The enforceable written contract is usually a damn fine thing.  The parties can perform or, if not, pay damages (unless liability has been excluded). 

Simple?  Sadly, not – as two recent English judgments and an article on the state of contract interpretation in Australia demonstrate.

Exclusion clauses – “perfectly clear”…

Manchester Central Convention Complex Ltd (MCCC) contracted with Kudos Catering (UK) Ltd in 2007 for the provision of catering services by Kudos at MCCC’s venues.  In 2010 MCCC purported to terminate the agreement.  Kudos rejected its right to do so, and itself purported to cancel the agreement for repudiation by MCCC – and so to Court.

Kudos claimed for a substantial sum of lost profits over the remaining intended term of the agreement.  In its defence, MCCC relied (among other things) on the following limitation of liability clause:

[Kudos] hereby acknowledges and agrees that [MCCC] shall have no liability whatsoever in contract, tort (including negligence) or otherwise for any loss of goodwill, business, revenue or profits…

So far, so simple.  And so the first instance judge thought.  He stated that the words of the clause were “perfectly clear…Their effect is that in any case in which there might otherwise be a liability in contract to pay damages in respect of loss of profits there is not one.  It is as simple as that.”  For this reason, it was unnecessary to inquire beyond the express words of the clause.  MCCC won.

…until the appeal

Not so in the Court of Appeal, which delivered its judgment in Kudos Catering (UK) Ltd v Manchester Central Convention Complex Ltd1 on 7 February this year. 

The Court repeated the now-familiar mantra that words cannot be interpreted other than by reference to the relevant factual background and context, and proceeded to examine what it regarded as the underlying nature and purpose of the parties’ agreement.

The key considerations informing the Court’s decision were:

  • the effect of the trial judge’s interpretation of the limitation clause was to exclude a claim in damages for the type of loss (lost profits) most likely to be suffered by Kudos if MCCC failed to perform its obligations
  • the ‘co-operative’ nature of the agreement and the underlying relationship were such that it was questionable whether it could have been enforced by way of specific performance
  • if neither specific performance nor damages were available, the effect of the limitation clause would be to leave Kudos without remedy for MCCC’s non-performance.  It was “inherently unlikely” that the parties intended the clause to have this effect
  • accordingly, this meaning of the clause should be rejected if there was any other available meaning.  Such a meaning could be found by concluding that the parties’ true intention was only to limit the liability of MCCC for defective performance, not for refusal to perform.  This conclusion was drawn from the wording of an accompanying indemnity, which protected Kudos against liabilities in relation to the negligence of MCCC when supplying property to Kudos under the agreement.

Really?

It is the last step in this reasoning that is most objectionable.  Undoubtedly, if parties wish to contract on terms that deprive a party of many of its normal rights of recourse for a breach by the other, they must make that abundantly clear.  But it is hard to see how the parties here could have been plainer. 

This case demonstrates how malleable the concepts of meaning and context have become in the hands of a Court that perceives a bargain as inherently unusual or unfair.  That has never been the function of contract law, and the Courts should not constitute themselves as the policemen of the parties’ commercial wisdom.

Notice of termination required 

The second disconcerting English decision was delivered in October 2012 by the Supreme Court.2  In a nutshell, the case turned on when an employment agreement had been terminated, but raised a key philosophical issue. 

In addition to a power to terminate on three months’ written notice, the agreement gave the employer a power to terminate “with immediate effect by making a payment to [the employee] in lieu of notice”.  On 29 November 2007, the employer summarily dismissed the employee.  He was taken to his desk to collect his belongings and escorted from the building.  He never returned. 

However, no payment was made to the employee on that date.  On 18 December 2007, the requisite payment in lieu of notice was paid into his bank account.  On 4 January 2008, the employer wrote to the employee advising that it had terminated his employment by payment in lieu of notice.

The key question was at what point in this narrative the employment contract was terminated.  This was important because the termination payment to which the employee was entitled was significantly higher if his employment continued beyond 31 December 2007.

Much of the discussion in the UK Supreme Court focussed on the longstanding debate between the ‘automatic’ and ‘elective’ theories of termination of employment contracts.  This debate has been resolved in New Zealand in favour of the ‘elective’ theory by the Supreme Court’s decision in Paper Reclaim Ltd v Aotearoa International Ltd.3

Implied requirement to explain notice in lieu

Also of interest is the conclusion by the majority of the UK Supreme Court that a term should be implied into the contract requiring the employer to give written notice to the employee stating that it was exercising its right to terminate by payment in lieu of notice.  In the absence of this notice, the termination was ineffective meaning that the employment contract did not come to an end until 6 January 2008, when the employee was deemed to have received that notice.

It is not at all clear why such a term could or should have been implied into this contract.  It was not necessary to make the arrangement work, and on its face seems inconsistent with the express words of the termination right. The employer was entitled to terminate “by payment in lieu of notice”. 

Read literally, termination is effected by the making of the payment, without any requirement for more.  But Baroness Hale, delivering the judgment of the majority on this point, took the view that it was inappropriate for the employee to be “required to check his bank account regularly to discover whether he was still employed”.4

Really?

The debate in this case was not about whether the employer had purported to exercise its power to terminate by payment in lieu of notice.  It was about whether it had done so validly. 

As Lord Sumption observed in his minority judgment, there can have been no doubt in the employee’s mind on 29 November 2007 that his employer regarded his employment as at an end.  He admitted under cross-examination that when he discovered the payment in his bank account in late December 2007, the only explanation for it was that it was a payment in lieu of notice.  The majority’s imposition of a notice requirement appears more calculated to punish the employer for getting it wrong the first time (in late November) than recognising the nature of the parties’ bargain.

Breach: wrong or efficient?

The key philosophical question on which the majority and the dissenter (Lord Sumption) differed is known in the trade as ‘efficient breach’.  The majority declare firmly that no-one ought to benefit from their own wrong – in this case from their breach of contract.  Lord Sumption (with whom the writers agree) offers a more utilitarian ‘efficient breach’ view. 

In doing so, he joins some eminent company.  In 1897, the American judge Oliver Wendell Holmes stated the concept plainly: “The duty to keep a contract at common law means a prediction that you must pay damages if you do not keep it – and nothing else”.5

Put simply, the contracting party has a choice: to perform or to pay damages.  If it is more efficient to pay damages than to perform, then that is the sensible thing to do.  It is also economically desirable, in that it ensures resources are allocated in the most efficient way. 

The law should have no interest in forcing parties into needless expenditure and is not there to ‘punish’ contract-breakers.  Nonetheless, in the UK (and, probably, New Zealand) the judges have favoured a quasi-moral approach over economic efficiency.

The ambiguity of ambiguity

Finally, Professor David McLauchlan and Matthew Lees’ recent article More Construction Controversy6 contains a detailed and illuminating review of two recent decisions, one English7, the other Australian8.  Professor McLauchlan has been based at the Victoria University of Wellington Law School for several decades, and is much published on contract interpretation issues. 

In both of the cases they considered, the authors point out that there is a serious discrepancy between what the Courts are saying and what they are doing in practice to the extent that they discuss the role of ambiguity as a gatekeeper in the interpretation of contracts. 

Both cases purport to adopt the statement of Lord Hoffmann in the ICS case9 that a contract can only be interpreted in the light of all the background circumstances which would have been known to the parties at the time of contracting.  But the High Court of Australia in Jireh also affirms its earlier statement that an ambiguity in the terms of the contract is required before such evidence may be considered. 

As the authors point out, these two propositions are contradictory.  Either the background is always a necessary part of interpretation or it is not.

Similarly, the English Supreme Court in Rainy Sky appears to require a preliminary finding of ambiguity before access may be had to the contractual background for the purpose of interpreting the contract.  Again, this appears inconsistent with the basic principle in ICS noted above.

So much for clarity

So what can we draw from these many thousands of judicial and academic words?  Readers will no doubt differ on the correct approach to each of these cases.  But we can probably agree that simplicity and predictability in the courts’ treatment of contracts have, like rainfall, been scarce commodities over the last few months. 

If there is any comfort to be had here, it is probably that all of the decisions discussed are from overseas Courts.  So if some of us lament the unnecessary inclarity of the law of contract in New Zealand, we are at least not alone.