Elite Underlay Ltd v Eco Rubber Industries Ltd

• Jurisdiction: New Zealand
• Judge: Courtney J
• Judgment Date: 29 March 2018
• Neutral Citation: [2018] NZHC 571
• Court: High Court
• Docket Number: CIV-2017-404-001871
• Date: 29 March 2018

In the Matter of an appeal against the decision of the District Court at Auckland

Between

Elite Underlay Limited

Applicant

and

Eco Rubber Industries Limited

Respondent

[2018] NZHC 571

CIV-2017-404-001871

IN THE HIGH COURT OF NEW ZEALAND

AUCKLAND REGISTRY

I TE KŌTI MATUA O AOTEAROA

TĀMAKI MAKAURAU ROHE

Company, Contract — appeal against a District Court (“DC”) decision which found that a management fee in a sale and purchase agreement was only payable while there was an operation that needed to be managed — premises damaged by fire — production ceased — whether management fee still payable

Appearances:

M D Branch for Applicant

M C Donovan for Respondent

JUDGMENT OF Courtney J

Introduction

1 In 2013 Elite Underlay Ltd (Elite) had a business in Hamilton manufacturing carpet underlay using recycled rubber crumb from the tyre industry. It agreed to sell the business to Eco Rubber Industries Ltd (Eco Rubber). Under the contract, Elite was to continue managing the business. Eco Rubber was to pay Elite $3,000 plus GST per month for management services for the first 36 months and $4,000 plus GST per month thereafter. This arrangement could only be terminated by agreement or by Eco Rubber if Elite was negligent in managing the business.

2 Two months after the contract was entered into, the oven used to manufacture the underlay was badly damaged by fire. Some repairs were undertaken but before they were completed Eco Rubber decided to cease production altogether. It dismantled the oven, moved it into storage and stopped paying the management fee. Elite sued for the management fees due from the first month of non-payment to 1 July 2015 ($44,850) and a declaration as to Eco Rubber's liability to pay $4,000 plus GST until 31 October 2023.

3 Judge B A Gibson found that the management fee was only payable while there was an operation that needed to be managed, and the contract did not require Eco Rubber to continue paying the management fee once production had ceased. Elite appeals. It says that the Judge wrongly interpreted the contract as a result of:

• (a) failing to consider the issue of termination;

• (b) wrongly treating Elite's bargaining position as a relevant consideration in the interpretation of the contract and, in doing so, making factual findings that were not supportable on the evidence;

• (c) relying on inadmissible evidence of the parties' subjective intentions;

• (d) failing to take into account evidence of clauses deleted from drafts of the contract;

• (e) failing to apply the contra proferentem rule against Eco Rubber; and

• (f) failing to consider the commercial absurdity resulting from the construction contended for by Eco Rubber.

Factual background

Elite's history

4 Prior to 2013, Elite's director and shareholder, Surindar Nanua, had some years' experience in the manufacture of rubber underlay using recycled rubber. In 2009, he became involved with two companies, Pinnacle Underlay Ltd and Impacta-phonic Ltd (together Pinnacle), which produced carpet underlay from recycled rubber. Mr Nanua also owned the intellectual property associated with the manufacturing process and was paid by Pinnacle for it.

5 Pinnacle did not succeed. The two directors wanted to concentrate on their other businesses. Mr Nanua's ownership of the intellectual property prevented a sale of the business. The other shareholders refused to pay the lease, which Mr Nanua had guaranteed. In early 2013, the plant was closed temporarily pending resolution of safety issues identified by the Department of Labour.

6 Mr Nanua decided to establish a new business. He incorporated Elite in May 2013. Superior Turf & Sports Ltd (now called Super Turf Ltd) requested a price list for underlay to use underneath artificial grass. Mr Nanua and Mr Brett Jenkins, a director of Super Turf Ltd, discussed the manufacture of high-density underlay best suited for safety surfacing that would comply with fall height requirements.

7 Mr Nanua set about attending to the issues identified by the Department of Labour inspectors and Elite commenced production in July 2013. It spent some $20,000 on new equipment suitable for manufacturing the higher density shock pads that Super Turf Ltd was looking for, undertook tests and discussed the results with Mr Jenkins and Super Turf Ltd's other director, Mr Byron Ballan.

Eco Rubber buys Elite's business

8 Mr Jenkins and Mr Ballan had been finding it difficult to source suitable underlay and proposed acquiring Elite to ensure a reliable and economic supply of first-grade rubber underlay. After some weeks of negotiation, the parties entered into the agreement that is the subject of this appeal. The agreement was drafted by Mr Ballan, with input from Mr Nanua. Neither party obtained legal advice, though Mr Nanua did discuss the sale with his accountant.

9 Eco Rubber was the named purchaser under the agreement, which was recorded as being for the “purchase of the assets and business of Elite Underlay Ltd”. The relevant clauses were:

From the 1 ^st of November 2013, being date of takeover, Eco Rubber Industries (ERIL) will be responsible for all legitimate running and purchase expenses relating to the business of Elite Underlay Ltd (EUL), except for interest and repayment obligations to the ANZ Bank or any other creditor of EUL that relates prior to the 1 ^st of November 2013.

…

• • EUL and ERIL acknowledge the assets and business of EUL are being sold as a going concern for GST purposes. …

• • ERIL's obligations include taking over the Lease of the premises at 47 Northway Street and ERIL will endeavour to provide alternative security in order to release [Mr Nanua] from his personal guarantee over the Lease.

• • From the 1 ^st of November, production will directed to producing the 10mm thick, 1.5 meters (sic) wide, 20 meters (sic) long rolls of 1 ^st grade rubber matting currently manufactured by EUL or as otherwise directed by ERIL. Any direction by ERIL to change production will not disadvantage EUL in regards any payments due to it.

• • When appropriate, as agreed between EUL and ERIL, EUL will use its resources, including the ANZ overdraft facility, to buy any equipment necessary to achieve a second mixer, when required to increase monthly production towards 10,000 square meters [sic].

• • For the first 36 months after the 1st of November, ERIL will pay EUL a fee of $3,000 plus GST per month, to manage staff, manage the production, document the manufacturing process and train new staff as required.

• • After 36 months ERIL will pay EUL $4,000 plus GST per month, plus a management bonus of 20 cents per square meter [sic] for 1 ^st grade product over 5,000 square metres in a month.

• • This arrangement will continue until it is mutually agreed that it should cease, or earlier if in ERIL's reasonable opinion, EUL has been negligent in its management responsibilities and EUL having been advised in writing of ERIL's reasonable concerns, EUL fails to address the concerns to ERIL's reasonable satisfaction, within 30 days.

For 36 months after the 1 ^st of November ERIL will make a Lease to Own payment for all the assets of the business of EUL including any Intellectual Property. The monthly Lease to Own payment will be $1,000 plus GST, regardless of production volumes, and 65 cents plus GST for every square meter [sic] of 1 ^st grade product produced in a month.

• • EUL will advise their Insurance Company that from the 1 ^st of November, ERIL has a ‘financial interest’ in the business and insured assets of EUL.

  …

• • In addition to monthly Lease to Own payments for the assets of the business of EUL, a monthly royalty is payable by ERIL to EUL, or as directed to an entity or person of EUL's choice, or any other associated entities where the EUL's intellectual property is used. The monthly royalty is 20 cents plus GST for every square meter [sic] of 1 ^st grade product produced from 1 ^st November 2013, for a period of 10 years. Monthly proof of production quantities are to be provided to EUL, should EUL cease to manage the business.

  …

• • All parties to this Agreement (and any associated entities) agree that for a period of 10 years, after the 1 ^st of November, they will not set up, manage or direct any business to compete with any party named in this Agreement either directly or indirectly, nor disclose any information to 3 ^rd parties regarding the business or intellectual property of ERIL, EUL or Surindar Nanua as it relates to ERIL and EUL, without the express approval of ERIL or EUL as the case may be.

• • Notwithstanding any other clause in this Agreement, all parties must agree in writing that for this Agreement to cease or be changed, that those changes must be noted accordingly and signed by all parties to the Agreement. …

(emphasis added)

10 Elite's case centred on the three italicised clauses. Together they were referred to in submissions as “the Management Agreement”. For convenience, I use the same expression.

A fire destroys the oven

11 In January 2014, there was a fire at the factory in Hamilton. The oven used to manufacture the rubber underlay was seriously damaged and production had to cease. Elite made a claim on its insurance policy. A valuation obtained for this purpose put the market value of the plant (including oven, controls, cooling and extraction units) on a going concern basis at $408,000. The insurer paid Elite $392,500. Elite paid $340,000 of that to Eco Rubber. Mr Nanua's explanation for not paying the full amount was unclear but was not an issue in the appeal.

12 It is obvious from the level of the insurer's payment compared to the pre-fire valuation that the insurer treated the claim as a total loss, which would be consistent with two opinions provided at the...