Data

Date:: 30-10-2009
Country:: Australia
Number:: (ACN 008 204 635) [2009] FCA 1220
Court:: Federal Court of Australia
Parties:: Australian Medic-Care Company Ltd v Hamilton Pharmaceutical Pty Limited

Keywords

LONG-TERM CONTRACTS - DISTRIBUTION AGREEMENT - BETWEEN TWO AUSTRALIAN COMPANIES - REFERENCE TO UNIDROIT PRINCIPLES AS MEANS OF INTERPRETING APPLICABLE DOMESTIC LAW (AUSTRALIAN LAW)

RELATIONAL CONTRACTS - SUPERVENING LOSS OF MUTUAL TRUST AND CONFIDENCE - NO REMEDY UNDER AUSTRALIAN CONTRACT LAW

PRE-CONTRACTUAL NEGOTIATIONS AND POST-CONTRACTUAL CONDUCT AS AID TO INTERPRETATION OF WRITTEN CONTRACT - WHETHER ADMISSIBLE UNDER AUSTRALIAN LAW - REFERENCE TO UNIDROIT PRINCIPLES (ARTICLE 4.3)

DUTY TO USE BEST EFFORTS - DIFFERENT FROM DUTY TO ACHIEVE A SPECIFIC RESULT - REFERENCE TO ART. 5.1.4 UNIDROIT PRINCIPLES

Abstract

A, an Australian pharmceutical company, entered into an contract with B, another Australian company, for the distribution on an exclusive basis of its products in Hong Kong (the "Distribution Agreement"). Over the years the parties repeatedly argued about the correct performance of the Distribution Agreement. Eventually A terminated the Distribution Agreement invoking a specific provision to this effect therein. B objected that A's termination was not justified and in turn claimed that A had breached the Distribution Agreement by failing, among others, to use its best efforts to prevent sales of its products in Hong Kong by third parties.

The Court held that A's termination was in accordance with the Distribution Agreement, but at the same time decided that B's allegation that A had breached the Distribution Agreement was founded.

In his opinion Justice Finn preliminarily noted that even before A's termination the business relationship between the parties had practically come to an end on account of a number of incidents leading to the total loss of mutual trust and confidence between them. He then pointed out that if the parties had chosen as their business form a company or a partnership, the unravelling of their relationship could have occurred reasonably expeditiously using specific statutory procedures provided for the case in which mutual trust and confidence between the partners have been destroyed. However in the case at hand the parties had left it to the law of contract to define their relationship, and, unlike other legal systems (see eg German BGB §314), Australian contract law does not have well developed default rules and procedures governing the termination of long term contracts for cause, i.e. for irreparable breakdown of mutual trust and confidence where such mutual trust and confidence is essential for the functioning of the contractual relationship.

As to the merits of both parties' claims, Justice Finn pointed out that it was basically a matter of the construction of the Distribution Agreement.

In this respect a first question to be decided was whether, and if so, to what extent, pre-contractual negotiations between the parties and their post-contractual conduct were admissible as an aid to the interpretation of their written contract. With respect to negotiations, while recalling that the prevailing view under Australian law was that they are excluded by the parol evidence rule, the learned Judge noted that this rule, though recently confirmed by the English House of Lords in Chartbrook Ltd v. Persimmon Homes Ltd. [2009] (see UNILEX), was not always accepted in other common law jurisdictions such as the United States and New Zealand, and in this respect referred, among others, to § 214(c) of the Restement of Contracts, Second, and to the decision of the New Zealand Court of Appeal in Yoshimoto v Canterbury Golf International Ltd [2000] (see UNILEX). Likewise, with respect to post-contractual conduct he acknowledged that the prevailing view was that such conduct was not admissible as an aid to interpretation, but at the same time recalled that this rule has met with considerable criticism on account of its inflexibility particularly in relational contract settings, and in this respect he referred, in addition to the findings of the Australian Federal Court in GEC Marconi Systems Pty v BHP Information Technology Pty Ltd [2003] (see UNILEX], to Article 4.3 of the UNIDROIT Principles.

As to the proper interpretation of the "best efforts" clause in the Distribution Agreement, Justice Finn pointed out that the clause did not impose a duty on either party to achieve a specific result, but merely to use best efforts to secure that result, and for this distinction he referred to Article 5.1.4, Comment 1, of the UNIDROIT Principles 2004. The “standard of endeavour” prescribed by a best efforts clause is characteristically measured by what is reasonable in the circumstances having regard to the particular contract in its business setting and to what could reasonably be expected of the party subject to the obligation.

Fulltext

[…]

Reasons for Judgment

1. This proceeding requires, in substance, the winding up of a business relationship between an Australian supplier of certain pharmaceutical products, Hamilton Laboratories Pty Ltd, and its sole distributor in Hong Kong, Australian Medic-Care Co Ltd (“AMC”). Viewed superficially, their formal relationship was that of supplier and exclusive distributor. Their relationship over time, though, was considerably more complex than that. It contained elements that could loosely be described as those of a joint venture. There was little reflected in the contract which, for the purpose of this matter, purportedly defined their relationship.

2. AMC (or its precursor) first began dealings with Hamilton in 1988. By the early 2000s, their business relationship began to fray. For practical purposes, it came to an end in 2006. What is now perfectly clear is that there was by then a total failure of mutual trust and confidence between the principals of the two companies.

3. If the business form they had chosen had been a company or a partnership, the unravelling of their relationship could have occurred reasonably expeditiously using well known and well worn statutory procedures which can be availed of when mutual trust and confidence have been destroyed: for companies, see Corporations Act 2001 (Cth), s 461(k); for partnerships, Partnership Act 1891 (SA), s 35(d). Here the parties left it to the law of contract to define their relationship. Unlike in some other legal systems, ours does not have well developed default rules and procedures governing the termination of long term contracts for cause (including irreparable breakdown of mutual trust and confidence where such is essential for the functioning of the contractual relationship): see eg German BGB §314 (in translation see www.iuscomp.org/gla/statutes/BGB.htm).
4. And so began a long and complex litigation which has traversed in detail much of the history of the parties’ relationship. Their respective allegations and recriminations have found legal expression in a significant number of causes of action and in about 1,000 pages of final submissions. The best that can be said about the matter is that it again demonstrates how inadequately our contract law can serve parties in long term business relationships which falter for whatever reason. It is not a reasonable response to say that they should have made better provision for their rights, etc into the future in the terms of their agreement. Contract law in its default rules should serve as well those who are not gifted with an all encompassing foresight.
5. In the result, while each party has secured victories of sorts, they each have sustained reverses. It could hardly have been otherwise despite their hopes, given the nature of their relationship and their manner of dealing.
6. To assist in the reading of what regrettably have to be lengthy reasons I have annexed two tables, the one being of the principal persons and companies referred to in these reasons; the other, of trade marks and pharmaceutical products.

Overview of Claims

7. By way of background I need to refer to two matters. The first relates to the evolution of the parties’ relationship; the second, to AMC’s intellectual property rights in aspects of the packaging and get up of the two principal Hamilton products distributed by AMC.

The parties’ relationship

8. The first and tentative dealings between Dr Keung (a director of AMC when it was later formed in Hong Kong in December 1990) and Hamilton began in 1988. Dr Keung’s purpose was to investigate the importation of one of Hamilton’s products into Hong Kong, China and Macau for sale principally to the Chinese speaking population of those localities. That product, Urederm was a 10% urea cream. An analgesic balm, it was used as a skin moisturiser.
9. The dealings of the parties progressed to the point that on 29 March 1990, Hamilton appointed the predecessor of AMC to be its sole distributor of a range of Hamilton products in Hong Kong and Macau. Those products included Urederm and, relevantly for present purposes, Rubesal (a topical analgesic balm used to treat muscle and joint pain). The letter of appointment, which contained only five clauses, provided (inter alia):

“[…]
3. Period
This Agreement shall commence from 31-03-90 and remain in force for a period of 5 years. At the completion of the initial 5 year period, this agreement may be extended for a further 5 years subject to review at the end of each year with respect to satisfactory sales performance. Thereafter, it shall be subject to the conditions set out in Clause 4(b). 4. Sales
(a) The Distributor will use its best endeavour to promote the sale of the Product in the Territory and to procure orders for the Product and will provide such information from time to time as may be required by HAMILTON to increase sales of, and promote new or existing products. (b) If sales of the Product are insufficient to meet the agreed minimum sales as defined in Schedule B (as amended from time to time) to meet the demand for the Product in the territory, HAMILTON may terminate the Distributorship by giving not less than three month’s notice to the Sole Distributor of the intention of HAMILTON to do so. HAMILTON may then offer the Product to others.
[…]”

[…]

The contract claims

14. The three classes of contract claims made by AMC relate respectively to these three groups of provisions. The first, alleges premature and unlawful termination, of the distribution agreement, by letters of 13 July 2006 and 23 March 2007. The wrongs alleged turn upon the construction propounded by AMC of what it describes as the provision for a “rolling 5 year term” and of the cl 41 termination provision. Needless to say the contract claims made here are twinned with alleged contraventions of s 52 of the Trade Practices Act 1974 (Cth). The second class of claims allege a failure by Hamilton to use its best efforts to prevent sales of its product in the area of the agreement otherwise than by AMC and its sub-distributors. AMC alleges that Hamilton allowed the parallel importation of its products by others into the Hong Kong market between 2000 and 2002, although AMC concedes it can only prove comparatively small amounts of parallel importation occurred in 2001-2002. The third class of claim relates to Hamilton’s wrongful cessation of supply of products to AMC and in particular, Hamilton’s failure to fulfil four orders immediately prior to the termination of the agreement. These claims raise questions of construction which turn on the alleged structure of the Distribution Agreement itself. The one matter I would emphasise about the claims made is that, notwithstanding the parties have been in sequential long term contractual relationships, AMC – and for that matter Hamilton – has not made any claim founded upon an alleged breach of an implied duty of good faith and fair dealing: on which duty see generally Cheshire and Fifoot’s Law of Contract 10.43-10.46 (9th Aust ed).
15. By way of relief, AMC seeks damages, a declaration that Hamilton’s purported terminations of the agreement were unlawful and ineffective, and rectification of the contract’s terms so as to embody the “rolling five year” term.
16. Hamilton has a number of layered defences to the contract claim. It is asserted that the Distribution Agreement was wholly in writing and was validly terminated on the giving of 60 days notice on 13 July 2006 as provided by cl 41.1.6 of the agreement. It is asserted additionally that, if that notice was invalid, the agreement was validly terminated by notice of 2 March 2007, in reliance upon some number of breaches of contract which were relied upon for that purpose or which could have been so relied upon.

[…]

A. The Contract Claims

112. When one aggregates the applicant’s claims in contract, the respondents’ defences to them and its contract based cross-claims, there is a considerable variety of issues potentially raised. Many, though, presuppose particular favourable or unfavourable findings by me on logically anterior claims or defences. For this reason I intend to deal first with those claims and defences which are fundamental in character. The first, and most important of these are (i) AMC’s claim that Hamilton’s purported termination of the Distribution Agreement, by its notices of 13 July 2006 and 23 March 2007, and its subsequent failure to supply product to AMC, constituted a repudiation of the Agreement which AMC accepted; and (ii) Hamilton’s defences that the first or else second of the notices gave rise to a valid and effectual termination of the Distribution Agreement.
113. I will deal with these compositely.

Applicable principles

114. There is a number of discrete bodies of principles to which it is necessary to refer. I will deal with these in turn.

(i) A partly oral and partly written agreement?

115. The case law on this matter has recently been essayed by Campbell JA (Allsop P and Bastin J concurring) in Masterton Homes Pty Ltd v Palm Assets Pty Ltd [2009] NSWCA 234 at [90]. I gratefully adopt what his Honour there said (omitting the quite exhaustive case citation):
The principles that are applicable in deciding whether an agreement that parties have entered is one that is wholly in writing, or partly written and partly oral, include the following:
(1) When there is a document that on its face appears to be a complete contract, that provides an evidentiary basis for inferring that the document contains the whole of the express contractual terms that bind the parties: (2) It is open to a party to prove that, even though there is a document that on its face appears to be a complete contract, the parties have agreed orally on terms additional to those contained in the writing: … Conversely, it is open to a party to prove that the parties have orally agreed that a document should contain the whole of the terms agreed between them: (3) The parol evidence rule applies only to contracts that are wholly in writing, and thus has no scope to operate until it has first been ascertained that the contract is wholly in writing: (4) Where a contract is partly written and partly oral, the terms of the contract are to be ascertained from the whole of the circumstances as a matter of fact: (5) In determining what are the terms of a contract that is partly written and partly oral, surrounding circumstances may be used as an aid to finding what the terms of the contract are: … If it is possible to make a finding about what were the words the parties said to each other, the meaning of those words is ascertained in the light of the surrounding circumstances: … If it is not possible to make a finding about the particular words that were used (as sometimes happens when a contract is partly written, partly oral and partly inferred from conduct) the surrounding circumstances can be looked at to find what in substance the parties agreed:
(6) A quite separate type of contractual arrangement to a contract that is partly written and partly oral is where there is a contract wholly in writing and an oral collateral contract.

(ii) Interpretation

116. First, it has for some time now been indicated “with tolerable clarity” (Masterton Homes, at [1]) that, in interpreting a contract, one is entitled to consider context, background and surrounding circumstances without the need first to find some textual ambiguity: [...]

117. Secondly, the rights and liabilities of the parties to a contract are determined by the “principle of objectivity”: [...].

118. Thirdly, if a written agreement has a history, “that history is part of the context in which the contract has its meaning”: International Air Transport Association v Ansett Australia Holdings Ltd (2008) 234 CLR 151 at [8]. Nonetheless, evidence of prior negotiations is, as a rule, to be excised from the “context”. The orthodoxy in this country – and the orthodoxy recently reaffirmed in English law: see Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38 – is that the negotiations of the parties prior to their contracting and their statements of their subjective intentions are, as a general rule, excluded by the parol evidence rule and cannot be used in the interpretation of the contract: see generally Lewison, The Interpretation of Contracts, 3.08 (4th ed, 2007). Given the recent decision of the House of Lords, I would note without disrespect that this rule does not as of course commend itself in all parts of the common law world and, in particular, in parts of the United States: see Restatement of Contracts, Second, §214(c); and generally, Farnsworth, Contracts, §7.12 (4th ed, 2004); Yoshimoto v Canterbury Golf International Ltd [2001] 1 NZLR 523 at [76]-[78].
119. Fourthly, although the present state of the law in this country is not yet settled on whether it is possible to use post-contractual conduct as an aid to construction of a written contract, the more favoured view is that it is not: see Masterton Homes, at [114]; FAI Traders Insurance Co Pty Ltd v Savoy Plaza Pty Ltd [1993] 2 VR 343. The criticisms of this view are, in the main, directed at its inflexibility particularly in relational contract settings: see eg GEC Marconi Systems Pty Ltd v BHP Information Technology Pty Ltd (2003) 128 FCR 1 at [351]; see also Unidroit Principles of International Commercial Contracts: 2004, Art 4.3.
120. Fifthly, a commercial contract is to be given “a businesslike interpretation”: International Air Transport Association v Ansett Australia Holdings Ltd at [8]; or as Lord Steyn put it (Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1997] AC 749 at 771); “a commercially sensible construction”.
121. Finally, I would comment that in a case such as the present where there are both a dispute as to whether the contract is or is not partly oral and claims as well of misleading or deceptive conduct in the negotiations for the contract, the evidence of the parties’ negotiations can be admitted on those issues and can result in the court obtaining an informed appreciation not only of the object and intent of the contract itself but also of individual clauses of it. Where it is found that the contract is, in fact, wholly written, to require the parol evidence rule to be applied to the construction of the contract in disregard of that informed appreciation does sit rather oddly with the concept of party autonomy.

BREACH/REPUDIATION OR VALID TERMINATION

122. The ultimate issue here is whether Hamilton validly terminated the Distribution Agreement in accordance with its terms, or else as permitted by law in the circumstances. To understand the variety of contentions this apparently simple question has raised, it is necessary to refer both to a deal of contextual material and then to the terms of the contract (insofar as presently relevant) as I find those terms to be.

1. Relevant Written Terms of the Signed Distribution Agreement

123. By way of background both parties agree that their contract contains at least those provisions contained in the Distribution Agreement they signed. Hamilton’s position is that that Agreement contains the entirety of the parties’ agreement. AMC’s position is that the agreement is partly oral as well. Importantly for present purposes, the alleged oral provisions bear directly upon the written provisions stipulating “the term” of the Distribution Agreement: cl 8; and the provision for termination of the “Licence”: cl 41.1.6.
[…]

Conclusion
260. I find, in the circumstances, that the 1999 Distribution Agreement was terminated under cl 41.1.6 on the expiration of 60 days written notice which notice was given to AMC on 13 July 2006.
261. This conclusion renders it unnecessary to consider the alternate bases advanced by Hamilton to justify termination under the 23 March 2007 notice.

PARALLEL IMPORTATION

262. The backdrop to this group of contract claims was provided by the sale in Hong Kong by persons other than AMC, of Hamilton products identical to those manufactured and packaged for AMC under the Distribution Agreement.
263. As pleaded, AMC alleges that Hamilton breached the Distribution Agreement by:
(i) failing to use its best endeavours to prevent the sale of products in the Territory by anyone other than AMC, in breach of cl 6.2; (ii) selling products in Hong Kong in breach of cl 9.1; (iii) granting similar rights to those of AMC to third parties in breach of cl 9.2.
Both injunctive relief and damages are sought.
[…]

The Contractual Setting and “Best Efforts” Clauses

267. Because of their alleged interaction it is appropriate to refer as well to cll 3, 4, 33.4, 33.5 and 34 of the Distribution Agreement. The clauses provide:

“3. Licence
Supplier grants to Distributor which accepts a Licence upon the following terms. 4. Wholesale or retail The Licence entitles Distributor to resell Products (on a retail or wholesale basis) to retail pharmacies dermatologists, medical practitioners, dentists, hospitals and scientific customers and to other persons or entities as agreed in writing between the parties from time to time. 5. Product range The Licence is only for the Products. 6. Territory 6.1 The Licence is only for the Territory.
6.2 Each party must use its best efforts to prevent the sale of Products in the Territory by persons other than Distributor (or a sub-distributor appointed in accordance with this agreement). … 9. Exclusive
Distributor’s rights under the Licence are exclusive and, without Distributor’s written consent (which Distributor may refuse without reason), Supplier may not: 9.1 sell Products in the Territory; 9.2 grant similar rights to a third party. … 33.4 Distributor must immediately inform Supplier about any wrongful use in the Territory of Supplier’s patents, trademarks, emblems, designs or similar rights of which Distributor learns. 33.5 Distributor must: 33.5.1 use its best efforts to protect the proprietary rights of Supplier; 33.5.2 help Supplier protect the proprietary rights of Supplier. … 34. Co-operation
Each party must do everything reasonable to help the other party carry out this agreement.”

268. Three aspects of cl 6.2 should be emphasised at the outset. The first is that cl 6.2 imposed reciprocal and, at least in the case of parallel importation, potentially interdependent obligations on AMC and Hamilton. Those obligations could operate upon the same subject matter for the reason that each could relate, as in the present case, to genuine Hamilton products finding their way into the Hong Kong market outside of the Distribution Agreement. Further, when considered together with cl 34, one party’s best efforts obligation could require it to do everything reasonable to help the other carry out its best efforts obligation. Secondly, the subclause did not impose a duty on either party to achieve a specific result, rather it was to use best efforts to secure that result: on the difference see Unidroit Principles of International Commercial Contracts: 2004, Art 5.1.4, Comment 1. The content of “best efforts” is considered below. Thirdly, the best efforts obligation was directed at preventing the occurrence of an undesired event, ie the sale “in the Territory” by third parties of products the subject of the Distribution Agreement. In this it was a less common form of the obligation, the more usual form being directed at procuring the occurrence of a desired result, eg the sale or promotion of a product: Hospital Products Ltd v United States Surgical Corporation (1984) 156 CLR 41 at 63-64; the exploitation of an invention: Terrell v Mabie Todd & Co Ltd (1952) 69 RPC 234; or the advancement of a business: Sheffield District Railway Co v Great Central Railway Co (1911) 27 TLR 451 at 452.
269. In relation to cl 9.1 AMC has submitted that this should be interpreted as encompassing selling products in the Territory “directly or indirectly”. Because I have concluded there is no evidentiary basis which would permit a finding that Hamilton has sold its products in breach of para 9.1 on either of the proposed bases, it is unnecessary for me to express a concluded view on this submission. Considered in context, though, it probably is the case that the proposed construction reflects the intent of the contractual provision.
270. The Distribution Agreement itself regulated directly the freedom to trade of both Hamilton and AMC in ways which respectively were designed, so far as they went, to prevent third parties in Hong Kong obtaining access to the Hamilton products for resale in Hong Kong. Clause 4 restricted to whom in Hong Kong AMC could resell the products supplied by Hamilton. Clause 9 not only precluded Hamilton from selling in the Territory, it also prohibited it granting rights to a third party similar to AMC’s rights. That the Agreement imposed such absolute restrictions on the parties in respect of their trading is, as will be seen, a matter of which account needs be taken in giving practical content to the best efforts requirement in the context of this agreement between these parties.
271. The “standard of endeavour” prescribed by a best efforts clause is characteristically measured by what is reasonable in the circumstances having regard to the particular contract in its business setting and to what could reasonably be expected of the party subject to the obligation: see Transfield Pty Ltd v Arlo Internation Ltd (1980) 144 CLR 83 at 101; see also Farnsworth, Contracts, §7.17. Or to put it shortly, the party’s obligation is “to do what [it] reasonably could do in the circumstances”: Terrel, at 237. It is nonetheless important in this setting to emphasise the importance of context in giving practical substance to the prescribed standard of endeavour. As Gibbs CJ said of a best efforts obligation in Hospital Products Ltd (at 64):
… it is trite to say that the meaning of particular words in a contract must be determined in the light of the context provided by the contract as a whole and the circumstances in which it was made, and that decisions on the effect of the same words in a different context must be viewed with caution.
Today this probably does no more than emphasise the contemporary significance of context in contractual interpretation: see Toll (FGCT) Pty Ltd at [40]; and, relevantly for present purposes, that a commercial contract is to be given “a businesslike interpretation”: International Air Transport Association at [8]; or as Lord Steyn put it (Mannai Investment Co Ltd at 771): “a commercially sensible construction”.

[…]

414. Having concluded that AMC has not proved it has suffered substantial damages as a result of Hamilton’s breach of cl 6.2 of the Distribution Agreement, I will award nominal damages for that breach of $100.

415. My conclusion has relieved me of the need to consider a significant body of evidence, expert and otherwise, and very detailed submissions from Hamilton in particular on AMC’s alleged loss of profits. I make no comment on that material beyond what has already been said.

[…]

CONCLUSION ON THE CONTRACT CLAIMS

459. I have found that:
(i) Hamilton was in breach of cl 6.2 (the “best efforts” clause) but AMC was entitled to nominal damages its claimed losses of profits not having been proved; (ii) Hamilton was in breach of cl 11.1 in consequence of its refusal to supply Products ordered on 9 May and 5 July 2006 but that AMC was entitled only to nominal damages for each breach because it failed to mitigate its losses; and (iii) the Distribution Agreement having been terminated lawfully on 13 September 2006 under cl 41.1.6, AMC’s claim for damages for Hamilton’s alleged repudiatory termination of the Distribution Agreement must be rejected.

[…]

CONCLUSION

692. As I foreshadowed at the outset, both AMC and Hamilton have enjoyed varying levels of success and reverses. I will give directions for the parties to bring in Agreed Minutes of Order to give effect to these reasons within 14 days of the date of publication of these reasons. If they cannot so agree, I direct the applicant to file Proposed Minutes of Order within that time.

693. While Hamilton alone has secured orders for other than nominal pecuniary relief, I do not consider that this matter is one in which it is appropriate to make an apportionment of the costs on an issue by issue basis. While I will give the parties the opportunity to put on submissions on costs, I should indicate my present inclination is to make no order as to costs. The submissions on costs are to be filed within 14 days of the publication of these reasons.}}

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