Contractual interpretation - Process Components Ltd v Kason Kek Gardner Ltd 2016 EWHC 2198 Ch

Should a contract be construed in light of a common assumption between the parties?

The facts

In 2009, Kemutec Powder Technologies (KPT) went into liquidation and entered into a pre-pack agreement with Process Components (PC). PC alleged that the object of the pre-pack agreement was to confer the rights to manufacture the machines and spare parts, together with related IP rights. Two weeks later, KPT entered into a separate sale agreement with Kason Kek-Gardener (KKG).

Later in 2009, PC entered into a licence agreement with KKG. The licence agreement expressly provided that PC owned all of the IP rights and granted KKG an exclusive licence to assemble and sell the machines. Clause 10 provided that the terms of the licence were to be kept confidential. Clause 11.2 stated that:

"Either party shall be entitled to terminate this Agreement immediately by written notice to the other in the event of:

a) Any material breach by the other party of any of its obligations under this Agreement which, being a breach capable of remedy, is not remedied within 30 days of notice to the party in breach specifying the breach and requiring its remedy. (For this purpose, non-payment of any royalty under clause 5 constitutes a remediable material breach and breach of the confidentiality obligations under clause 10 constitutes a non-remediable breach)."

In 2015, a competitor of PC bought KKG. As part of the due diligence process, KKG provided a copy of the licence agreement to the purchaser. In October 2015, PC purported to terminate the licence agreement for breach of the confidentiality obligations in clause 10.

The issues were: (1) whether PC or KKG owned the IP rights; and (2) whether the licence agreement had been validly terminated by PC.

The decision

PC relied upon the "common assumption" principle, namely that where PC and KPT’s administrators had acted before and after the contract on a common assumption that PC would buy all of the KPT’s IP rights – a common assumption which was also shared KKG – the pre-pack agreement ought to be construed in light of that common assumption.

However, the Court rejected this as the assumption relied too much on the subjective intentions of the parties. The Court relied upon Arnold v Britton that only the terms of the contract should be taken into account, except in a very unusual case. The pre-pack agreement had to be construed as a whole according to its terms, and, on that basis, it did not operate to sell all of the IP rights to PC.

As to termination of the licence agreement, KKG argued that it was ludicrous to take clause 11.2 at face value since the confidentiality clause covered both serious and more trivial breaches. But the Court found that the parties to an agreement were entitled to expressly stipulate in the contract the conditions that would enable the parties to terminate the contract (as per the Court of Appeal in Hongkong Fir Shipping Co Ltd v Kawasaki Kisen Kaisha Ltd [1962] 2 QB 26). The confidentiality clause was either a condition or an innominate term entitling the innocent party to immediate termination. In any event, showing the licence to the purchaser of KKG (a competitor of PC) also constituted a repudiatory breach.

PC also argued that it could rely on rectification and/or estoppel as it was always the intention to confer all of the IP to PC and KKG had acted on that basis. The Court found that rectification of the pre-pack agreement was not possible because KPT was not before the Court and there was no one before the Court who could speak of KPT’s intentions at that time.

On the question of estoppel, it was unfair and unconscionable for KKG to comply with the licence agreement for so long without query until it was taken over by another company. KKG was therefore permanently estopped from denying that PC owned the relevant IP.

Why is this important?

The decision is a good example of the Court applying a number of established principles to complex and difficult factual circumstances. On contractual interpretation, it is the words of the relevant agreement and the objective intentions of the parties (not their "common assumption") which are relevant. The parties are entitled to stipulate the grounds for terminating their agreement. An estoppel may arise from a party’s course of conduct, even though the estoppel may be "permanent".

Any practical tips?

Ensure that the agreement correctly describes the parties’ intentions – common assumptions and subsequent dealings may not assist.

Also take care when drafting "material breach" clauses. Where the parties expressly state that a breach entitles a party to terminate the agreement this may well be determinative (even if it is not a serious breach).

But, notwithstanding the contractual provisions, if a party has adopted a particular course of action over a period of time, which another has relied upon, it may establish an estoppel preventing the party acting inconsistently with that established course.