Judgments give a superficial insight to disputes and the influences on the protagonists – for example, NZX Ltd v Ralec Commodities Ltd and others [2016] NZHC 2742. There were some harsh lessons here. This article will introduce some of those lessons, briefly state the relevant facts and then discuss one view of the lessons.
Facts of the dispute
NZX sought expansion by following Bloomberg’s example of selling market information, but in the agri business. They identified Ralec’s electronic grain trading platform and business as a means to pursue that ambition. After identifying the opportunity on 14 July 2009 “[i]t was a case of a very willing seller and a very willing buyer. This probably contributed to both sides materially overstating their position in pre-contractual dealings with the other”. The terms were signed on 4 September 2009 and a final agreement was settled on 30 October 2009.
The price was AU$7 million payable on settlement with equally substantial performance indexed additional payments possible thereafter. Post settlement NZX was obliged to “ensure that the Businesses are resourced and financed to an extent which in the reasonable opinion of [NZX] is appropriate, having regard to the criteria which must be met in order for the [earn out] payments to be made,...”.
The Court found NZX had overstated the prospects of it investing a further AU$100 million as part of a pattern of overly-enthusiastic views by CEO Mark Weldon. His email asserting the desirability of contracting in the language of business rather than legalese proved ironical in hindsight. The businesses acquired failed to meet even worst-case expectations. NZX never considered the extent of resources required to meet the earn-out targets. Relationships rapidly deteriorated after settlement with the key personnel and guarantors at Ralec departing.
NZX asserted the final terms meant its overstatements had no legal effect and the Court largely agreed. From 2011 there were nine hearings, culminating in the 38-day hearing over 10 weeks.
Words in a commercial contract probably mean something
The Agreement for Sale and Purchase (ASP) obliged NZX to “…ensure that the Businesses are resourced and financed to an extent which in the reasonable opinion of [NZX] is appropriate, having regard to the criteria which must be met in order for the [earn out] payments to be made,...”.
NZX argued the clause left it essentially unfettered while Ralec argued it almost required NZX to fund the businesses so they met the criteria. The judgment inquired what “a reasonable and properly informed third party would consider the parties intended the words of their contract to mean.” It conventionally identified the matrix of fact which might affect that understanding such as the commercial context and pre-contractual negotiations.
The relevant clause dealt with post-completion obligations for Ralec’s benefit. Pre-contractually NZX emphasised its resources to, and interest in, making the businesses successful. The obligation was mandatory, “the purchaser shall…”, and extended to both money and resources. The Court focused on how was the ‘reasonable opinion’ to be assessed and what was required of NZX to ‘have regard’ to the criteria.
“reasonable opinion”
NZX argued it need only to be in its reasonable opinion following what is labelled the Wednesbury test for reasonableness intended to stop unreasonable or arbitrary behaviour. The Court distinguished between constraints on discretions inserted for the benefit of the decider as opposed to those for the benefit of the other, non-deciding party. “The reasonableness of the resourcing decision is to be objectively gauged having regard to what would be needed for the businesses to reach the earn-out targets.” (at [324]).
“have regard to”
This aspect ranged from mandatory to discretionary. The approach used in relation to statutory powers, consideration without mandatory weight, was rejected. “In assessing the parties’ objectively reasonable intention, there would be no point in including a clause that did not require NZX to consider the resources to reach the earn-out targets, and have some level of regard to the view formed about it.” (at [329]). This was not an unqualified obligation to resource.
There was no evidence of NZX considering the resources required to meet the earn-out criteria. NZX’s argument, that efforts to maximise the performance of the businesses implicitly included the required consideration, (at [348]-[349]) was rejected. The words were chosen by independently advised experienced parties not subject to disabilities or duress. They were interpreted and applied by the Court.
Contemporaneous evidence against a party’s interest will be difficult to disown
NZX sought damages on two bases. First, reliance losses for sums committed to the businesses that were said to be wasted (at [461]) of AU$13.76 million. Secondly, expectation loss being the difference between what it got and what it should have got if what it was represented were true. This expectation ranged from AU $33.5 million to AU $44.2 million. NZX did not quantify its losses until four years after it issued the proceedings.
The judge cited Tipping J in Marlborough District Council v Altimarloch Joint Ventures Ltd [2012] NZSC 11 warning there were no rules with damages assessed as a question of fact. Analysis of the losses was based on accounts prepared by NZX and undertaken by an independent forensic accountant. The expectation loss was not strongly supported by the expert due to numerous uncertainties. The Judge described the prospects of NZX making out the expectation losses as unrealistic (at [485]) even on a loss of a chance basis (at [486]). NZX’s own arguments in defence of the Ralec counterclaim, that there was no chance of the earn-out, conflicted with its own expectation loss claim.
NZX’s evidence was criticised for its disregard of its own valuation of the assets acquired adopted following settlement; as is for about AU$7 million. In December 2009 the NZX Audit and Risk Committee confirmed management’s assessment of value of the software alone at AU$13.2 million. Another NZX valuation suggested a worst-case value of NZ$9 million.
Subsequent to settlement of the purchase, the assets acquired were regularly tested by NZX for value impairment. Four years after completion, and two and a half after commencement of the proceedings, impairment of NZ$2.41 million occurred including NZ$395,000 goodwill, with the rest applied to the carrying value of the intangible software (at [502]).
While NZX sought to distinguish its own valuations the judgment stated [499]:
“I am not persuaded that the different context in which that valuation was prepared requires it to be disregarded in considering the loss that NZX has claimed in the proceeding.”
NZX’s two witnesses on this aspect of the claim agreed that if NZX’s valuations were accepted there was no meaningful reliance loss.
The overwhelming proportion of the purchase price was for the software rights which on NZX’s own valuations it got value. As NZX paid no more and was found not liable to pay any more it got full value. The remainder of the transaction was for a high-risk endeavour with unpredictable capital requirements (at [516]). Some of NZX’s earlier valuations were contemporaneous and mostly against its interest so very likely to be adopted.
Contracting parties don’t readily form a fiduciary relationship
Ralec pleaded that NZX owed it fiduciary duties due to their being in a joint venture with Ralec having reposed trust and confidence in NZX in the manner in which it managed the businesses. The Court confirmed the established approach. Unless the relationship is one of a few special types such as solicitor/client or agent/principal, the particular relationship must be examined.
A joint venture is not within those particular relationship categories. A consistent characteristic is the entitlement of a claimant to place trust and confidence in the other party.
No single formula or test for identifying such relationships has been settled (Chirnside v Fay [2006] NZSC 68 at [75]). While the Court accepted Ralec was vulnerable to NZX, it found it was unnecessary for Ralec to repose trust and confidence in NZX. While the contract created a shared interest in the businesses doing well that was said to be so in all contracts involving deferred consideration, thus insufficient to comprise a joint venture let alone a fiduciary relationship (Paper Reclaim Ltd v Aotearoa International Ltd [2007] NZSC 26, at [31]).
A breach of contract attracts no remedy unless damage is caused by the breach
This consequence for NZX arose in relation to its damages claims and the judgement as to the finding NZX had breached its obligation to reasonably commit funding having regard to the earn-out scheme. Further, in considering whether Ralec could make out a recoverable loss (starting at [529]) the Court found it must show:
- That a different level of resourcing, which NZX could reasonably be expected to have committed if it had regard to the earn-out targets would have resulted in the targets being met; or
- Loss of the chance to achieve that outcome.
Ralec postulated strategies that NZX could have applied to the business so as to trigger the earn-outs. The Court found that the earn-out targets would not be achieved and that there was no reasonable prospect of that occurring (at [625]) having regard to NZX’s reasonable range of choices as to how it ran the businesses. The existence of alternatives to what it actually did is insufficient to establish on the balance of probabilities that the failure to consider the earn-out as contractually required caused the loss of the earn-out or even a chance to achieve it.
Judicial findings rarely amount to a good public relations strategy
Justice Dobson, a specialist in securities and commercial law, said:
“[16] Both sides were exceptionally keen to consummate a deal. It was a case of a very willing seller, and a very willing buyer. This probably contributed to both sides materially overstating their position in pre-contractual dealings with the other.”
After a short period of due diligence, settlement occurred. The CEO of NZX promptly fell out with the leading shareholders at Ralec. The inability to meet targets was said to be quickly apparent. It was not until November last year that NZX exited via a management buy-out of the businesses it had acquired. The price paid is confidential and said not to be material to NZX, so probably small. It does appear as if the failed purchase was compounded by an inability to promptly develop a cure or exit strategy.
The National Business Review quoted NZX’s CEO as estimating its legal costs at about NZ$10 million without costing NZX’s own staff time. Ralec, as a defendant, seemingly had little choice but to defend these massive claims but its counterclaims may have made the litigation difficult to settle.
There are numerous findings in the case that those subject to them would have preferred not to read or have read. While the Judge called it a “nil all draw” both sides suffered substantial public relations damage.
Alan Sorrell is an Auckland barrister at Bankside Chambers. Since 1974 he has acted in a wide range of contract, partnership and shareholder disputes, securities regulation issues, and real property, trust and estate matters.
The Lessons
- Words in a commercial contract probably mean something.
- Contemporaneous evidence against a party’s interest will be difficult to disown.
- Contracting parties don’t readily form a fiduciary relationship.
- A breach of contract attracts no right to damages unless the breach causes loss.
- Judicial findings rarely amount to a good public relations strategy.
NZX alleged
- Misrepresentations induced it to purchase businesses from Ralec.
- There were overlapping breaches of warranty and the Fair Trading Act.
Ralec alleged:
- NZX defaulted on financially resourcing the businesses thus thwarting the earn-out aspects of the transaction.
- NZX made pre-contractual misrepresentations and breached the Fair Trading Act.
- NZX subsidiary and CEO owed Ralec a tortious duty of care, fiduciary obligations and had knowing involvement of NZX’s breach of the Act.
Despite findings in favour of both parties no money is to change hands and each party is likely to bear its own costs; what the Judge called a “nil all draw.”