First published in NZ Lawyer 20 May 2011.

Both parties to a contract often think they have a right to cancel the contract as a result of the other's breach. The Supreme Court's decision last week in Ingram v Patcroft Properties Ltd [2011] NZSC 49 demonstrates that who is right can have drastic consequences.

The Court ruled that a party may not be entitled to cancel a contract because of the other party's breach, if the cancelling party was itself already in breach. If the cancelling party's breach made the other party's performance of the contract futile, then the cancelling party cannot validly cancel and is not entitled to damages.

What's more, not only is the cancelling party not entitled to damages for the other party's breach, but the cancelling party itself may be liable for damages for an invalid cancellation. In Ingram, one party's attempted cancellation was invalid, making it liable for damages for the other party's loss of business. Parties must carefully consider whether they are entitled to cancel a contract, because the consequences of an invalid cancellation may be disastrous.

The Dispute

The case concerned the Central City Backpackers and Embargo Bar in Auckland. Ingram and others (Ingram) leased the premises from Patcroft, but had fallen behind in the rent. Under the lease agreement, Patcroft could re-enter the premises and terminate the lease 14 days after the rent had become due and remained unpaid.

Unfortunately, Patcroft miscalculated and re-entered and purported to terminate 13 days after the rent was due. It changed the locks and took possession of the premises. When Ingram arrived he was denied entry and served with notice of re-entry and cancellation, a trespass notice and a notice of distraint. Patcroft also told Ingram that any attempt to seek relief against forfeiture would be defended.

All of the courts concluded that, because of the unlawful re-entry, Patcroft had repudiated the lease agreement. As a result, Ingram could have cancelled the agreement under the Contractual Remedies Act and avoided any further obligations under the agreement. But he did not.

The next day, the rent became 14 days overdue. Ingram still did not pay, although he gave evidence that he had intended to pay on the same date that Patcroft re-entered.

For the next year, nothing more happened. Ingram did not cancel the agreement, and did not attempt to regain possession. He did not pay rent. Patcroft, meanwhile, ran a backpackers and bar on the premises.

Ironically, the dispute was then precipitated by Patcroft, which took the position that by continuing to exclude Ingram after the 14th day, it had validly cancelled the lease agreement. Patcroft demanded $1.3 million from Ingram in unpaid rent and other amounts which it said was due for the remainder of the term of the lease. Ingram responded a few days later by filing proceedings seeking damages for the loss of his business caused by Patcroft's wrongful re-entry.

High Court

Justice Allan in the High Court found for Ingram: Ingram v Patcroft Properties Ltd (2009) 10 NZCPR 426. His Honour ruled that Patcroft's re-entry on the 13th day was unlawful, and that Patcroft's argument that the unlawful re-entry became lawful "simply by expiration of time" was "not immediately attractive" ([57]). Justice Allan found that Ingram had accepted Patcroft's repudiation of the lease agreement by issuing proceedings, and that he was entitled to $200,000 in damages for the loss of his business caused by Patcroft's unlawful re-entry, as well as other damages.

Court of Appeal

By a majority, the Court of Appeal overturned the High Court decision: Patcroft Properties Ltd v Ingram [2010] NZCA 275. Justices O'Regan and Ronald Young ruled that Ingram failed to cancel the lease after Patcroft wrongfully re-entered, and that the contract therefore remained alive. The next day the rent became 14 days overdue, and because Ingram had not cancelled, his failure to pay rent entitled Patcroft to cancel the lease. Their Honours observed that they found it "unlikely that the lease (under which the tenant was deprived of possession of the premises and the landlord received no rent) remained on foot for an extended period with neither side cancelling" ([56]).

Justice Priestly dissented, holding that Patcroft's continued possession meant that it remained in breach, and that Patcroft's repudiation could not "metamorphose into a cancellation through the passage of time" ([88]). His Honour also observed that Patcroft was not ready and willing to perform the agreement, which (at least at common law) is a necessary requirement for a party to cancel.

The Supreme Court

The Supreme Court unanimously reversed the Court of Appeal. Delivering the Court's judgment, Justice Blanchard ruled that the on-going repudiation by Patcroft (by re-entering one day early) prevented it from claiming a right to cancel for non-payment of rent – even though Ingram himself did not cancel the lease agreement before failing to pay the rent.

Justice Blanchard said that because of Patcroft's repudiatory act, Ingram could not operate his business. The non-payment of the rent was justified by Patcroft's unlawful re-entry, because Patcroft "was in effect representing that any such payment would be futile" ([30]).

Unaccepted Repudiation

However, Ingram did not accept Patcroft's repudiation until a year later, when it issued proceedings. There is authority that an unaccepted repudiation is a "thing writ in water and of no value to anybody: it confers no legal rights of any sort or kind." Howard v Pickford Tool Co Ltd [1951] 1 KB 417, 421 (CA). Under this principle, because Ingram had not accepted Patcroft's repudiation and did not cancel the lease agreement, the agreement continued on foot and Patcroft was entitled to cancel for Ingram's subsequent failure to pay rent.

Justice Blanchard accepted University of Sydney Professor John Carter's criticism of Howard as a "misleading, unhelpful and gross oversimplification of the law" ([31]). It is true that if the innocent party has not accepted the repudiation and has not cancelled the agreement, the repudiating party can retract the repudiation and make amends, thereby preventing the innocent party from cancelling. It is also true that until a repudiation is accepted, the contract continues on foot.

However, Professor Carter argues that at common law, an unaccepted repudiation may still have consequences. Not only does it give the innocent party the right to cancel, but it may prevent the repudiating party from exercising his or her rights under the contract. It may also absolve an innocent party from performing his or her obligations under the contract.

Consistently with Professor Carter's argument, the New South Wales Court of Appeal has held that repudiatory conduct by one party is a representation to the other party that the contract is at an end, and may therefore constitute an estoppel by conduct: Nina's Bar Bistro Pty Ltd v MBE Corp (Sydney) Pty Ltd [1984] 3 NSWLR 613 (CA). More recently, that same court ruled that a party that has repudiated a contract cannot cancel for another party's breach where there is a nexus between the repudiatory conduct and the breach: Idameneo P/L v Ticro P/L [2004] NSWCA 329 (CA).

Likewise, the Privy Council had approved a judgment delivered by Justice Blanchard in a earlier case, in which His Honour found that a landlord was "disentitled" from cancelling a lease agreement for a tenant's failure to pay rent, because the landlord had earlier repudiated the agreement: Hirst v Vousden [2004] UKPC 24.

Contractual Remedies Act

Justice Blanchard applied these principles in his analysis under the Contractual Remedies Act, noting that it would be "entirely unfair if the Act produced a different outcome" ([40]). His Honour also noted that in their 1981 text concerning the Act, Francis Dawson and David McLauchlan suggested a similar approach. Thus, if a party indicates that the other party's performance is unnecessary or of no avail, and the other party relies on this, the first party is unable afterwards to complain of non-performance, and cannot cancel under section 7 of the Act.

More generally, the Court approved Justice Glazebrook's observation in Noble Investments Ltd v Keenan [2006] NZAR 594 (CA) that a party seeking to cancel cannot do so if it would thereby benefit from its own wrong. If the other party's breach is a "direct result" of a breach committed by the party seeking to cancel, that party cannot cancel. Likewise, if the party seeking to cancel is "unable or unwilling" to perform its obligations under the contract, that party cannot cancel ([40]).

Here, the Court concluded that Patcroft's unlawful re-entry was an unretracted repudiation that intimated that it would be futile for Ingram to pay the rent, because the premises would not be reinstated. As a result, Patcroft was precluded from cancelling for non-payment of the rent, and Ingram is entitled to $200,000 in damages for his lost business resulting from Patcroft's unlawful re-entry and purported termination.

Comment

The Supreme Court was right to hold that Patcroft could not cancel the lease agreement. It seems wrong that an unlawful repudiation on one day can become a valid cancellation the very next day as a result of nothing more than the passage of time. And if a repudiation is continuing, it seems unfair to allow the repudiating party to cancel with impunity.

There are two key takeaways from the Court's decision. First, there are risks to leaving a repudiation unaccepted. Ingram could have avoided the dispute by cancelling the lease agreement as soon as Patcroft unlawfully re-entered. Although the Court ruled that Patcroft intimated that the payment of rent by Ingram would be futile, the Supreme Court has previously observed in the context of settlement that the conclusion that it would have been futile for a party to perform its obligations under a contract "is not one which is lightly to be drawn": Bahramitash v Kumar [2005] NZSC 39 at [20].

Likewise, if a party accepts a repudiation and cancels, that party can avoid a factual dispute as to whether its subsequent breach was "directly caused" by the other party's repudiation, or whether the repudiating party was willing and able to perform.

Second, it is critical that parties carefully consider whether they are entitled to cancel a contract. Patcroft only miscalculated the date for re-entry by one day, but that one day's difference cost it four and a half years of litigation and $200,000 in damages. If there is any doubt that a party's breach allows the other party to cancel, the party seeking to cancel may be advised to wait until it has a clear right to cancel. Otherwise, the consequences may be disastrous.