.

Proper legal process remains important.  In the end, the seller’s invalid issue of a Notice to Complete and wrongful termination in reliance on the buyer’s (legally correct) refusal not to comply with that Notice cost the seller dearly.

By their nature, unanticipated or unforeseen events are not predicted by the parties.  However it is well worth the parties’ time to consider when one or both may wish to exit the agreement before completion, based on measurable parameters, e.g., profitability, regulatory changes, licensing conditions, etc.

The fact that the Court of Appeal reached a split decision suggests this case was a hard decision to make, and alternative interpretations were possible.  This case highlights the need for clear and specific drafting.

 

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

[2] To recap, frustration in legal terms occurs when a supervening event, for which neither party is at fault, renders performance of a contract impossible, or significantly changes the nature of the contractual obligations beyond the intentions of both parties.

[3] Dyco Hotels Pty Ltd v Laundy Hotels (Quarry) Pty Ltd (2021) 396 ALR 340.

[4] For example, the Court considered the language of the Information Memorandum which was distributed to prospective buyers.

[5] Quoted at [160].

[6] At [161].

[7] At [47].

[8] At [48]

[9] At [75].

[10] At [56], quoting CJ Jordan in Mc Farlane v Daniell (1938) 38 SR (NSW) 337(345).