Malthouse Ltd v Rangatira Ltd [2018] NZCA 621 (20 December 2018) the Court of Appeal clarifies the role of “commercial sense” in contract interpretation
Introduction
Interpreting contracts is like drinking beer.1 Some prefer the old “what-you-see-is-what-you-get” beers, while others like beer that looks like ale and tastes like chilli-chocolate. In a similar way, the modern approach to contracts has sometimes appeared to stretch the limits of what words could mean in a contract, to make so-called commercial sense of it. In this case, The Malthouse Ltd v Rangatira Ltd,2 the Court of Appeal gives guidance on New Zealand’s approach to interpretation of commercial contracts including the extent to which a Court can interpret the words to make commercial sense of them.
Background Facts
The founding shareholders (Malthouse) of the Tuatara Brewing Company Ltd (Tuatara), a successful craft brewer, and a private equity firm, Rangatira Ltd (Rangatira) got into conflict over an investment agreement. Malthouse introduced Rangatira to the brewery in 2013 to provide management expertise, and capital to entice a major brewery to buy Tuatara.
Rangatira agreed to acquire a 35% shareholding in Tuatara from Malthouse under an Investment Agreement dated 30 June 2013 (Agreement). Malthouse valued Tuatara at $12 million and wanted $4.5 million for its shareholding, while Rangatira valued Tuatara at $10 million and wanted to pay $3.5 million for 35% of the shares.
The Agreement
To get around this impasse, the Agreement included clauses 9.1 to 9.8 which set out, among other things, “trigger events” by which Rangatira would pay Malthouse more money for the shares. If the events weren’t triggered, Rangatira’s valuation would prevail.
Trigger 1
The first triggering event was Tuatara achieving what was known as the EBITDA3 Hurdle under clause 9.1. That clause provided:
9.1 EBITDA Hurdle: The:
9.1.1 Contingent Subscription Price shall be payable to [Tuatara] in immediately available funds; and
9.1.2 Contingent Purchase Price shall be payable to the vendors in immediately available funds,
within seven (7) days of [Tuatara], [Rangatira] and the [vendors’] Representatives agreeing, or it being determined pursuant to this clause 9, that [Tuatara] has met the EBITDA Hurdle, provided that the EBITDA Hurdle is met on or before the Contingent Sunset Date.
The EBITDA Hurdle required EBITDA of $2 million over any period of 12 consecutive months. Provided Tuatara achieved the EBITDA Hurdle then the additional payment had to be made. Importantly, the EBITDA Hurdle clause included a Sunset Date of 31 December 2015, which was called the Contingent Sunset Date.
Trigger 2
Clause 9.8 of the Agreement contained a trigger event called the “Exit Event”. It provided:
9.8 Exit event: If an Exit event occurs which actually or by implication values [Tuatara’s business] or [Tuatara] at greater than $12,000,000, then the Contingent Payments shall become immediately due and payable.
Issue
In 2017 Rangatira sold Tuatara to DB Breweries for more than $12 million. Malthouse said that this triggered clause 9.8 and claimed more money. Rangatira argued that the Sunset Date from clause 9.1 applied to 9.8 (though the words “Contingent Sunset Date” are not in 9.8), so that clause 9.8 expired on the Sunset Date (31 December 2015).
It was agreed that if Malthouse’s interpretation was right, Rangatira owed Malthouse approximately $920,000.
The Arguments
Rangatira’s witnesses said they wanted to ensure that Trigger 1 was achieved before having to make the additional payment.4 As it transpired, the EBITDA Hurdle was not met by the Contingent Sunset Date. It pointed out that clause 9.8 was included in the first draft with a note: “Not anticipated but included for completeness”. Rangatira said this all pointed to the intention that clause 9.8 was also subject to the Sunset Date.
Rangatira argued if clause 9.8 had no Sunset Date, then it would be liable to make the additional payments at any point in time. That did not make commercial sense. It said, the commercial objective of the clauses was to establish a fair value of the shares as at mid-2013, the date when the parties could not agree.
High Court
In the High Court, Churchman J agreed with Rangatira and held that, on its proper interpretation, clause 9.8 was also subject to the Sunset Date. His Honour gave importance to the “commercial objective” of the transaction, which was to establish a fair value of the shares to facilitate the sale as at 2013. Looking at the commercial objective of the transaction and the surrounding circumstances, he held an informed bystander would conclude that the provisions of clause 9, including 9.8, were directed at establishing a fair purchase price for the shares in mid-2013. Therefore, the parties must have intended Trigger 2 to expire on the Sunset Date, 31 December 2015.
Court of Appeal
The question for the Court of Appeal was whether the “plain meaning” of clause 9.8 should prevail (which would result in Rangatira paying Malthouse more money), or whether the Court should “read in” the Contingent Sunset Date from clause 9.1 into that clause.
The Guidance on Contractual Interpretation – Legal Principles
The Court of Appeal considered the law on contractual interpretation. The two leading cases in New Zealand are the Supreme Court’s judgments in Vector Gas Ltd v Bay of Plenty Energy Ltd (Vector)5 and Firm PI 1 Ltd v Zurich Australian Insurance Ltd (Firm PI).6
The key legal principles of contractual interpretation which can be derived from Vector, Firm PI and the Malthouse decisions are:
1. Objective Test
The proper approach to contractual interpretation is an objective one. The aim being to ascertain:
the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.
2. Background Facts
There is no limit to the background (extrinsic) material which may be considered in order to interpret the contract. The material must, however, be reasonably relevant, and it must be objective.
3. Subjective Intention
Evidence of a party’s individual subjective intentions is inadmissible to interpret the contract. For example, evidence such as how the parties were thinking, their individual intentions and the stance they were taking in the negotiation process.
4. Ambiguity and Background
There need not be any ambiguity in the meaning of a contract before regard can be had to background evidence to shed light on its meaning.
5. The Words
The text of the contract remains “centrally important”. If the language at issue, construed in the context of the contract as a whole, has an ordinary and natural meaning, that will be a powerful, albeit not conclusive, indicator of what the parties meant.
6. Cross-checking
The provisional meaning derived from the language of the contract is cross-checked against the contractual context. The concept of a cross-check is helpful in affirming that a meaning which appears plain and unambiguous on its face is always susceptible to being altered by context.
7. Red Ink
It follows that although there is in principle no limit to the amount of “red ink” a Court can use in interpreting a contract, there is a practical need for a party seeking to rely on the red pen to point to clear evidence justifying its use.
8. Limits
The exercise is and remains one of interpretation. There are limits to what the Courts can do under the guise of interpretation, and words can only be construed with meanings that they can reasonably bear.
9. Plain Language
Where there is a natural and ordinary meaning to the term in issue, departing from it for reasons of commercial common-sense should only occur “in the most obvious and extreme of cases”.
The Correct Interpretation of Clause 9.8
Step 1 – The Actual Words
First it started with the words.
The only link clause 9.8 had to any other term in the Agreement was that it used the defined term “Exit Event”. The clause operated clearly enough on its own terms: If an Exit Event occurs which values the business at $12 million, the additional payments become immediately due and payable. Nothing in the clause determined when the Exit Event would occur.
Step 2 – The Contract as a Whole
The Court of Appeal considered clause 9.8 in the Agreement as a whole. This approach can assist in understanding how provisions function.
Clause 9.1 required extra payment if the company reaching the EBITDA Hurdle before the Contingent Sunset Date. Unlike clause 9.8, clause 9.1 is contingent on the Contingent Sunset Date being met. The contract drafters could have chosen to include “Sunset Date” in clause 9.8, but they did not.
The Court of Appeal then considered clauses 9.2 to 9.7. Clause 9.8 was unique among them in that it did not refer to the balance of clause 9. The Court of Appeal said that when read in the context of clause 9, clause 9.8 clearly operated independently. Rangatira’s attempt to link clauses 9.1 and 9.2 with clause 9.8 was rejected.
Stage 3 – The Objective Background
The Court conducted a cross-check of its interpretation of the words in clause 9.8 against the background evidence. The background evidence did not shed any light on the meaning of clause 9.8. The Court emphasised that even if it was wrong about this, it would require clear explicit objective evidence to alter the natural meaning of 9.8.
Stage 4 – The Commercial Objectives of the Agreement
The Court of Appeal held that it was only in a very clear case that a Court should depart from the plain meaning of a closely negotiated commercial contract to achieve a commercial purpose. It disagreed with the High Court Judge that it was appropriate to do so here.
Our Comments
In overturning the High Court’s decision, the Court of Appeal followed a four-stage process to interpret clause 9.8. It gave much greater prominence to the plain meaning of 9.8 as the primary indicator of meaning. Although the background evidence, including the pre-contractual negotiations and the commercial objective of the transaction, remained part of the interpretative process, that evidence was given less weight than the plain words. As the Supreme Court said in Firm PI, the text remains centrally important. Where the words in the contract have a natural ordinary meaning, the Court of Appeal confirmed it is only in an exceptional case that a Court should depart from that meaning to achieve a commercial purpose.
The Malthouse case serves as a useful reminder that the primary focus when undertaking contractual interpretation will usually be the meaning of the words which the parties have chosen to use in their contract in the context of the agreement as a whole. Where the words have a plain meaning, it is unlikely a Court will find a different interpretation based on background material or commercial purpose. That will be particularly so where the contract has been prepared as part of a closely negotiated agreement and/or with the benefit of legal advice.
It turns out, sometimes beer is just beer as words are just words, with no hidden chilli-chocolate.
- Well, it’s probably not much like it, but work with us here!
- Malthouse Ltd v Rangatira Ltd [2018] NZCA 621 (20 December 2018).
- EBITDA is a measure of a company’s financial performance.
- There is some doubt whether this evidence was admissible. Parties’ subjective intentions are not usually relevant to contractual interpretation.
- Vector Gas Ltd v Bay of Plenty Energy Ltd [2010] NZSC 5, [2010] 2 NZLR 444.
- Firm PI 1 Ltd v Zurich Australian Insurance Ltd [2014] NZSC 147, [2015] 1 NZLR 432.
This publication is intended as a general overview and discussion of the content dealt with. It should not be used in any specific situation, in which case you should seek specific legal advice.