Public Sector

The Background To A Contract Can Be Just As Important As The Terms Of That Contract

In a recent Supreme Court decision, Planet Kids Limited ("PK") v Auckland Council ("Council"), High Court and subsequent Court of Appeal decisions have been overturned. The question was whether a Public Works Act 1981 ("PWA") agreement between the parties was frustrated by the inability of PK to exactly comply with some of the terms of that settlement agreement and accordingly should be terminated.

The Supreme Court looked at the settlement arrangements between the parties in a broad manner rather than relying on strict interpretation of the contract provisions themselves and made it clear that the compensation provision in the PWA were not relevant as an agreement as to compensation had been entered into by those parties.

Background

Council was landlord of premises leased by PK and in October 2009 gave notice of its desire to acquire PK's leasehold interest under s 18 of the PWA in order to undertake road works on the land. Negotiations followed between the parties.

By the end of April 2010, PK and Council had reached substantial agreement on the terms of the settlement agreement. PK was advised that there was urgency "as this agreement is the sole outstanding document that will enable the Council to continue its tender process". The settlement agreement was signed on 3 June 2010, with a settlement date of 20 December 2010.

In early August 2010, PK's staff were advised of the pending closure of the business. Around 7 September 2010, parents of children attending PK were advised of the pending closure of the business.

Tender for the works affecting the property.

The tender was awarded by Council to the successful tenderer on 1 October 2010.

On the night of 2 October 2010, PK's premises were destroyed by fire. As a result, a clause of the lease between PK and Council brought the lease to an end. The relevant part of that clause provided for termination of the lease if the premises were "destroyed or so damaged by fire ... so as to be rendered untenantable or unfit for business or occupation".

The recitals of the settlement agreement recorded that:

  1. PK carried on business as a childcare centre from land leased from Council;
  2. Council needed to obtain possession of and demolish the premises to enable it to complete certain road works;
  3. this would necessarily require the closure of PKs' business;
  4. the parties negotiated a basis for payment under the PWA; and
  5. as PK had been unable to locate comparable premises, it had been agreed that the payment of "compensation on the basis of business relocation and disturbance was not considered either a fair or appropriate basis for payment of compensation". Therefore PK was to be compensated for the loss of goodwill arising from the closure of the its business, calculated on the same basis as if PK had sold its business to Council as a going concern.

The settlement agreement further provided:

  1. Council would pay PK in full and final settlement of any claim for compensation that PK had under PWA and arising directly or indirectly out of the undertaking of the works by Council and the closure of PK's business. PK accepted payment on that basis for the goodwill of the business, together with certain chattels and plant on the premises, and a sum sufficient to reimburse the reasonable valuation, accountancy and legal fees incurred by PK relating to the negotiation and settlement of the agreement ("the compensation").
  2. on the settlement date, PK was required to yield up vacant possession of the premises and deliver:
    1. a validly executed surrender of the lease; and
    2. a validly executed restraint of trade covenant on the agreed terms;
  3. in consideration of PK entering into the settlement agreement, certain arrears of rent owing were forgiven;
  4. PK's business remained at its sole risk until the settlement date;
  5. PK acknowledged that Council was not purchasing the business and it therefore remained liable for all liabilities of the business and agreed to indemnify Council in respect of all claims that arose in relation to such liabilities, whether incurred before or after the settlement date of the agreement;
  6. Council was entitled, after execution of the settlement agreement, to enter the land to conduct any investigations into the land or any preliminary works, provided 48 hours notice was given and the investigations and works did not, without the consent of PK, interfere with the conduct of its business.

Section 68(1) of the PWA provides that the owner of any land acquired under the PWA for a public work shall be entitled to compensation for:

"(a) business loss resulting from relocation of the business made necessary by the taking or acquisition which loss, unless the owner and the Minister or local authority otherwise agree, shall not be determined until the business has moved and (if the circumstances so require) until sufficient time has elapsed since the relocation of the business to enable the extent of the loss to be quantified; or

(b) loss of goodwill of any such business, if-

(i) the land is valued on the basis of its existing use; and

(ii) the owner gives such assurances and undertakings not to dispose of the goodwill and not to engage in any similar trade or business as may be required by the Minister or local authority."

The Question considered

The question arose as to whether the fire rendered performance of the settlement agreement impossible or so radically different that the agreement had been "frustrated" and the contract brought to an end at the time of the fire.

The Court's Decision

The Court came to the following conclusions:

    1. The fire did render parts of the settlement agreement impossible to perform.  Following the fire, PK could not deliver:
    2. (a) a validly executed surrender of the lease; and 
      (b) the chattels and plant that were lost in the fire.
    1. A number of benefits had been enjoyed under the contract and some still could be performed, including:
    2. (a)Council's forgiveness of the disputed rent; and
      (b)Council's right of entry onto the land before the settlement date.

The settlement agreement was not an agreement for the sale of a business.  The goodwill figure was a notional amount for loss of goodwill caused by Council's intended acquisition of the PK lease because of the road works.

  1. Closure of PK's business was a necessary consequence of the agreement to surrender the lease.  The closure of PK's business was underway before the fire.
  2. Where there remain significant aspects of a contract that can still be performed the case is one of partial impossibility only.  In such cases, a contract is only frustrated if the main purpose of the contract is defeated.
  3. In this case, what had already been performed and what could still be performed (despite the fire) were significant enough to render this a case of partial impossibility only.
  4. The main focus of the settlement agreement was on the closure of the business and the compensation to be paid for the closure, rather than on the surrender of lease.  The formal surrender document was a technicality as the lease was not registered.
  5. The benefit for Council was "acquiring" the surrender of lease so that it would have an unencumbered freehold interest, as was necessary for it to undertake the road works.  The fire, far from having thwarted this, in fact brought forward the date of termination of the lease.

Summary

In the Court's view, the main purpose for both parties in entering into the settlement agreement, as against letting the compulsory acquisition take its course, was certainty of outcome, timing and amount of compensation.

The Court found the main common purpose of the contract was to settle the PWA dispute and achieve certainty that the PK lease would be terminated, to identify the timing of that termination and to set the amount of compensation payable for the consequential closure of PK's business. This purpose of certainty was not thwarted by the fire but was, for all practical purposes, fulfilled before the date of the fire. Indeed, the dispute was settled immediately upon entering into the settlement agreement.

Therefore notwithstanding PK was unable to meet certain of its obligations under the settlement agreement, the failure to do so did not bring the settlement agreement to an end as the common purpose of the settlement agreement was still achieved, albeit by different means and Council was accordingly required to meet its financial obligations under the agreement (adjusted to take account of insurance payments received by PK).

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The contents of this publication are general in nature and are not intended to serve as a substitute for legal advice on a specific matter. In the absence of such advice no responsibility is accepted by Brookfields for reliance on any of the information provided in this publication.

 

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