Completion of sale contracts where the law changes: what it means to “carry on the business in the usual and ordinary course”

In a recent decision, the High Court has considered the proper construction of a common pre-completion obligation in sale agreements to "carry on the business in the usual and ordinary course as regards its nature, scope and manner". 

In a recent decision, the High Court has considered the proper construction of a common pre-completion obligation in sale agreements to "carry on the business in the usual and ordinary course as regards its nature, scope and manner" in the context of COVID-19 restrictions. In this article, we consider the issues explored by the decision of Laundy Hotels (Quarry) Pty Limited v Dyco Hotels Pty Limited.¹

IN BRIEF

• In March this year, the High Court handed down its decision in Laundy v Dyco, a case which concerned a contract for the sale of a hotel during COVID-19, and held that, despite the operation of the business being restricted by a public health order, the Vendor was still “ready, willing and able to complete” its contractual obligations as the Vendor was only obliged to carry on the business to the extent that doing so was lawful.
• The meaning of the pre-completion obligation to "carry on the business in the usual and ordinary course" is not only dynamic and subject to change according to circumstances, but is also to be qualified as being “in accordance with law” where this is consistent with the context of the agreement as a whole.
• This case serves as an important reminder of the primacy of contractual terms. In particular, it highlights the need for sale agreements to expressly deal with the risk of changes in law where the target is a regulated business or asset.
• Parties cannot always rely on the doctrine of frustration to avoid completion in circumstances where the performance of contractual obligations is affected by newly imposed laws or regulations.

CONTEXT: COVID-19 AND BUYER’S REGRET

The COVID-19 pandemic brought into focus the ways in which sale agreements deal with (or fail to do so) changes in the legal and regulatory landscape, including in the context of what it means to be carrying on a business in the ordinary and usual course. The impact of the pandemic on business conditions and markets naturally saw purchasers seeking to minimise their loss by looking for ways to avoid completion under sale agreements entered into prior to COVID-19. As such, this resulted in some purchasers critically reviewing whether or not there had been failures by vendors to comply with the contractual pre-completion obligation to carry on a business in the ordinary course. The case of Laundy v Dyco is one such example where this issue was examined.

CASE BACKGROUND

KEY TAKEAWAYS

The High Court identified a number of relevant factors in reaching its decision. While this case was in the context of COVID-19, the High Court’s reasoning has important implications for how the terms of sale agreements are to be interpreted more generally. In addition to the key outcome that the words “carrying on a business” in a sale agreement are generally to be interpreted as incorporating an “inherent requirement to do so in accordance with law”,⁶ parties should also be aware of the following factors when negotiating terms.

Back to basics: objective test in contractual interpretation and primacy of contract

First, the High Court reiterated that the terms of a commercial contract are to be understood objectively, by what a reasonable businessperson would have understood them to mean.

In this case, a reasonable businessperson in the position of the parties would have understood the relevant pre-completion clause to mean that from the date of the contract until completion, the Vendor was required to carry on the business “in the usual and ordinary course” in accordance with law. This was in part due to the fact that one of the warranties stated that, as at the completion date, the Licence would not be subject to any conditions “other than any condition already imposed on the Licence or automatically imposed by virtue of the Liquor Act and the Regulations under that act from time to time”,⁷ which the High Court construed as an express acknowledgment that the requirements for the lawful operation of the business were variable.

This serves as an important reminder of not only the primacy of the contract, but also that the terms of a contract as a whole are relevant to contractual interpretation. As the High Court observed, the “Vendor's warranties…expose that the regulatory environment within which the Business operated was dynamic.”⁸ Accordingly, parties that are at risk of changes to the legal and regulatory landscape should take care to ensure that sale agreements expressly deal with such risk. A key takeaway for vendors in this respect is to be aware of the common pre-completion obligation to conduct the business in a manner that is “consistent with past practice”. To avoid any doubt as to the vendor’s ability to comply with changes in laws and regulations, while also satisfying its obligations under the contract, it is important that the terms clearly state that any such pre-completion restriction is subject to a proviso that allows the vendor (and the target business) to appropriately respond to such changes.

Frustration is not always the answer

Further, parties cannot simply rely on the doctrine of frustration in circumstances where the business or asset being sold is affected by newly imposed laws or regulations, particularly where compliance with legislative requirements can clearly be inferred from the “nature, scope and manner” of the business and the commercial construct of the agreement as a whole.

Nor can parties rely on the doctrine of implied terms to impose an obligation on another party where the terms of a contract can be understood by virtue of the principles outlined above. As the High Court noted, the “past, current, and anticipated future lawfulness of the operation of the Business was objectively essential and a commercial necessity to the parties”.⁹

Warranties are reflective of the parties’ intention

The warranties given can also be used to interpret the true subject matter of a sale contract and, importantly, the risk allocation between the parties. In this case, the Vendor did not warrant that the value of the assets being sold would remain the same between the contract date and completion and the warranties given by the Vendor specifically excluded the “present and future financial or income return to be derived from the Property or the Business”.¹⁰ The High Court pointed to these factors as reinforcement that the subject matter of the contract was the business (as opposed to the value of the assets), as well as the fact that the Vendor did not accept the risk of the value of the assets reducing between signing and completion.

Accordingly, if there is concern with respect to the value of a business or asset and who bares the risk of this prior to completion, then it is important that this is dealt with in the contract. Not only will it be important to ensure that adequate warranties are included, but also that the terms of the contract are clear as to who bares this risk in circumstances where the value of such business or asset changes (for example, through a change in law or material adverse change (MAC) provision). In practice, if a purchaser is seeking an ability to avoid completion of an acquisition in circumstances where the target is materially impacted by changes to the legal landscape or other such events, then ultimately a MAC provision (either by way of condition precedent or termination right) is required.¹¹

Meaning of “in the usual and ordinary course”

Finally, the High Court noted that the phrase “in the usual and ordinary course” ultimately incorporates a requirement of lawfulness. This was particularly relevant in this case due to the Licence and the legislative scheme by which the Licence was controlled. As such, these words were said to reflect the commercial reality that ongoing legal compliance was essential to the business. However, this nonetheless has a broad application for regulated businesses or assets.

1. [2023] HCA 6 (Laundy v Dyco).
2. [2023] HCA 6, [9].
3. [2023] HCA 6, [6].
4. Dyco Hotels Pty Ltd v Laundy Hotels (Quarry) Pty Ltd [2021] NSWSC 504.
5. Dyco Hotels Pty Ltd & Ors v Laundy Hotels (Quarry) Pty Ltd [2021] NSWCA 332; (2021) 396 ALR 340.
6. [2023] HCA 6, [28].
7. [2023] HCA 6, [30].
8. [2023] HCA 6, [37].
9. [2023] HCA 6, [31].
10. [2023] HCA 6, [42].
11. For further commentary on MAC conditions in the context of COVID-19, see our article “COVID-19: Pressure Points: Material Adverse Change conditions take centre stage (Australia)”.