Australia: Collateral contracts, weak warranties and the risk of a handshake on the side

Last Updated: 21 July 2017
Article by Darren Pereira and Georgia Milne

Most Read Contributor in Australia, July 2017

In a recent decision, the NSW Supreme Court has adopted a narrow interpretation of a relatively standard warranty that is often included in share and asset sale and purchase agreements, on the basis that a strict interpretation of the wording of the warranty was inconsistent with an intention to warrant the accuracy of information disclosed. The case also concerned the use of 'side agreements' in commercial transactions.

This judgement is a timely reminder of the risks associated with side deals and 'quick-fix' variations, as well as the importance of constructional care when it comes to drafting your warranties.

Background

ACN 151 368 124 v Pro-Pac Packaging (Aust) Pty Ltd [2017] NSWSC 913, handed down on 30 June 2017, focused on a sale of business by ACN 151 368 124 (formerly Eco Food Pack Australia Pty Ltd) (Plaintiff, Seller) to Pro-Pac Packaging (Aust) Pty Ltd (Defendant, Buyer). The parties entered into a sale agreement in June 2013, along with a number of ancillary agreements including a "side letter". The purchase price structure included The sale agreement contemplated a total consideration of approximately $6 million, payable by way of a completion payment, earnings incentives, stock and a "deferred payment" of $250,000 spread across four half-yearly instalments.

The Plaintiff commenced proceedings to recover the balance of the deferred payment together with the stock sum. While the Defendant conceded partial liability for the stock sum, it denied any exposure to the Deferred Payment and sought to set off any liability against damages claimed against the Plaintiff for breach of warranty, breach of collateral contract and/or misleading or deceptive conduct.

Interpretation of warranty

In seeking to set-off its liability for the deferred payment and stock sum, the Defendant claimed that the Plaintiff was in breach of, amongst other things, the warranties to the sale agreement. In particular, the Defendant relied on warranty 3.1(a) which stated:

All copies of documents and information provided by or on behalf of the Seller to the Buyer are complete, accurate and true copies in all material respects and are not false, misleading or deceptive.

The claim centred on a representation regarding rebate thresholds which was made by an agent of the Plaintiff to the Defendant prior to entry into the agreement. The court accepted that the representation had been made and was indeed false. Notwithstanding this, McDougall J was compelled to conclude that, based on close textual and syntactical analysis of 3.1(a), there was no breach of warranty.

While the Buyer believed the provision warranted both the completeness and accuracy of the documents, as well as the accuracy of the information, the Seller argued that where properly construed, warranty 3.1(a) gave no assurances as to the accuracy of information provided. Instead, its application was limited to warranting the accuracy of the copies only insofar as they were 'copies'.

McDougall J conceded that the warranty was 'difficult to construe'. If the Buyer's approach was adopted, the warranty should have been be read as if it stated 'all copies of documents, and all information, provided...are complete, accurate and true copies', providing two separate warranties. However, his Honour considered that such a reading did 'not sit comfortably with the repetition of the word 'copies'' or the use of the plural verb 'are'. Had the word 'copies' not appeared a second time, it would have been a simple and straightforward exercise in purposive construction to interpret the warranty as confirming the completeness and accuracy of both the copies and the information itself.

Ultimately, it was this double reference to the word 'copies' which persuaded McDougall J that the warranty was 'concerned only with the accuracy of copies' and that it would be inconsistent with that approach to interpret as 'containing an independent warranty of the accuracy (etc) of information in its character as information'.

The result was that clause 3.1(a) gave no undertakings as to the accuracy of information disclosed, and as such there was no breach and no relief for the Buyer. In acknowledging the feebleness of the resulting warranty, McDougall J noted it nevertheless represented a 'syntactically harmonious construction of the paragraph' as drafted by the parties and as such, it was the court's role to give effect to it, regardless of commerciality. While not explicitly cited, the decision did note that the agreement was drafted by the Defendant's solicitors, consistent with the principle of contra proferentum (whereby a contract may be construed against the drafting party).

Validity of Side Agreement

In denying its liability for the deferred sum, the Defendant also sought to rely on the side letter. The letter provided, amongst other things, that (a) 'in consideration of the Seller granting the Buyer a licence to occupy Premises...under the [sale agreement], the Buyer will pay the Seller the Deferred Payment...' but (b) if the Premises were sublet, assigned or otherwise disposed of before a certain date, the Seller would make a pro-rata refund the deferred payment and waive all future instalments by the Buyer.

The Plaintiff contended that the side letter was without contractual effect, either because:

  • as a collateral contract, it was inconsistent with the sale agreement, which already granted a licence to occupy the Premises and in consideration of which the letter was entered into; or
  • that it was without consideration and therefore unenforceable.

In holding the side deed invalid, McDougall J considered that its promise 'to grant that same licence' as given under the sale agreement could not be good consideration and that the resulting lack of consideration was fatal. For these reasons, and noting the inconsistency between the collateral contract and the sale agreement, his Honour held that the side letter was unenforceable and of itself offered no relief from liability for the deferred payment.

Takeaways

The case is a cautionary tale against complacency in the legal documentation for business transactions, especially when it comes to side deals and warranties. When drafting an agreement, parties should remember that a key function of the document is to offer certainty in the event of a dispute. It is a timely reminder that a failure to accurately express the parties' intentions, particularly when it comes to the scope of warranties, can have significant and unintended consequences. Commercial parties should resist the urge to plug the gaps in contractual arrangements with informal or ill-considered variations, and practitioners should revisit their standard warranties to consider the objective outcome of a text-based construction.

This publication does not deal with every important topic or change in law and is not intended to be relied upon as a substitute for legal or other advice that may be relevant to the reader's specific circumstances. If you have found this publication of interest and would like to know more or wish to obtain legal advice relevant to your circumstances please contact one of the named individuals listed.

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