UK: Commercial Contracts

Last Updated: 31 May 2012
Article by Richard Thomas and Anna Puzitskaya

Three recent cases highlighted how important it is for the parties to carefully consider what they would like to achieve under the certain provisions of an agreement, as opposed to over-relying on contractual phrases.

"Consent not to be unreasonably withheld"

One commonly found contractual phrase is "such consent not to be unreasonably withheld". The case of Porton Capital Technology Funds & Others v 3M UK Holdings Ltd & Another [2011] EWHC 2895 (Comm) is a notable example confirming that the party's reasons for withholding consent do not need to be accurate or justified, they just need to be reasonable taking into account their own interests and not those of the counterparty seeking consent.

The purchasers who were the defendants in the proceedings (together 3M) purchased the entire shareholding in Acolyte Biomedica Limited (Acolyte).

Payment for the shareholding was structured so that the sellers received £10.4 million on completion and a future earn-out of up to £41 million based on Acolyte's 2009 sales. The sellers therefore had an interest in Acolyte's on-going performance. The sale agreement included a clause stating that Acolyte would not cease to carry on its business "without the written consent of the sellers, which shall not be unreasonably withheld".

Acolyte's business failed and 3M asked the sellers to consent to Acolyte ceasing business and offered the sellers US$1.07 million compensation. The sellers refused to consent unless 3M paid them the maximum £41 million earn-out. 3M refused and closed down the operations of Acolyte, resulting in no sales in 2009 at all and, therefore Alcolyte not able to afford to pay the earn-out.

The sellers maintained the cessation of business of Acolyte was due to 3M's breach of the sales agreement and sued for loss of profits (the potential earn-out). 3M argued that the sellers had acted unreasonably in withholding consent to Acolyte ceasing business and 3M accordingly had the right to simply shut down Acolyte.

The question before the High Court was whether the sellers had acted reasonably in withholding consent to Acolyte ceasing business. Applying existing case law the judge held that the sellers had indeed acted reasonably. The following main points can be inferred from this judgment:

  • It is for the party seeking consent to prove that the withholding party's refusal to consent is unreasonable
  • The withholding party does not need to show that its refusal to consent was correct or justified. It just needs to prove that its refusal was reasonable in the circumstances, which is a question of fact
  • In deciding what is reasonable, the withholding party is only required to consider its own interests
  • The withholding party does not need to balance its interests against the interests of the party seeking consent, unless the competing interests are completely disproportionate.

Rights of first refusal

Another provision which is often found in commercial contracts is a right of first refusal. The judgment in AstraZeneca UK Ltd v Albemarle International Corp & Another [2011] EWHC 1574 (Comm) held that such right can require the grantor to match an offer to a third party on terms, which the grantor is prepared to accept, even though the detailed terms of any resulting contract may require further negotiation.

AstraZeneca UK Ltd (AZ) produced an anaesthetic known as "Diprivan".

Pursuant to an agreement with Albemarle International Corporation (AB), AB agreed to supply AZ with a chemical "DIP" which AZ used to produce propofol, an active ingredient of Diprivan. The agreement stated that should AZ decide to cease production of propofol and instead to purchase propofol direct; AB would have the "first opportunity and right of first refusal" to supply propofol to AZ.

AZ later decided to purchase propofol from a third party (S). AB objected that it had not been offered an opportunity to exercise its right of first refusal and served notice to terminate the agreement for breach of contract.

AZ submitted that it was, at most, required to give AB an "opportunity to negotiate" on the same terms as S. The submission was rejected and it was held that a right of first refusal conferred a right to be given an opportunity to match any third-party offer which the grantor might be minded to accept, and, in the event that the grantee matched the offer, to be awarded the business. It was held that AZ had to act in good faith and to provide AB with the full details of S's offer. That obligation arose as soon as AZ was "minded to accept" S's offer. Since AB was willing to match the terms of S's offer, AZ was obliged to accept AB's offer. It did not matter that the detailed terms may have needed negotiation and may not have even materialised into a contract at all.

Notices

The recent case of Ener-G Holdings PLC v Philip Hormell [2011] EWHC 3290 (Comm) raises some interesting points in relation to notice provisions. It serves as a reminder of the care and attention to detail that is required when co-coordinating the process of serving notices in compliance with contractual provisions.

This case concerned a share purchase agreement which provided that notice of warranty claims had to be given within a set period of time (in this case two years) and, in addition, that following notice of a claim, proceedings had to be issued within another time limit (one year from the date of the notice), otherwise the claim would lapse. Completion occurred on 2 April 2010.

The buyer alleged a breach of warranty and served a notice of claim on 30 March 2010. The notice of claim was served, as permitted by the provisions of the agreement, both by personal delivery (first notice) and by post (second notice). Under the agreement, the first notice was deemed received on the date of delivery (30 March 2010), and the second notice was deemed received two days later (1 April 2010).

One year later, on 29 March 2011, the buyer served proceedings by means of personal delivery using a process server, who served the proceedings by taking the claim form to the address and placing it through the letter box. The seller was away at the time and did not receive the claim form until 2 April 2011.

The provisions of the agreement relating to issue of proceedings provided that they could be issued in accordance with the terms of the agreement or by any other means permitted by law, such as under the Civil Procedure Rules (CPR). The Notice provisions of the agreement also stated that notice "may be served by delivering it personally".

The seller claimed the service of the proceedings was out of time on the basis that they had to be served within 12 months of the notice of claim. The Court had to decide whether the proceedings had been served before the first anniversary of the notice of claim. To do this it was necessary to work out when each was served.

Based on case law, the Court held that, for service to be valid, the notice must be personally delivered to the addressee (or someone who can accept the delivery on their behalf). In other words, it is not the delivery that must be personal, but the receipt. Therefore in this situation, as the seller was away when the claim form was placed in its letter box, the delivery on 29 March 2011 was ineffective.

However, as the agreement expressly provided for service of proceedings (as opposed to simple notices) by any method permitted by law, under the CPR, receipt was deemed to be two days after they were left at the seller's address (31 March 2011).

For service of proceedings to be within the prescribed first anniversary of the notice of claim, the claim form had to be served before 31 March 2011.

Therefore, it was held that as notice of the claim was effectively served on 30 March 2010, and service of the proceedings on 31 March 2011 the proceedings were served one day late and out of time. It was held that the warranty claim had therefore lapsed.

Practical tips to be drawn from the cases

  • It may be worth questioning whether adding the words "not to be unreasonably withheld" is in fact achieving anything, as common law principles state that a party with a right to exercise a discretion under a contract must in any event exercise that discretion honestly and in good faith, and not "arbitrarily, capriciously or unreasonably". From a drafting perspective, depending on the circumstances, it might be useful to consider including wording like "but taking into account [my] interests" or similar
  • Rights of first refusal will be enforced by the courts where possible – parties giving such rights should not assume that they can be avoided by arguments as to uncertainty. It may be also useful to define criteria to be met to qualify for such rights as well as specifying that right is subject to the grantee not being in breach of contract itself, as it is clear from this case that the courts expect a grantor to be fair towards the grantee
  • From a drafting perspective, flexibility in drafting the clauses may prevent problems in the future, so it is worth including other provisions to allow for speedy delivery, such as fax or e-mail. For example, if the clause stated that service could be effected by leaving a notice of claim at a particular place instead of delivering it "personally" this would have resulted in a different outcome for the claimant in this case.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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