Squire Patton Boggs has secured victory for its client in the Court of Appeal in one of the first cases to apply the Supreme Court’s seminal ruling in Wood v Capita on the approach to contractual interpretation.
What happened in this case?
Squire Patton Boggs acted for Process Components Limited (PCL).
KPTL was a company operating in the field of powder processing and handling. Its business consisted of four areas known as ‘Unit Machines’, ‘Systems’, ‘Mucon’ and ‘Spares’. KPTL owned a number of intellectual property rights, including the brand name ‘KEK’, which was a registered trade mark (No. 2506657).
On 30 June 2009, KPTL went into administration. It entered into two asset sale agreements; one with PCL for the assets of the Mucon and Spares businesses (the ‘PCL Agreement’) and, ten days later, an agreement with KGL for the assets of the Unit Machine and Systems businesses (the ‘KGL Agreement’). PCL and KGL also entered into an agreement by which PCL licensed KGL to use intellectual property rights that had formerly belonged to KPTL (the ‘Licence’).
The asset sale agreements were unclear on which of KPTL’s intellectual property rights had been transferred to PCL and KGL respectively. The High Court held that, properly construed, the PCL Agreement transferred the intellectual property rights in the Mucon and Spares divisions to PCL. KGL had appealed against that, and other aspects of, the High Court’s ruling.
Intellectual Property Rights (IPR)
The Court of Appeal’s task was to interpret the asset sale agreements.
KGL argued that, as both agreements were part of the same administration, they must be read together, not as a “suite of documents” as such, but taking into account the factual background known to the parties when they entered into the agreements. All of the parties knew that KPTL was in administration and that the administrators were under an obligation to realise KPTL’s assets for the best price they could. It was, therefore, obvious (common sense) that the administrators would not have intended to sell the Unit Machine and Systems businesses to KGL without the accompanying IPR, as this would have seriously depreciated the value of the assets being sold. This meant that the PCL Agreement must be interpreted as transferring to PCL the IPR it needed for the business it had acquired, and the KGL Agreement as transferring to KGL the IPR it needed for its business.
The Court of Appeal held that the agreements should not be read together. It was a general rule that the subsequent conduct of the parties to an agreement cannot affect the true interpretation of it. Similarly, the agreements were not “contemporaneous contracts made between the same parties which formed part of a single composite transaction”.
The Court disagreed with KGL’s arguments on the relevance of factual background. It held that the admissible factual background relevant to interpretation is limited to facts that were known or reasonably available to both (or all) of the parties (not only to one of them), disregarding subjective intention about what the contract means. Following Wood v Capita, the Court emphasised that reliance on commercial common sense and background should not be used to devalue the importance of the language used. KGL’s argument, it said, was entirely dependent on background and commercial common sense. There would be no depreciatory effect on the overall outcome of the administration if the assets were sold for more under the PCL Agreement than they would have been had more limited IPR been transferred. In addition, it was an overstatement to say that KGL could not operate its business without ownership of the IPR, as all of the parties knew that PCL would grant an IPR licence to whoever acquired the Unit Machine and Systems businesses.
Accordingly, there was nothing in the language of the PCL Agreement or the admissible background to support KGL’s argument that the IPR had been divided according to business need. Interpreting the PCL Agreement independently of the KGL Agreement, the Court held that KGL had not acquired the IPR in the business divisions it had purchased.
Rectification or construction?
The Court considered how to deal with an error in the PCL Agreement. Reference had been made to the “registered trade mark number 46553 KEK”. Trade mark 46553 KEK was not, in fact, registered. There was a registered trade mark for KEK, but this had the number 2506657.
The Court adopted the (relatively rarely used) principle of falsa demonstratio non nocet (“a plain misdescription does no harm”). It held that either the number of the trade mark mentioned in the PCL Agreement must be rejected, or the description of the trade mark as registered must be rejected; the two could not stand together. The Court was entitled to place weight on the description ‘registered’ and to reject the number, replacing it with the correct number. The Court emphasised that, in doing this, it was not rectifying the contract but merely interpreting it. Rectification and interpretation were two different things. The Court approved earlier rulings that had said, “there is no … limit to the amount of red ink or verbal rearrangement or correction which the court is allowed.”
The Court also considered the termination provisions in the Licence. They provided as follows:
10.1 Each party agrees to keep the terms of this Agreement confidential…
11.2 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 material breach).
In August 2015, Kason Industries Inc had bought all of the shares in KGL and KGL had supplied Kason with a copy of the Licence as part of the due diligence process. PCL argued that this was a breach of clause 10.1 and terminated the licence pursuant to clause 11.2. KGL argued that clause 10.1 was subject to an implied term that permitted it to disclose the agreement for reasonable business purposes.
The Court confirmed that a term will not be implied into a detailed commercial contract unless it is necessary to give the contract business efficacy or is so obvious it goes without saying. The key point here is that the term must be necessary to give business efficacy to the contract, not some wider business purpose of a contracting party. The business purpose of the Licence was to enable KGL to operate the Unit Machine and System businesses. A sale of KGL’s business was not a necessary business purpose of the Licence itself. Nor was such an implied term so obvious it went without saying. It was by no means obvious that PCL would have consented to the disclosure of the Licence to a competitor.
KGL argued that clause 11.2 of the Licence should be interpreted as saying that a material breach of clause 10.1 would be non-remediable, entitling PCL to terminate the licence; not that any breach of clause 10.1 would be deemed to be material. The Court rejected that argument. The natural meaning of 11.2 was that breach of clause 10.1 was deemed to be a non-remediable, material breach. To hold otherwise would shift “material” from its position in the clause (“breach of the confidentiality obligations under clause 10 constitutes a non-remediable material breach”) to the beginning of the phrase (“material breach of the confidentiality obligations under clause 10 constitutes a non-remediable breach”). However, that would entirely change the natural meaning of the phrase. Accordingly, PCL had been entitled to terminate for KGL’s disclosure of the Licence to Kason. The Court went on to add that a material breach of a confidentiality obligation was generally unlikely by nature to be capable of remedy as the cat was already ‘out of the bag’.
In Wood v Capita, the Supreme Court held that, when interpreting a contract, the courts should give effect to the natural meaning of the language. Where there are two competing interpretations of potentially equal merit, then the interpretation that makes commercial common sense should be preferred. The PCL ruling is interesting as an early application of Wood v Capita, the Court of Appeal emphasising that language is key. Those drafting agreements should be aware that a contract will mean what it says. Perhaps there is now increased pressure to get the drafting right.