High Court overturns decision on the impact of COVID19 on a business sale agreement

What you need to know

• The High Court has unanimously held a purchaser was obliged to complete a business purchase, although before the date for completion the business was largely unable to continue to operate as it had at the date of the contract, due to a COVID-19 public health order.
• The High Court found that an obligation to continue to conduct the business in the usual and ordinary course meant conducting it in accordance with the law from time to time, even where the change in the law was unexpected and radically altered the business between exchange and completion.  Although the case turns on the terms of the particular contract, the High Court did not consider the serious impact of the COVID-19 public health order entitled the purchaser not to complete.    

What you need to do

• Ensure that business sale agreements are clear on what is to occur in the event of a legal or regulatory change to the ways the business can operate.  Purchasers of a business cannot rely on the operation of legal doctrines of illegality or frustration to avoid the risk of having to complete a contract where the law impacts the business.  

Today the High Court of Australia has handed down an important decision on contract law for business sale agreements.

The case concerns a contract for the sale of the Quarryman's Hotel in Pyrmont, Sydney, entered into just before the COVID-19 pandemic.  On 23 March 2020, after the date of the contract but before completion was due on 31 March 2020, the NSW Health Minister made a public health order that required pubs to be closed to the public except for takeaway food and drinks.

The contract provided that up to the date of completion, the vendor was required to operate the pub in the "usual and ordinary course" of business.  The purchaser argued that, as the pub was not operating in the usual and ordinary course of business, the vendor was no longer ready, willing and able to complete the contract.  The High Court of Australia unanimously rejected this argument.

In doing so, the High Court held that the obligation of the vendor to operate the business of the pub was an obligation to operate the business according to the law from time to time.

What did the contract say?

The key clause considered by the High Court provided that "from the date of this contract until Completion, the vendor must carry on the Business in the usual and ordinary course as regards its nature, scope and manner".

The contract expressly provided that the vendor made no warranties about any future financial position or performance of the pub.  The contract also provided that title and risk in the pub's assets passed to the purchaser on completion of the contract.

What happened?

On 23 March 2020, the Health Minister of NSW directed pubs to close save for the sale of takeaway food and drinks.  The Quarryman's Hotel closed that day, save for the sale of takeaway beer and food.

The purchaser declined to complete, alleging the vendor was not conducting the usual and ordinary business of the pub, as required by the contract.  The vendor served a notice to complete.  When the notice to complete lapsed, the vendor terminated the contract.

The purchaser commenced proceedings before the Supreme Court of NSW.  At trial, Darke J found for the vendors, which was overturned by the Court of Appeal by majority.  The vendor appealed to the High Court of Australia.

What did the High Court of Australia say?

Today, the High Court of Australia unanimously allowed the vendor's appeal and overturned the Court of Appeal's decision.

The High Court considered that the matter fell to be determined by contractual interpretation (and, not for example, by reference to doctrines of illegality).    The High Court cited well known principles of contractual interpretation:

"It is well established that the terms of a commercial contract are to be understood objectively, by what a reasonable businessperson would have understood them to mean, rather than by reference to the subjectively stated intentions of the parties to the contract. In a practical sense, this requires that the reasonable businessperson be placed in the position of the parties. It is from that perspective that the court considers the circumstances surrounding the contract and the commercial purpose and objects to be achieved by it."

The High Court held that the clause requiring the vendor to carry on the business in the usual and ordinary course necessarily included an inherent requirement to operate the pub according to law.  There could be no obligation requiring the vendor to operate the business unlawfully.  The Court said that the vendor's obligation was necessarily moulded by, and subject to, the operation of the law at the time.

The Court noted the pub necessarily operated in a dynamic regulatory environment (including the liquor licensing regime) that was outside of the vendor's control.  The Court noted that there was no warranty the business would remain the same between the date of the contract and completion. 

The Court held that it was not necessary to imply any terms into the contract or have regard to supervening events.  It was simply a matter of contractual interpretation.

The purchasers also sought to rely on a clause of the contract that provided that title and risk only passed to the purchasers on completion.  The Court dismissed this argument, saying that the passing of risk at completion does not mean that the vendor guaranteed that the value of the goodwill in the pub would remain the same.  Goodwill is "ephemeral" rather than "permanent".  There was no warranty from the vendor that the assets of the pub would not decline, or that the pub could operate in the same manner on completion as it did on the date the contract was entered into. The passing of risk being deferred to completion simply displaced the usual position that title and risk passed in equity on contracting. 

Accordingly, the purchaser had remained obliged to complete the contract, and wrongfully repudiated it when it refused to complete.  

What does this mean for you?

The approach of the High Court highlights the primacy of the terms of the contract.  Although the Court did not rule that contractual obligations are generally to be read down as subject to any legal requirements from time to time, the decision shows contractual interpretation will, where the language allows it, have regard to what is legal.  In this instance, this was on the basis that a "reasonable businessperson" would expect that conducting the ordinary or usual business means to do so according to law in force from time to time.

The majority approach in the NSW Court of Appeal suggested that a purchaser would not be compelled to proceed with a purchase where a change in the law had radically altered the business being acquired.  The High Court has emphasised that changes in the law will occur, and should be seen as an inherent part of any regulated business. 

This means that if a party wishes to protect itself against the risk of legal or regulatory change when negotiating a business sale, it needs to ensure this is expressly addressed in the contract (for example, by obtaining warranties there will be no material change in the business prior to completion).  

Authors: Andrew Carter, Partner; Luke Dominish, Senior Associate; Carla-Rose Brett, Lawyer.