Another Wine Case Spat: Important lessons affecting contracts

25 September 2014

Another Wine Case Spat: Important lessons affecting contracts

Introduction

Earlier this month the Supreme Court delivered a judgment that contains some important lessons for those dealing with the transfer of the benefits (and burdens) of contracts.

This is the second case in recent memory where the financial difficulties faced by those in the wine industry in recent years have delivered some important lessons that have wider application for those dealing with commercial contracts. On further inspection, it appears that both cases stem from the demise of winemaker Matakana Estate and sister company Goldridge Estate.

In the first case , the liquidator faced a claim from 3rd party financiers who had funded the company’s vintages through a special purpose vehicle set up to fund a particular year’s vintage. The vintage SPVs bought the grapes for that year’s vintage from Matakana which produced and bottled the wine at the winery. Production costs were met by the vintage SPVs for an agreed price and they then delivered the bottled wine to Goldridge Estate under a supply agreement. Goldridge repaid the vintage SPVs what they were owed for interest and capital from the proceeds of sale. In that case, the High Court applied some well-established principles to conclude that:

• unblended and blended juice for which the vintage SPVs were invoiced and which remained in separate, identifiable, vessels – remained the property of the relevant vintage SPV; and
• blended (invoiced) juice which had been commingled with juice belonging to others (including where it had been made into wine was held by the contributors as tenants in common according to their contribution.

In the most recent case, the Supreme Court has made some important findings about the practicalities of transfer of contractual rights and obligations.

Savvy case

In Savvy Vineyards v Karaka Estate , the contract in question affected Karaka Estate in Marlborough. Goldridge Estate managed Karaka’s vineyard, and had the first right to acquire any grapes, under a series of long-term contracts between the parties. Whilst the contracts were for a long term, they could be cancelled by either party if the other went into liquidation.

An attempt was made by Goldridge to transfer its rights and obligations under the contracts to its subsidiary (Savvy). The relevant provisions in the contract did not specifically contemplate such a transfer. Instead, the assignment mechanism provided only that Goldridge must not assign its interest in the contract to an unrelated party without Karaka’s consent.

Goldridge sought to make the transfer by means of a novation (the substitution of a new contract for an old one – which usually extinguishes the rights and obligations under the old contract). A formal document was prepared which was labelled a ‘deed of assignment’ but which was in effect a deed of novation – providing for Savvy to be substituted for Goldridge, and which would have released Goldridge from its obligations and made Savvy liable in its place. However, whilst Karaka dealt with Savvy for a period of 2 years as if it had replaced Goldridge, it did not sign the deed of novation.

Goldridge subsequently went into liquidation, and Karaka claimed (as a basis for terminating the contracts) that Goldridge was still a party – with the result that was in a position to terminate the contracts because a party was in liquidation.

In response, Savvy claimed that Goldridge was no longer a party, so that the contracts remained on foot, unaffected by the liquidation of Goldridge, and that Karaka wrongfully terminated them.

Decision

The High Court held that the transfer had effected a novation of the contract, with Savvy being substituted as a party in place of Goldridge. By the time Goldridge went into liquidation, it was no longer a party to the contract. As a result, the purported termination was invalid.

On appeal, the Court of Appeal held that the vineyard agreements had been assigned by Goldridge to Savvy, there had been no novation, so Goldridge was still a party at the time of its liquidation and the contract was validly terminated.

A majority of the Supreme Court has held that the termination of the contract was invalid. The majority decided that the transfer of contractual obligations can only be achieved by novation. Because Savvy assumed both the rights and obligations of Goldridge, the transfer was necessarily agreed to as a novation. (Also that that the only terms that Goldridge and the Savvy offered to transfer the contract were the novation set out in the deeds – including the provision that Savvy would replace Goldridge, it was therefore not possible to accept Savvy as a contracting party without also accepting the release of Goldridge from liability as a party). As a result, at the time of termination – Goldridge was no longer a party.

Until a recent Court of Appeal decision, it was considered that the burden of contractual obligations could not be transferred to a 3rd party unless both the 3rd party and all of the original parties agreed. The majority decision reaffirmed the traditional view. (As a result, unless there was consent to Savvy taking over Goldridge’s obligations, the transfer would have been ineffective).

The majority decision provided two alternatives for this outcome:

• First, the original contract provided a right of transfer the obligations under the contract to a subsidiary – without the need for consent by Karaka to the transfer. The majority also concluded that there was scope for finding that, when taken as a whole, the deed of assignment / novation did record Karaka’s prior consent to Goldridge transferring the contract to a related party (i.e. Savvy).
• Secondly, and the main plank of the majority decision, that Karaka did actually consent to the novation by the conduct of treating Savvy as if it had taken over the contract. The Court reached this conclusion even though Karaka had not signed the proposed deed of novation, and even through there was a clause in the offtake contract requiring amendments to be in writing. Instead, Karaka’s consent came in the form of such actions as paying invoices submitted by Savvy and correspondence treating Savvy as the current party.

Ultimately, the reason why the Savvy case went through the High Court and two further appeals to the Supreme Court appears to be as a result of the opaqueness of the drafting. The majority decision suggests that this might have been a little deliberate (to clothe a novation, for which Goldridge would remove itself from liability, as an assignment for which it would not). However, this opaqueness also provided Karaka with the opportunity to seize on the liquidation of Goldridge and seek to terminate the contract.

Unfortunately, whilst the High Court saw the evidence of Karaka failing to object to the transfer of the contracts to Savvy and treating Savvy as the relevant party to the contract as sufficient to overcome any objections to the lack of formal consent to the novation, the Court of Appeal was not so convinced that this was sufficient evidence that Karaka did not wish to be bound.

Important lessons

There are a number of important lessons to be taken from this decision, including:
1. When drafting or reviewing a contract, it is necessary to think about the right to transfer the benefits and burdens of the contract (particularly in a manner that will enable the original party to cease to have any ongoing obligations) – and whether counterparty consent to such a transfer is needed.
2. If the effect of transfer is such that an original party will cease to have any ongoing rights or obligations – it is necessary to think about the knock-on impact on other provisions in the contract. For example, what might be the impact on the ability of the other party to perform the contract, enforce the default mechanism or even terminate the contract?
3. If the counterparty either formally seeks your consent to a transfer of obligations, or simply starts to engineer a situation where a 3rd party is performing some or all of its obligations, you should not sit on your hands without assessing the need to clearly indicate whether or not you accept the change that has occurred. (Noting that silence is likely to be regarded by both the counterparty and, ultimately, the Courts as indicating consent). In some cases, it may be necessary to both set out your position in writing – and then act on it, such as by ceasing supply, or stopping payment.
Typically, the burdens (obligations) under a contract cannot be simply assigned. Instead, they must be novated. Increasingly, parties to commercial contracts are seeking to preserve their ability to do so without consent from the other party. That is, they wish to be able to substitute a new party (and be released from their own obligations) without the consent of the counterparty. Often, this comes in the form of the ability to shift the contract within a corporate group. However, there are some subtleties that need to be considered, including:

• What happens if the transferee ceases to be a member of the group at some time after the transfer has occurred?
• Is an overseas company, including one operating in New Zealand as a branch, contemplated by the description of the corporate group?

Another issue highlighted by the Supreme Court decision is that the typical boilerplate language which is expressed to prevent variations to the contract (typically – unless in writing and approved by both parties) will not stand in the way of finding that a transfer has occurred where there is clear conduct indicating that a party has accepted such a transfer – such as by accepting or making payment or otherwise treating the purported transferee as the counterparty to the contract.

There has also been an increasing focus on the impact of corporate restructurings on existing contracts. Many contracts contain boilerplate language that contemplates solvent restructuring without really explaining what falls in/outside the net. For example, the question needs to be asked whether the transfer is an assignment – and (if so) whether the insolvency of the assignor may trigger rights of termination.

Further information

If you would like more information about any of the matters discussed in this note, please contact me.