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Case law: Court clarifies how commercial agreements should be interpreted

Businesses will welcome a Court of Appeal ruling clarifying how commercial agreements are to be interpreted, and the circumstances in which terms may be implied into such agreements.

March 2018

This update was published in Legal Alert - March 2018

Legal Alert is a monthly checklist from Atom Content Marketing highlighting new and pending laws, regulations, codes of practice and rulings that could have an impact on your business.

A company in administration agreed to sell four of its operating divisions, two to company 'PC' and two to company 'KKG', each of which had been newly incorporated for the purpose. PC had been set up by a former director of the company, and KKG by another former director. Completion of both sales took place ten days apart. Each sale agreement included certain intellectual property rights (IPR).

Subsequently, PC and KKG entered into a licence agreement whereby:

  • KKG acknowledged that PC in fact owned all the IPR formerly owned by the company in administration, and
  • PC granted KKG a licence to use the IPR it needed to run the two divisions it had bought

There was a confidentiality clause in the licence agreement. This was supplemented by another clause saying that a breach of the confidentiality clause was a non-remedial, material breach of the agreement, which would entitle the other party to immediately terminate the licence agreement by notice in writing.

The shareholders of KKG subsequently sold their shares to a third party, a competitor of PC. During the buyer's 'due diligence', KKG disclosed a copy of the licence agreement to the buyer. PC claimed this breached the confidentiality clause, terminated the licence agreement, and told KKG it could no longer use the relevant IPR.

KKG argued that the licence agreement was irrelevant, and that the original sale agreement under which it bought its two divisions had assigned to it all the IPR it needed to run those two divisions. Therefore, it had not required a licence from PC to use that IPR in any event. In support of its argument, KKG claimed:

  • The two sales agreements to itself and PC respectively should be read together because they were part of the same administration proceedings. Therefore, as a matter of common sense it was obvious that the sales agreement to PC was intended to transfer to it the IPR it needed to run the two divisions it had bought from the company in administration, and the sales agreement to KKG transferred to it the IPR it needed to run its two divisions
  • Administrators are required to get the best price for assets sold. The administrators in this case would have known that if they assigned all the company's IPR to PC on the first sale, they would reduce the price they could get on the second sale. A reasonable person would therefore have been surprised if the IPR transferred by the first sale agreement comprised more than the IPR necessary for PC to run its divisions
  • If the intention had been to transfer all the company's IPR to PC, the agreement would have expressly said so

The Court of Appeal ruled that agreements made at the same time between the same parties as part of a single, composite transaction can be read together. However, in this case the sales agreements were with different buyers, and completed ten days apart. They were separate transactions, not part of a single, composite transaction, and could not therefore be read together as claimed.

It also confirmed that while some background facts can be taken into account when interpreting an agreement, they are limited to facts that are known, or reasonably available, to both parties at the time they entered into the agreement, not just one party.

The Court also found that nothing in the wording of the sale agreement with PC, or in the admissible background facts, led to the conclusion that the IPR had been divided up between PC and KKG, as the latter claimed. It also confirmed that commercial common sense could only be used to help interpret an agreement if the actual words used were not clear (in this case, they were).

KKG had not acquired the IPR it needed for the divisions it had purchased, and the provisions in the licence agreement therefore applied.

Implied term?
KKG therefore argued that the confidentiality clause was subject to an implied term that the licence agreement could be disclosed for reasonable business purposes, such as in the course of due diligence investigations by a potential buyer of the company.

The Court of Appeal confirmed that a term will only be implied into a commercial agreement if it is:

  • necessary to give the agreement business efficacy, or
  • so obvious that it goes without saying

It is not enough that the implied term is commercially sensible or that, without it, the agreement operates to the detriment of one of the parties.

Applying these tests, the Court ruled that the implied term KKG was arguing for was too wide to be implied into the agreement, as it would allow disclosure not just to KKG's advisors or to a regulator, for instance, but to a competitor of the other party to the licence agreement.

It also pointed out that for a term to be implied, it had to be necessary to give business efficacy to the licence agreement – ie, it had to be a necessary term if KKG was to be able to run the two divisions it had bought. However, KKG was arguing the implied term was necessary to enable the sale of KKG's shares. The ability (or inability) sale of KKG's shares did not have anything to do with the business efficacy of the licence agreement.

Finally, the Court found that it was not obvious that had PC been asked to expressly consent to disclosure of the licence agreement to a competitor, it would have replied 'of course'. It is more likely that it would have refused or, at least, negotiated significant conditions. Therefore, the implied term argued for by KKG was not so obvious that it went without saying.

Operative date

  • Now

Recommendation

  • Businesses disputing the meaning of the terms of a commercial agreement should take legal advice on how such agreements are being interpreted by the courts, and implications of arguing that terms should be implied into the agreement. The rules of contractual interpretation are complex

Case ref: Kason Kek-Gardner Ltd v Process Components Ltd [2017] EWCA Civ 2132

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