This appeal concerns whether the appellant, WEL Energy Group Limited ("WEL"), an electricity wholesaler, was entitled to give notice of termination of a hedge contract to the counter-party, Electricity Corporation of New Zealand Ltd ("ECNZ"), in circumstances where ECNZ had proceeded to sell the major part of its business or undertaking without obtaining WEL’s consent. In practical terms, the matter to be determined is whether under a contractual provision WEL unreasonably withheld that consent in the particular circumstances. The failure to obtain a necessary consent was a stipulated Event of Default entitling the other party to give notice of termination of the hedge contract.
As matters stood at the relevant time, there was substantial financial advantage to WEL if it could exit the hedge contract, and corresponding disadvantage to ECNZ.
Over a period of several years, culminating in changes provided for in the Electricity Industry Reform Act 1998, passed in July 1998, the Government made very substantial changes to the electricity generation and distribution industry. In two stages the large state-owned ECNZ was broken up and its assets distributed to other entities. In 1996 a competitor, Contact Energy Ltd, was created and about 27 percent of New Zealand’s generating capacity was vested in it. At that time ECNZ retained approximately 70 percent of that capacity.
With the arrival of competition a spot market for wholesale electricity was created in which prices could move every half hour. The Government recognised that it was desirable that hedging arrangements be available for those trading in this market. It is common ground that participants in such hedging contracts required them for the conduct of their electricity trading business. They were not engaged in speculation.
The hedge contract with which this appeal is concerned was entered into in March 1998, not long before the Government announced that it was intended to break up the remaining generation capacity of ECNZ. Eventually three new competitive generators were formed — Genesis, Mighty River and Meridian.
ECNZ now survives only as the holder of certain residual assets, amongst which are its interests in hedge contracts entered into before the break up. Instead of transferring the hedges held by ECNZ proportionately to the new generators along with the generation assets, ECNZ retained them but entered into back to back hedging arrangements with the new companies. The reason why this was done will emerge from the description of the hedge contract with WEL which now follows.
THE HEDGE CONTRACT
The hedge contract of 3 March 1998 replaced a contract of 10 May 1996 which had been on generally similar terms. Except as mentioned, the provisions which feature in this judgment were unchanged and can be regarded as ECNZ’s standard terms for contracts of this type.
In a recital it was recorded that ECNZ generated electricity sold through the NZ Electricity Market Pool, set up for the trading of wholesale electricity with wholesale purchasers. The price of electricity sold through the Pool was likely to fluctuate. ECNZ, wholesale purchasers, users of electricity and others desired security of pricing. Accordingly, it was recited, ECNZ was to allocate hedges directly or by tender on particular terms set out at the time of allocation, including the hedge price "and otherwise on the general terms set out in this Hedge Contract". It was further recited that such hedges were intended to be traded.
The contract provided that Hedge Quantities at any time held by the Purchaser (WEL) would be held on the terms set out in the contract including the General Terms of Hedge Contract in Schedule 1.
Other schedules provided formulae for calculation of the amounts payable by ECNZ or WEL under various types of hedge facilities and for settlement between them each month by the making of so-called Difference Payments. In simple form, this involved ECNZ paying any amounts by which market spot prices exceeded the relevant strike price agreed between the parties and for WEL to pay any amounts by which spot prices were less than strike prices. The hedge contract did not involve supplies of physical electricity. It was simply a mechanism for smoothing price fluctuations. During argument Mr Dobson QC, for the appellant, accepted the description of the arrangements as creating a proxy for forward sales and purchases of electricity.
Clause 4 of Schedule 1 provided for situations in which a Pool Price was unavailable and for adjustments to allow for the impact of certain future tax changes and for changes to National Grid charges.
Clause 6 of Schedule 1 of the standard terms, which previously permitted assignment of WEL’s interest in Hedge Quantities with the consent of ECNZ, was replaced in the March 1998 contract by a special provision which in relevant part reads:
Either Party may transfer its rights and obligations under the Hedge Contract to another entity but only with the prior written consent of the other Party, whose answer must be given within 90 days of the operative date of the transfer. Such consent may not be unreasonably withheld or made subject to unreasonable conditions and, in considering whether or not to give that consent, that Party shall take into account:
It can be accepted that it was because of the likelihood that WEL might withhold consent under this clause if Hedge Quantities were transferred to the new electricity generators that ECNZ retained the Hedge Quantities and made the back to back arrangements earlier referred to.
The special provision replacing cl 6 of the standard terms also limited the range of persons to whom any assignment of Hedge Quantities could be made, but stated that consent could not unreasonably be withheld in the case of a solvent counter-party who was within a defined level of credit risk.
Clause 7 of the standard terms in Schedule 1 was a force majeure provision relating to events affecting ECNZ’s capacity to inject electricity into the National Grid or WEL’s ability to uplift electricity. It provided for pro-rating of Hedge Quantities in such circumstances. But a purchaser who was not a party to a contract for the physical supply of electricity could not invoke it.
Clause 8, which again was an unamended standard term, was as follows (the contentious provision being highlighted below):
DEFAULT AND TERMINATION
There followed provisions enabling the party who had given a termination notice to act as the other’s agent to trade or assign remaining Hedge Quantities and for a consequential accounting.
WEL claims that ECNZ, having sold the major part of its business or undertaking (to Genesis, Mighty River and Meridian) without WEL’s consent is in default in terms of cl 8.1.3(d). WEL has therefore purported to terminate the hedge contract.
It was not suggested that any other contractual provisions are of present relevance.
THE HIGH COURT JUDGMENT
In a reserved judgment delivered in the High Court at Wellington on 26 June 2000, McGechan J found that at the time the March 1998 hedge contract was entered into WEL was aware of the "distinct possibility", as a result of industry development, of spot market price reductions of "as low as 10% to as high as around 30%." It was in WEL’s interest to keep the strike price of future Hedge Quantities as low as possible and to protect against the impact of the possible introduction of a carbon tax (referred to in cl 6.1) and "the implications of involvement with a new split-off fossil fuel generator" using the Huntly supply point (the Huntly Power Station uses fossil fuels; WEL has operated as a wholesaler in the Waikato).
McGechan J summarised in this way the approach taken by ECNZ and the Government:
ECNZ and Government wished to retain the benefits of existing ECNZ hedge contracts, including the WEL contract. WEL had negotiated a long hedge contract, and the lowest strike price ever. While WEL had been doing quite nicely pre-split, with a net flow of hedge payments in WEL’s favour, ECNZ and Government believed that position would reverse following the ECNZ split (a belief which proved to be correct).
ECNZ and Government appear to have appreciated that an application for consent to assignment of the WEL hedge contract to a new unit or units made in terms of clause [6.1] could trigger a refusal which would be justifiable under the "other commercial matters" ground. On a general commercial basis, it could be said to be reasonable to refuse to consent to assignment of a hedge contract when that assignment would facilitate arrangements resulting in an indefinite shift to a liability situation under that hedge contract. If consent was refused, that would not terminate the hedge contract, but of course it could not be assigned. On advice, ECNZ (which would survive purely as a residual unit) elected instead to retain the hedge contract in its own name, and enter into back-to-back hedge contracts with the three new units concerned. There was no assignment of the WEL hedge agreement, but its economic benefit was transferred in this way.
In construing cl 8.1.3(d) McGechan J began with what he described as a narrow focus on the sub-clause itself. He said there was an "obvious minimum purpose" namely that disposal of an undertaking, or even the major part of an undertaking, could leave the disposing party an empty shell, or with greatly reduced commercial viability. Even if there were terms as to receipt and retention of equivalent value or reserving control and entitlements, there would be a risk to which a counter-party could not be expected to consent on an open-ended basis in advance. On the other hand, consent should be withheld only if there was truly a risk that damage to creditworthiness would occur. "The purpose of the requirement for consent is to guard against deterioration of creditworthiness". No other matters entered into consideration. (It is common ground that ECNZ remains creditworthy.)
In support of this view McGechan J said that the most immediate textual context was paras (a), (b) and (c) of cl 8.1.3 which dealt with "various debt crisis situations". The event of default created by para (d) — sale of undertaking — followed immediately afterwards and in the Judge’s view was to be given a similar colouration.
The Judge then looked at "the wider textual context", and in particular cl 6.1. He drew from the different way in which it was drafted that where the draftsman intended to allow wider commercial considerations to enter into decisions, that had been said in express terms. The omission to add similar qualifying words supported the approach that cl 8.1.3(d) confined legitimate consent considerations to creditworthiness questions.
The Judge said that arguments based on surrounding circumstances did not require departure from the plain meaning of the text.
If followed, in the Judge’s view, that WEL was not entitled to refuse consent under cl 8.1.3(d) on grounds unrelated to creditworthiness of ECNZ. WEL’s consent was unreasonably withheld. Accordingly, there had been no Event of Default under cl 8 and no right of termination had arisen.
SUBMISSIONS FOR WEL
For the appellant, Mr Dobson submitted that cl 8.1.3(d) could not be restricted to questions of creditworthiness. He said that what is reasonable in terms of cl 8.1.3(d) has to be measured against the consequences of the sale for the counter-party. Prices had fallen after the announcement of the break up and before consent was refused. Nothing in the clause, it was said, created any limit on the reasons which might in particular circumstances be reasonable. Reasonableness, said Mr Dobson, is a question of fact in each case.
Mr Dobson emphasised the interdependence of dealings in physical energy and the related hedges. The latter were intended to moderate risks in the physical market and to be related to the underlying businesses of the parties. Here, as a result of the sale of ECNZ’s undertaking, ECNZ is no longer involved in transactions in the physical market. It was submitted that such a situation could not have been intended to be permitted without the counter-party’s consent (regardless of whether the sale raised questions of solvency), particularly when the sale itself affects competition and therefore substantially lowers spot prices and increases the amounts payable by the counter-party. The linkage to the physical market was said to be supported by the force majeure clause which could not be invoked except where physical transactions of the party concerned were affected.
Moreover, submitted Mr Dobson, the Judge was wrong to have concluded that sale of an undertaking was an event that could even raise questions of solvency. Sale contemplated only a disposition for full value. Clause 8.1.3(d) was not contemplating any inquiry into what might be done with the proceeds. Counsel noted in this connection the inadequacy of the ten day period for the making of a decision about the seller’s continuing solvency. ECNZ’s creditworthiness would never have been in issue. In the event of asset sales by WEL, ECNZ was said not to need insolvency protection under cl 8.1.3(d) because of other protections, including its power to monitor WEL’s credit risk profile from time to time and a provision to prevent excessive hedging commitments.
The Judge was also said to have been wrong in his approach to comparing cl 8.1.3(d) with cl 6.1. Clause 6.1 allocated risk with reference to assignments. It was said that the parties must also have intended to preclude (without consent) "in substance" assignments of the kind now entered by ECNZ. Clause 8.1.3(d) should be interpreted consistently with this intention — and in the context of the 1996 standard terms in which it was first included.
Notwithstanding the skill with which Mr Dobson deployed his client’s arguments, we have no doubt that McGechan J approached the matter correctly and came to the right and, we think, inevitable conclusion. Much of WEL’s argument was directed to showing that it would not have agreed to accept the risk of Government interference in the market as has occurred. But, whilst it might not have wished to do so, the question is, rather, whether WEL actually, in contractual terms, has accepted the risk. It should be noted that WEL has not put its case on the basis of an implied term relating to risk allocation. It is necessary therefore to confine the search to the meaning of the express terms in their overall contractual setting.
WEL’s counsel accepted that he could not call in aid his client’s negotiating position at the time cl 6.1 was added. That clause must speak for itself. As well, there was no challenge to the Judge’s view that no attention seems to have been paid to cl 8.1.3(d), which was already in the standard terms when cl 6.1 was inserted. Mr Dobson argued that its meaning could not have been changed when cl 6.1 was added, but this point seems to tell against the interpretation for which WEL argues. The 1996 contract provided for adjusting mechanisms for various possible impacts on market prices (for example, anticipating the possibility of a carbon tax or changes to National Grid charges). In contrast, cl 8.1.3(d) appears on its face and from its position in the 1996 standard terms to be merely an insolvency provision.
The words of cl 8.1.3(d) must be the primary focus, but it is part of one long sentence (there is a direction to disregard headings) and it cannot sensibly be read in isolation. It is immediately necessary to notice that (d) describes one of a series of Events of Default and that it has, unlike the events of non-payment (8.1.1) and breach (8.1.2) which are separately dealt with, been grouped by the draftsperson with paras (a) [inability to pay debts], (b) [proceedings under bankruptcy etc. law or appointment of a receiver] and (c) [entry into composition with creditors], all of which are plainly concerned only with the insolvency risk to the counter-party. Why, it may be asked, was para (d) not placed separately (as 8.1.4) if its concern was broader?
And coming to the words of (d) itself, there is a feature which Mr Dobson was not able to explain and which points strongly to this paragraph being directed to insolvency considerations, suggesting that the other words in the paragraph cannot be read literally as imposing no limitation on relevant considerations. That feature, which Tipping J pointed out during argument, is that a party which is not a "company" (a word possibly able to be construed to encompass any body corporate) is free to sell its "business or undertaking" (which would seem to be the same thing) without any consent being required. What purpose could there be in singling out a "company" other than the characteristic of limited liability? If the desire was, as submitted, to allow other matters to be taken into account by the non-selling counter-party, why was there no like restriction upon an individual? Both contracting parties were of course companies, but it could not be assumed that this state of affairs would necessarily continue. The party whose sale was being considered might be a successor of ECNZ or of WEL, and that is addressed by the use of the contingent "if".
Even if WEL were correct in its contention that a sale in this context must mean a sale for equivalent value, which is a debatable proposition, the assets received, though the equivalent on paper, might be in an illiquid form or susceptible to substantial changes in value which would make them unsuitable as a source of meeting Difference Payments under the hedge contract. The events of the 1980s in New Zealand provide many examples of companies transforming themselves by "paper" transactions, but not necessarily to their advantage or those of their creditors.
It was said for WEL that cl 8.1.3(d) was so seriously flawed in various respects (for example, giving the ability to make successive sales of up to half the business or remaining business on each occasion) that it cannot be seen as having been intended merely as an insolvency provision. But that does not assist WEL’s argument since the same flaws would attend any wider application. At the time when the contract was entered into in March 1998 it was already a real possibility that a significant part of ECNZ would be sold, with potential effect on prices, yet no provision was made for any consent by WEL unless that part amounted to more than 50 percent.
Looking more widely at the contract as a whole and the factual matrix outlined earlier in this judgment, there are no matters in favour of the interpretation sought by the appellant which outweigh those already mentioned. To the contrary, the absence of any amendment to cl 8.1.3(d) when the new cl 6.1 was substituted (and extended to ECNZ as well as to WEL) suggests that cl 8.1.3(d) was not intended to impose the same wider control as was henceforth to apply to any assignment of hedge contracts, namely the ability of the counter-party to refuse a consent on the basis of "other commercial matters", as well as on the basis of creditworthiness (in that case, of the transferee).
Nor does it seem to us that the fact that hedges were a means of smoothing fluctuations in the physical electricity market requires a reading of the clause in a way which allows WEL to withhold an approval because the counter-party may no longer be a participant in the physical market. There was, after all, no provision expressly requiring that any assignment of the hedge contracts be to another participant in the physical market. Quite the contrary; the list of acceptable counter-parties (subject to creditworthiness) included registered banks and habitual investors of money. The limitation upon the use of the force majeure clause is, against this, only a weak indicator of any intention that cl 8.1.3(d) is to confer an unfettered right to object to a sale on any reasonable grounds.
What has occurred is that the Government and ECNZ have taken advantage of what is, from WEL’s present perspective, a deficiency in the express contractual terms in order to carry through arrangements which bypass cl 6.1. As mentioned earlier, WEL did not plead that there was any implied term preventing this course of action. It cannot, instead, by invoking a broad reading of a provision which on its own wording and in its context is plainly aimed at the narrower question of insolvency risk, seek to remedy the deficiency.
The appeal is dismissed. The appellant must pay the respondent’s costs on the appeal in the sum of $5,000 together with its reasonable disbursements to be fixed, in the absence of agreement, by the Registrar.
A Dobson QC, C J Allan and G F Dawson for Appellant (instructed by Rudd Watts
& Stone, Auckland).
I R Millard QC and I R Veale for Respondent (instructed by Ivan Veale, Wellington)
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