Malaysian Federal Court reemphasises the need for careful drafting of termination provisions

The Malaysian Federal Court in Catajaya Sdn Bhd v Shoppoint Sdn Bhd [2020] MLJU 2333 has provided its latest guidance on interpreting termination clauses under contracts governed by Malaysian law.  The decision highlights that contracts should be read strictly such that their express wording and cross-references between provisions are given effect.  For drafters, Catajaya serves as a cautionary note of the ambiguities that can arise in termination clauses and how such provisions can be drafted with greater precision.

Facts

Shoppoint Sdn Bhd (Shoppoint) was a Malaysian company whose sole asset was a piece of land in Kuala Lumpur (Land) purchased from its previous owner, Mampu Jaya. A few months following the Land acquisition, Catajaya Sdn Bhd (Catajaya) sought to purchase the entire issued and paid up shares in Shoppoint from its two shareholders (collectively the Vendors) together with Shoppoint's interest in the Land. Catajaya and the Vendors executed, among others, a share sale agreement (SSA) to effect the transaction. A dispute later arose concerning the termination of the SSA.

The SSA required Catajaya to pay the purchase price in two parts: the first comprising a set of agreed deposits; and the second being the balance of the purchase price to be settled by an agreed completion date. Section 13.1 of the SSA made time of the essence under the agreement.

While the agreed deposits were paid on time, Catajaya did not pay the balance of the purchase price by the agreed completion date. Catajaya contended that it discovered, after executing the SSA, that Mampu Jaya – the original owner of the Land – was under receivership and that it became necessary to ascertain if a change to the balance purchase price was required.

Catajaya applied to the Vendors for an extension of time for the payment of the balance of the purchase price but was rejected on the basis that time was of the essence under the SSA. In response, Catajaya lodged a private caveat on the Land.

The Vendors gave notice to Catajaya exercising their right of termination under Section 11 of the SSA, and subsequently filed an action in the Malaysian High Court for various declaratory orders to validate the termination of the agreement and the removal of Catajaya's private caveat. Catajaya challenged the validity of the Vendors' termination denying that it committed a breach of the SSA, and raised a counterclaim alleging that the Vendors had instead breached certain warranties under the SSA by failing to provide agreed due diligence documents.

High Court decision

The High Court allowed the Vendors' claims. In determining the validity of the Vendor's termination, the High Court analysed the relationship between two termination clauses under the SSA:

Section 11 – Purchaser's Breach

11.1 In the event that the Purchaser shall breach any of its obligations herein, the Vendors may by notice in writing terminate this Agreement … provided always that Completion has not taken place whereupon this Agreement shall forthwith cease to have any further effect or force and neither party shall have any further claim against the other save for antecedent breach…

Section 12 – Termination

12.1 This Agreement shall continue to be valid and binding until completion via receipt of the full Purchase Price… unless terminated earlier pursuant to Section 12.2 hereunder.

12.2 This Agreement may be terminated by either party by notice in writing to the other and wherein the consequences under Section 10 and Section 11 shall be applicable to the Purchaser and the Vendor respectively:

i) if either of the parties hereto shall commit any material breach of its obligations under this Agreement and shall fail to make good such breach within thirty (30) days from the date of receipt of noticefrom the other party requiring it to do so. (Own emphasis added.)

An issue was whether a termination under Section 11, upon which the Vendors relied to terminate the SSA, was subject to a requirement under Section 12 for a notice to remedy the default within a specified timeline. Were this the case, the Vendors' termination of the SSA would have been invalid as Catajaya was not allowed an opportunity to remedy its failure to settle the balancing payment by the completion date.

The High Court held that both clauses were independent provisions, whereby Section 11 covered termination in the event of a fundamental breach. It was viewed that a conjunctive interpretation would effectively grant more time to Catajaya to complete the purchase beyond the agreed completion date, which would be inconsistent with time being of the essence under the SSA.

Court of Appeal decision

The Court of Appeal upheld the High Court's decision, agreeing that Sections 11 and 12 of the SSA were independent provisions catering for the termination under different circumstances. It viewed that Section 11 was applicable in a situation where the agreement has been completed, even though the express wording of Section 11.1 says "provided always that Completion ha[d] not taken place", whereas a Section 12 termination applied to a termination by either party prior to the completion date.

The Court of Appeal shared the High Court's view that extending the Section 12 remedial notice requirement to a Section 11 termination would render the contractual payment deadlines ineffective. This would have contradicted the parties' intention that time was of the essence under the SSA.

Federal Court decision

Catajaya succeeded before the Federal Court, which took an entirely different view on the relationship between the two termination clauses. It found that the true intention of the parties was reflected in the express wording of both termination clauses, particularly the cross-reference to Section 11 within Section 12, which therefore required both provisions to be read conjunctively. The court viewed that to decouple the remedial notice requirement from Section 11 would be inconsistent with the rule under Malaysian law that contracts are to be interpreted strictly and in a manner consistent with the agreement as a whole.

This interpretation, in the court's view, would also be aligned with the underlying commercial sense of the SSA as Catajaya should be given an opportunity to rectify the breach having paid a substantial sum as a deposit under the transaction.

The court provided a further reminder that headings in contracts should not have any bearing on their interpretation.  It was emphasised that contractual headings do not have substantive meaning or interpretive value, and serve a limited function as a brief guide to the content of the section and for reference and identification.

Accordingly, the termination clauses had to be understood as requiring a defaulting party to be given an opportunity to remedy its default.

Key takeaways

Termination under commercial contracts are commonly governed by multiple clauses with each providing for different termination scenarios. The Catajaya line of cases highlights the importance of meticulous drafting so as to delineate the scope of each termination provision clearly and unambiguously, and that the functions of particular cross-references within the contract can be understood clearly. Any ambiguity can give rise to protracted challenges against any attempts to terminate the contract and leave parties uncertain over the subsistence of their contractual relationship, which in Catajaya lasted over ten years.

Catajaya also provides a helpful reminder of how differently termination clauses can be understood by contracting parties and the courts, which can risk parties being required to meet additional requirements prior to effecting a lawful termination. Such risks can be managed by careful drafting.

An English version of the decision can be accessed here.

For further information, please contact Peter Godwin, Lim Tse Wei, or your usual Herbert Smith Freehills contact.

Disclaimer

Herbert Smith Freehills LLP is licensed to operate as a Qualified Foreign Law Firm in Malaysia. Where advice on Malaysian law is required, we will refer the matter to and work with licensed Malaysian law practices where necessary.