It would be unsettling for a party to an agreement to realize that the terms of its agreement could be interpreted to mean something other than its express terms. For example, what if the holder of a demand note found out that it was not payable on demand? That was the decision of the British Columbia Court of Appeal in 3 Oaks Dairy Farms1. That case demonstrates that certain agreements entered into in respect of a prior overarching agreement will be interpreted to be a single package contract with interrelated rights and obligations.
In 3 Oaks Dairy Farms, two family members, “Robert” and “James”, were invited to become partners in their family’s dairy farm operation and received their equity interests as gifts. They both, along with other family members, executed a partnership agreement which provided that no partner would “do any act detrimental to the best interests of the partnership, or which would make it impossible to carry on the ordinary business of the partnership.” The partnership structure was eventually converted to a corporate structure. Robert and James rolled their partnership interests into the defendant company, “3 Oaks”, in return for shares and promissory notes representing shareholder loans provided to 3 Oaks. The promissory notes were demand promissory notes payable without interest 30 days after demand. A shareholders’ agreement was not executed and the original partnership agreement was not expressly terminated.
James eventually sought to be bought out of the business and Robert resisted. James then assigned his promissory notes to 0930032 B.C. Ltd. (“Numberco”) in exchange for cash and a note from Numberco representing the balance of his shareholder loan to 3 Oaks (the “Assignment”). Numberco made written demand on 3 Oaks for the repayment of James’ shareholder loan pursuant to the terms of the promissory note less than three weeks after the Assignment and then commenced a proceeding against 3 Oaks seeking a judgment in the amount of the shareholder loan.
At trial it was determined that Numberco was not entitled to payment on demand of James’ shareholder loan. The trial judge noted that the parties knew and understood that some of the terms of the partnership agreement continued to apply to the shareholders of 3 Oaks. Specifically it was understood that the parties would continue to operate the business and not take steps that would frustrate its operations. The trial judge noted that requiring 3 Oaks to repay to Numberco the amount of James’ assigned shareholder loan would endanger the viability of 3 Oaks’ business operations contrary to the foundation of the original partnership arrangements.
The BC Court of Appeal upheld the reasoning of the trial judge. The Court found that the parties continued to govern themselves in accordance with the subsisting terms of the partnership agreement, which it characterized as an umbrella or overarching agreement, and that the parties could not act to frustrate 3 Oaks’ business operations. The Court also found that Robert and James had received their equity in the partnership subject to the conditions set out in the partnership agreement, and those terms and conditions continued to bind the parties notwithstanding the transition of the partnership to a corporation.2 Numberco, as the assignee of James, took the Assignment subject to any conditions by which James was bound.3
The Court drew an analogy to a borrower and a bank entering into a main umbrella or overarching agreement (e.g. a loan agreement) and the borrower issuing a demand promissory note as security for the loan. The bank might also agree not to make demand unless a default in the terms of the overarching agreement occurs, and in making that agreement altering the interpretation of the express terms of the promissory note.4 In the case at hand, even though the promissory note clearly specified that it was payable on demand, the promissory note and the partnership agreement were interpreted as a single agreement with terms affecting the demand nature of the promissory note. This was not, in the Court’s view, a case of implying a term into a contract that contradicts its other express terms. Rather it was an exercise of interpreting the note in the context of other overarching terms governing the parties that remained in force.5
This case should serve as a careful and cautious reminder to lenders and assignees of loans to always review the terms and conditions of any individual agreement in the context of the loan or credit facility for which it is provided. The context of the terms of a prior overarching agreement may serve to modify the interpretation of the expressly stated provisions in a related agreement, leading to a result contrary to the anticipated outcome.