Ipsofactoj.com: International Cases  Part 2 Case 8 [NZCA]
COURT OF APPEAL, NEW ZEALAND
Bobux Marketing Ltd
- vs -
Raynor Marketing Ltd
3 OCTOBER 2001
(delivered judgment of the court)
THE OBJECTIVE INTERPRETATION
Skipp J’s observation in Treen Gloves & Safety Products Ltd v Degil Safety Products (1989) Inc. (1990) 33 CPR (3d) 74, at 81, has become deservedly noted: "The concept of a perpetual distributorship agreement is difficult to entertain". I suspect that the dictum owes its currency to the fact that it expresses a truism. A contract by which one party agrees to supply a product and the other party agrees to distribute that product for a period stretching into eternity is difficult to reconcile with the realities of commercial life. Yet, in its plain terms the contract in issue between Bobux Marketing Ltd, the supplier, and Raynor Marketing Ltd, the distributor, is to last for an "indefinite period".
I have been pleased to closely peruse the draft judgment of the majority, to be delivered by Blanchard J. Adopting the conventional objective approach to contractual interpretation, the majority hold that the express wording of the contract makes it impossible to imply a term giving Bobux the right to terminate the agreement on reasonable notice. Such a finding carries the weight of orthodoxy.
Interpreted in this way, however, the contract does not make commercial sense. Entering into a distribution agreement without a finite term would be unassailable if the parties both had the general right to terminate the agreement on four months notice. But only Raynor, the distributor, has the right to terminate the contract on that basis. That right is denied to Bobux, the supplier. In the express terms of the contract, Bobux cannot terminate the agreement on four months notice unless Raynor fails to order the minimum quantity of the product per quarter. The one-sided nature of this arrangement is even more odd when it is considered that Bobux is the proprietor of the product. It developed the product. It owns the intellectual property rights in the product. Yet, it has no security of tenure. Moreover, throughout the duration of the contract Bobux cannot market its product in the United Kingdom.
The right for Bobux to terminate the contract if Raynor does not order the minimum quantity is then more illusory than real. The minimum quantity is 1,500 pairs of shoes per quarter. If this quantity was not unrealistically low in the first place, it necessarily becomes so by virtue of the provision requiring any orders in excess of 1,500 pairs to count towards and be treated as having been ordered in the next three month period. As Mr Brown, who appeared for Bobux, observed, as a result of orders already placed Raynor could theoretically meet the minimum contractual requirement if it did not place another order for 21 years!
For myself, I would be prepared to import a term giving Bobux the right to terminate the contract on reasonable notice simply to avoid giving effect to a contract which is otherwise commercially unrealistic. The contract purports to be for an "indefinite period". But that phrase can be construed in the sense that the period of the contract has not been defined; not that it is intended to last in perpetuity. Bobux cannot give four months notice to terminate the contract, but this prohibition does not necessarily exclude an intention on the part of the parties that the agreement could be terminated by a longer, and possibly significantly longer, period of notice.
Essentially, I would base this interpretation on the nature of the contract. The notion that the parties intended what was a distributorship between small private companies to last until the year 3000, or the year 4000, or even beyond that, is utterly implausible. Clearly, they must have envisaged that it would continue for a long time, but not even the corporate immortality enjoyed by the parties would suggest a contract lasting for all time. If, when the contract was entered into, the question had been raised as to what would happen if Mr Bennett, the proprietor of Bobux, wished to retire or otherwise withdraw from the business, the parties would surely have rejoined; "Of course, if we cannot otherwise agree, the agreement can be terminated by Bobux giving sufficient notice to enable Raynor to discharge its commitments and recoup its investment". The parties must have contemplated that, at some future point of time, the relationship could be brought to an end.
I would meet Raynor’s claim that it planned and committed its resources and invested monies on the basis that the agreement could not be terminated by Bobux other than for breach by, if necessary, adjusting the period of notice which it is reasonable to stipulate. Such a period may be nine months, as approved by the trial Judge, or it may be two years or more as may be reasonable having regard to the party’s original expectations. But Raynor cannot insist that the contract is intended to last from here to eternity because of its economic planning and expenditure. It is likely that such economic planning and expenditure would have been undertaken as part of any long-term finite contract. Indeed, many commercial entities commit themselves to substantial investment pursuant to long-term or relational contracts which contain a provision permitting termination on reasonably lengthy notice. Investment, itself, is not eternal.
The sheer commercial absurdity of this lopsided bargain prompts the question as to how it could have come about. There is an explanation.
In 1993 Mr Bennett had set up a distribution arrangement with a company in the United States called Almega Marketing Inc. He sent the company a short agreement which he had drafted himself and which he had previously used with a distributor in Australia. Clause 11 of this agreement provided for an initial trial period of six months followed by a further period of six months during which a minimum total order of 3,000 pairs of shoes was expected. It was then provided:
After the first year this agreement shall continue until the expiration of a 4 month prior written notice given by one party to the other.
Clause 12 then set a sales target of 1,000 pairs per month. Before the agreement was signed, Almega expressed concern as to what would happen if this sales target was not met. The company was fearful that the agreement might be terminated for that reason. Mr Bennett indicated that it was not his intention to cancel the agreement if Almega did not meet the sales target. In order to reflect this intention, Almega’s attorneys drafted a clause as an additional cl 13. It reads:
This agreement shall not be terminated by "Bobux Marketing LTD" as long as "Almega Marketing" continues to meet the minimum purchase requirements as well as all other stipulations stated in this agreement.
Mr Bennett executed the agreement in this form believing that he could still give Almega four months notice under clause 11. Consequently, under a misapprehension as to what the wording meant, he used this agreement as the basis for the agreement which he submitted to Raynor. The similarity and structure of clause 19(a), in particular, the provision literally limiting Bobux’s ability to terminate the agreement if Raynor failed to order the minimum quantity as defined in the following clause, is clearly evident. But there is no evidence that this background to clauses 19 and 20 was ever made known to Raynor. I do not contend that it can be brought within the matrix of fact relevant to the question of interpretation.
In the result, the contract illustrates the conflict or tension which can arise between the fundamental principle that the parties must be ad idem for a valid contract to exist and the requirement that a contract be interpreted objectively. The literal meaning of clause 19(a) was not intended by Bobux, but the company is now to be fixed with that meaning.
In the nineteenth century, a contract would not have come into existence unless there was a meeting of the minds of the parties, a consensus ad idem. With the passage of time that agreement, although important, is no longer decisive. It is now sufficient if there is an apparent consensus. Where the conduct of one party is such that a reasonable person would believe that he or she was unequivocally consenting to the terms proposed by the other party, that party will generally be precluded from denying that they have agreed to those terms. One need look no further than Blackburn J’s famous dictum in Smith v Hughes (1871) LR 6 QB 597, at 607, for authority for this formulation. It has been fairly said that one of the primary reasons why the objective theory of agreement was adopted was to protect the party’s reasonable expectation that a specific contractual relation exists between that party and another party by preventing the latter from relying on a mistake of which the former could not reasonably have been aware. (See J P Vorster, "A Comment on the Meaning of Objectivity in Contract" (1987) 103 LQR 274, at 282.)
But as Blackburn J’s dictum itself indicates, the objective principle of the reasonable person involves a subjective element. A reasonable person must not only believe that the promisor is assenting to the terms proposed by the other party, but also must believe "that other party upon that belief enters into the contract with him". Smith v Hughes, supra, at 607. (And see D W McLauchlan, "Actual Consensus ad idem in Contract – Unnecessary but Surely Sufficient?" (1995) NZLJ 45). While the approach of English law, contrary to the largely subjective approach adhered to in civil law systems, may be said to be objective, the intention of the parties cannot be fully ignored if the ludicrous situation of binding a party to a contract which he or she never remotely intended is to be avoided.
I do not suggest, however, that there need be a departure from the objective approach to contractual interpretation in this case. The contract may be given the meaning it would have been understood to have by a reasonable person in the situation of the party to the contract to whom it was addressed, having regard to the surrounding circumstances. I depart from the majority in that I do not consider that a reasonable person in Raynor’s position would have understood the limitation on Bobux’s ability to give notice other than for breach to exclude that company’s right to terminate the contract on reasonable notice (that is, for a longer period, and possibly a much longer period, than four months). It would not have conveyed to a reasonable person a contract in perpetuity at Raynor’s will. As, however, the majority have reached a different view, it may be more productive to look elsewhere.
AN OBLIGATION OF GOOD FAITH?
I do not accept that, even if it is not open to Bobux to terminate the contract on reasonable notice, that company is without recourse against Raynor in the circumstances which it alleges in this case. The law should not be bereft of relevance in a situation which has become commercially unrealistic or intolerable.
In my view, therefore, the courts would be prepared to import into the contract in issue an obligation on the parties to perform the contract in good faith. It would be open to Bobux to allege that Raynor was in breach of that obligation. This being the case, the contract could be terminated for breach under clause 19(b).
Before touching upon the concept of good faith, it is necessary to ascertain that there is a factual foundation for such a plea. As the facts have not been tested from this perspective any observation regarding the facts must necessarily be tentative. The objective, however, is not to reach a firm finding of fact, but rather to demonstrate that the courts are not necessarily impotent in commercial circumstances which would seem to cry out for the assistance of the law. The law exists to serve the community, including in particular the needs of commerce, and there may be occasions, admittedly rare, where it is apposite to indicate the direction which the law is taking to discharge that function. I turn then to confirm that there is a sufficient factual foundation to justify this exercise.
1. The performance of the contract
Notwithstanding Raynor’s weak protestations to the contrary, it would seem that the mutual trust and confidence which existed between the parties at the outset of the contract has completely broken down. The parties set out to establish a business relationship. Bobux, as manufacturer, designed and supplied an "original" product and Raynor, as distributor, obtained a customer base for that product in the United Kingdom. Both parties had a vested interest in promoting the brand name "Bobux". Continuing communications between them, especially as they are situated on the opposite sides of the world, was essential. Indeed, the success of the enterprise depended on co-operation between them. Mrs Beattie, who together with her husband, was a director of Raynor, recognised that the agreement was predicated on close communication and co-operation when, before the contract was completed, she observed that, "if our proposed business relationship is to be fruitful and enduring, it is paramount that you are and continue to be candid with us". Mr Bennett, the proprietor of Bobux, would undoubtedly have expressed the same point of view.
According to Bobux, the mutual trust and confidence which existed between them has been destroyed by the actions of Raynor. The disintegration of the relationship began in May 1997, four years after the contract had been completed and the business relationship had begun. Raynor raised the possibility of making Bobux shoes in larger sizes for older children than those being catered for at the time. Raynor claimed to have received inquiries from its customers about such a product and considered that increasing the range would be a desirable "brand extension" for Bobux. At that time Bobux was not prepared to produce such a product. It was outside its niche market and shoes for older children were not perceived to be shoes so much as slippers.
Over the course of the next 2½ years, however, until mid-1998, the parties had a number of discussions and exchanged correspondence in an attempt to set up a structure through which to develop such a market extension. But they were unable to reach agreement. Bobux informed Raynor that it would only be prepared to market the further products under a licence agreement.
Notwithstanding this firm advice, Raynor went ahead and produced its own range of larger shoes and sold them under the brand name "Sole Mania". It advised Bobux what it had done on 28 September 1998. The Sole Mania shoes were introduced to Raynor’s established customers. But Raynor claimed that, being larger in size, the shoes would not compete with Bobux’s shoes.
Mr Bennett asserts that, despite extensive correspondence between them on other matters, this advice came like "a bolt out of the blue". From his perspective Raynor was producing these shoes using the "Bobux" design. Yet, there had been no mention of the larger size shoes since Bobux had written to the company on 10 January 1998 making it clear that any marketing under the Bobux label would need to be undertaken pursuant to a licence agreement. Nor had anything been said about Raynor producing the larger shoes under its own label.
Bobux wrote to Raynor the next day requesting it to desist from all production of Sole Mania shoes, and to withdraw all stock production and all advertising material, including any brochures, associated with such shoes. Bobux advised that it regarded Raynor as being in serious breach of the agreement and that it wished the matter to be resolved as a matter of urgency. Raynor responded promptly enough. It claimed that it had acted in all its dealings with Bobux "in the utmost good faith" and that it was and would "remain loyal" to Bobux. It reiterated that the Sole Mania product did not compete, and was not intended to compete, with Bobux products. Sole Mania shoes, it claimed, were a complementary product extending the current options available to Bobux customers and enhancing customer loyalty.
Bobux next indicated that it accepted legal advice to the effect that Raynor was not in breach of the agreement. The agreement restricted Raynor from manufacturing and distributing children’s shoes during the currency of the agreement, or for a period of 18 months after its expiry, in competition with the product "as manufactured by Bobux at the date of such expiry". But Mr Bennett described Raynor’s action as being a "clever legal interpretation of the clause" and questioned whether it was a "wise and prudent business decision". He concluded, "your ambush and betrayal was from our prospective (sic) a breach of the trust that had existed between us both".
Evidencing his distrust of Raynor, Mr Bennett arranged an order of Sole Mania shoes from Raynor. The shoes were supplied under cover of a standard form letter signed by Ms Beattie on Raynor’s letterhead. The opening sentence read, "Thank you for your recent order of Bobux shoes, which we enclose".
Bobux protested. Raynor assured Bobux, however, that it used the Bobux logo and trademark for the marketing and distribution of Bobux products only. It claimed that it would never market other products under the Bobux brand.
Then, on 19 April 1999, Bobux finally received a written assurance from Raynor that it would no longer manufacture or distribute Sole Mania products.
But this was not the end of the matter. In October 1999 Bobux discovered that the Sole Mania shoes were still being sold in the United Kingdom. The shoes were now being distributed by a company called Marketing Mania Ltd. A brochure put out by this company advertised Bobux shoes in all styles and sizes and, in the same brochure, contained a two page spread advertising Sole Mania shoes. The address for Marketing Mania Ltd in the brochure was the same as that of Raynor. This development came as a complete surprise to Mr Bennett. At no stage had there been any mention of a company called Marketing Mania Ltd. Mr Bennett then ascertained that Marketing Mania Ltd had been incorporated by the directors of Raynor, Mrs Beattie and her husband. He complained that the company was using the goodwill of the Bobux brand to sell Sole Mania shoes.
Mr Bennett also found out, after making further inquiries during October and November of 1999, that all the Bobux shoes being distributed in the United Kingdom had a "Marketing Mania Ltd" sticker on them overlaying the Bobux sticker. He also subsequently discovered that Marketing Mania Ltd was in fact offering Sole Mania shoes in a catalogue issued by it for the northern spring/summer 1999.
Mr Bennett felt that Bobux was in an intolerable position. Raynor, through a new company, Marketing Mania Ltd, was selling larger size copies of Bobux shoes. At the same time, the new company was putting its name and stickers on all the Bobux shoes being distributed in the United Kingdom market. This manipulation of the stickers conveyed to the market that the same company manufactured both Bobux and Sole Mania products. The goodwill of Bobux was being used to sell Sole Mania shoes with no recompense or value whatever to Bobux. Mr Bennett also considered that Marketing Mania Ltd, which had no contractual relationship with Bobux, was acting as the effective distributor of Bobux shoes in that its marketing material advertised Bobux products. Thus, Bobux had no control over a brand name which it had spent nine years building up and protecting. It was then that Mr Bennett instructed Bobux’s solicitors to give Raynor nine months notice of termination of the agreement.
Of course, as I have emphasised above, the allegations made by Bobux have not yet been fully tested. But much of what it asserts would seem to be corroborated by contemporaneous documentation. In any event, it is difficult to accept that a skerrick of mutual trust and confidence remains between the parties. From Bobux’s point of view, Raynor systematically and surreptitiously set out to circumvent the agreement; filched the copyright in the design of Bobux products; took advantage of and usurped the information and knowledge imparted by it to Raynor in confidence in building up the business relationship with that company; utilised the goodwill in the "Bobux" brand label by passing off its shoes as a Bobux product; and had, while still a distributor of Bobux shoes, been effectively in competition with Bobux. If these allegations are only partially correct, the relationship which now exists between Bobux and Raynor is commercially unrealistic and, indeed, intolerable.
2. An obligation of good faith?
As Lord Steyn has observed, the emphasis of English law on an objective approach to contractual issues tends to make England somewhat infertile soil for the development of a generalised duty of good faith in the performance of contracts. (The Hon Mr Justice Steyn, "The Role of Good Faith and Fair Dealing in Contract Law: A Hair-Shirt Philosophy?" (1991) Denning LJ 131, at 132). Classical contract law is based on certain implicit paradigm cases, the most common of which is the contract for an identified commodity between two strangers operating in a perfect spot market. Contractual principles provide a relatively rigid offer and acceptance format and are intolerant of such issues as indefiniteness, agreement to agree, and agreements to negotiate in good faith. Principles of classical contract law like the bargain theory of consideration, the objective theory of interpretation, and the rule that silence is not acceptance are particularly apt for contracts of this kind. (See Melvin A Eisenberg, "Relational Contracts" in Good Faith and Fault in Contract Law (1995 - Eds, Jack Beatson and Daniel Friedmann) at 297). Lord Wilberforce put it this way in New Zealand Shipping Co Ltd v A M Satterthwaite & Co Ltd  AC 154, at 167:
English law, having committed itself to a rather technical and schematic doctrine of contract, in application takes a practical approach, often at the cost of forcing the facts to fit uneasily into the marked slots of offer, acceptance and consideration.
Thus, the traditional law of contract does not readily accommodate a general duty of good faith in the performance of contractual obligations. It was not, of course, always so. In 1766, the great Lord Mansefield proclaimed his famous description of good faith as "the governing principle .... applicable to all contracts and dealings." See Carter v Boehm 97 ER 1162, at 1164. But his vision was swamped by a law reflecting the laissez-faire economics and liberal individualistic theories of the nineteenth century. The classical theory of contract was seen to offer predictability and certainty, although, as Sir Anthony Mason has observed; "It later emerged, as is the case with many legal concepts rooted in formalism, that the element of certainty was illusory". (A F Mason, "Contract, Good Faith and Equitable Standards in Fair Dealing (2000) 116 LQR 66, at 70).
Despite its tradition, however, the law of England, and by derivation the law of this country, could not forever ignore the fundamental weakness of the classical conception of contract law. The formalistic approach was overtaken by the good sense of those Judges who recognised that the function of the law of contract is to provide an effective and fair framework for contractual dealings based on achieving the reasonable expectation of the parties. See Johan Steyn, "Contract Law: Fulfilling the Reasonable Expectations of Honest Men" (1997) 113 LQR 433, at 434. The fundamental flaw of the classical conception of contract law was its empirical premise that most contracts are discrete. That premise is false. Most commercial contracts are in fact relational contracts. The great bulk of contracts either create or reflect relationships. It is discrete contracts that are unusual, not relational contracts. See Eisenberg, supra, at 297.
It is not surprising, therefore, that a considerable volume of commentary has been devoted to the question whether the law of contract should recognise a general duty of good faith in the performance of contractual obligations. Books on the topic have proliferated. See, for example, Good Faith and Fault in Contract Law, supra, esp Chap 11; A D M Forte (Ed), Good Faith in Contract and Property Law (1999), (Eds, Roger Brownsword, Norma J Hird and Geraint Howells); and Good Faith in Contract: Concept and Context (1999) Publishing Co Ltd. The chapter by Melvin A Eisenberg in Good Faith and Fault in Contract Law is extremely helpful.
A selection of articles would include the following: H O Hunter, "The Duty of Good Faith and Security of Performance", Jnl of Contract Law (1993) 19; Charles J Goetz and Robert E Scott, "Principles of Relational Contracts" (1981) 67 Virginia L R 1089; H K Lücke, "Good Faith and Contractual Performance" in P D Finn (ed) Essays on Contract (1987); The Hon Mr Justice Steyn, "The Role of Good Faith and Fair Dealing in Contract Law: A Hair– Shirt Philosophy?", supra; The Hon Mr Justice T R H Cole, "Law – All in Good Faith" (1995) 10 Building and Construction Law 18; Veronica L Taylor, "Contracts with the Lot: Franchises, Good Faith and Contract Regulation"  NZLRev 459; David Goddard, "Long-Term Contracts: A Law and Economics Perspective"  NZLRev 423; Johan Steyn, "Contract Law, Fulfilling the Reasonable Expectations of Honest Men" supra; Ian B Stewart, "Good Faith in Contractual Performance and in Negotiation" (1998) 72 The Australian LJ 370; A F Mason, "Contract, Good Faith and Equitable Standards in Fair Dealing" supra; Judith Cheyne "Commercial Good Faith"  NZLJ 245 and Eileen Webb, "The Scope of the Implied Duty of Good Faith – Lessons from Commercial and Retail Leasing Cases" (2001) 9 Australian Property Law Journal. Of these articles, the seminal article of H K Lücke and the address by Sir Anthony Mason are outstanding contributions to this topic.
Nor is it surprising that there have been judicial excursions into the subject. See, for example, Mr Justice Steyn (as he then was) in Banque Financiere de la Cite SA v Westgate Insurance Co Ltd  2 AC 249; Sir Thomas Bingham (as he then was) in Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd  QB 433 and Philips Electronique Grand Public SA v British Sky Broadcasting Ltd  EMLR 472; and my own observations in Livingstone v Roskilly  3 NZLR 230, at 237-238, and [other cases]
The notion of a general obligation to perform contractual obligations in good faith also received a boost from the fact it has been adopted in the United States and in international trade law without any evidence that commercial transactions have become unworkable or uncertain as a result. Section 1-203 of the Uniform Commercial Code in the United States provides an important milestone in the evolution of the principle. It states that "every contract or duty within this Act imposes an obligation of good faith in its performance or enforcement". Initiated by the American Law Institute in 1970 and finally promulgated in 1981, Section 205 of the Restatement of Contracts, Second, which is applicable to all contracts, reads: "Every contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement". Then, Article 1.7 of the 1994 UNIDROIT Principles of International Commercial Contracts provides that, "each party must act in accordance with good faith and fair dealing in international trade" and further that, "the parties may not exclude or limit this duty". Similarly, Article 7(1) of the 1980 United Nations Convention on Contracts for the International Sale of Goods states that in the interpretation of the Convention regard is to be had, inter alia, to the "observance of good faith in international trade".
Moreover, the concept of good faith is the latent premise of much of the law of contract relating to the performance of contractual obligations. (See Livingstone v Roskilly, supra, at 237-238). Lücke suggests that obvious examples of principles of contract law palpably designed to bring about just and fair results are the doctrine of promissory estoppel, the rule which provides relief against forfeiture, the rule which invalidates penalty clauses, and some of the established rules of construction such as the contra preferendum rule and the presumption that exemption clauses in contracts are not intended to confer immunity from the consequences of a fundamental breach. (Lücke, supra, at 158). Then, too, apart from fiduciary relationships, notions of good faith and fair dealing have left their imprint on English contract law in respect of contracts of insurance, suretyship, salvage and partnership, which are all characterised as contracts of the utmost good faith (Steyn, supra, at 136). Sir Anthony Mason lists a number of well-recognised unrelated situations in which a party is required to take account of the interests of another party, notwithstanding that the initial foundation of the relationship is that each is pursuing his or her own interests. (Mason, supra, at 72-73). The learned jurist also canvasses the various means by which the courts have sought to fill the void caused by the absence of a general good faith doctrine; the fiduciary principle, unconscionable bargains, estoppel and restitutionary relief. (Ibid, at 84).
Certainly, the notion of a more explicit concept of good faith in the law of contract will continue to have its detractors. The principle is already beset by agonising inquiries into what is or can be meant by good faith. But these digressions need not detain us here. Good faith is closely associated with notions of fairness, honesty and reasonableness which are already well recognised in the law (Lücke, supra, at 161). Fried has correctly pointed out that good faith as honesty is quite compatible with the traditional "concept as promise" concept. (See Fried, Contracts as Promise (1981) at 85). Underlying the concept, to my mind, is a perception of loyalty to the promise made which provides a standard, rather than a rule, and which does not require the abandonment of self-interest. The Official Comment to Section 205 of the Restatement of Contracts, Second (supra) rightly points out that the meaning will depend on its context. The basic ethic in good faith performance and enforcement of a contract is said to be "faithfulness to an agreed common purpose and consistency with the justified expectations of the other party". This ethic evinces my perception of good faith as loyalty to a promise.
We have already noted that a duty to exercise good faith in the performance of a contractual obligation is most often asserted in the context of relational contracts, such as agency relationships, distributorships, partnerships, franchise arrangements and joint ventures. Readiness to import such a term is founded on the fact that the parties have a mutual interest in the successful performance of their agreement.
There is again no need for a dissertation on the characteristics of relational contracts as the present agreement undoubtedly falls within that category. Relational contracts are often long-term contracts, but not necessarily so, but long-term contracts by their nature are likely to be relational. In essence, relational contracts recognise the existence of a business relationship between the parties and the need to maintain that relationship; the difficulty of reducing important terms to well defined obligations; the impossibility of foretelling all the events which may impinge upon the contract; the need to adjust the relationship over time to provide for unforeseen factors or contingencies which cannot readily be provided for in advance; the commitment, likely to be extensive, which one party must make to the other, including significant investment; and that they are in an economic sense likely to be incomplete in failing to allocate, or allocate optimally, the risk between the parties in the event of certain future contingencies. See Taylor, supra, at 459 and 479; Hunter, supra, at 19; Goetz and Scott, supra, at 1090 and 1091; Goddard, supra, 436, 430-431, 436, and 457 (424 and 426); and Eisenberg, supra, at 294-295 and 296.
Consequently, a relational contract is one which involves not merely an exchange but a relationship between the contractual parties. The parties are not "strangers" in the accepted sense and much of their interaction takes place "off the contract" requiring a deliberate measure of communication, co-operation, and predictable performance based on mutual trust and confidence. Expectations of loyalty and interdependence mark the formation of the contract and become the basis for the rational economic planning of the parties. (Taylor, supra, 479). The norms of the ongoing relationship, of necessity, tend to supplement the express contractual obligations. Good faith is required to ensure that the requisite communication, co-operation and predictable performance occurs for the advantage of both parties. In short, the obligation seeks to hold the parties to the promise implicit in a continuing, relational commercial transaction. (Ibid).
Such considerations as these led Elias CJ to say in Stanley v Fuji Xerox (NZ) Ltd (Unreported, HC Auckland, CP 479/96, 5 November 1997, at 58 that the implication of good faith "necessarily arises whenever a contract is predicated upon mutual confidence". Other cases in New Zealand which recognise this obligation are referred to in Cheyne, supra. The cases in Australia which recognise the obligation in relational contracts are dealt with in Webb, supra. Those cases need not be repeated here.
There can be little doubt that the contract between Bobux and Raynor is predicated upon mutual trust and confidence and gave rise to a reasonable expectation of communication, co-operation and predictable performance. These features become all the more important when the contract is for an indefinite period. With the passing of time there could be no other effective basis on which the parties could pursue their mutual interest in the supply and distribution of Bobux products in the United Kingdom.
It therefore seems to me that it would be open to Bobux to assert that the parties’ obligations under the contract are subject to an obligation to act in good faith. Assuming that the evidence briefly traversed above can be established, Raynor would appear to have failed to demonstrate the requisite good faith. Either it has already failed to remedy that breach in failing to cease distribution of Sole Mania products after expressly indicating it had done so in April 1999 or it would, virtually by definition, be unable to remedy the breach on receiving a notice under clause 19(b). Hence, Bobux could seek to terminate the contract for breach, and the termination would have "immediate effect". Alternatively, Bobux could argue that Raynor’s breach amounted to a repudiation of the contract.
I have elsewhere noted the void in the law due to the absence of a developed doctrine of good faith. ("An Affirmation of the Fiduciary Principle" (1996) NZLJ 405, at 407-408). Importing an obligation to perform contractual promises in relational contracts of the present kind would assist in filling that void. Commerce would undoubtedly be better served by a law which recognised the underlying imperative arising from the mutual trust and confidence which the parties repose in one another in a relational or long-term contract. Business situations in which the relationship of the parties had become commercially unrealistic or intolerable would be reduced or avoided. It is that objective which has driven the above exercise.
Having regard to the decision of the majority, however, the appeal must be dismissed. But, for myself, I would have invoked this Court’s powers under s 62 of the Judicature Act 1908 and r 19 of the Court of Appeal (Civil) Rules 1997 and remitted the proceeding back to the High Court to give Bobux the opportunity to litigate the question whether Raynor is in breach of an obligation of good faith. I would have given Bobux 27 days within which to amend its pleading and suspended Raynor’s ability to enter judgment until the expiry of that 27 days, or the further determination of the proceeding should Bobux decide to amend its pleading and proceed on the basis that Raynor is in breach of an obligation to perform the contract in good faith. Bobux can, of course, start afresh. That is entirely a decision for Bobux and its advisers to make. No question of res judicata can arise.
Keith & Blanchard JJ
(delivered by Blanchard J)
This appeal is about the interpretation of a distribution agreement for babies’ leather booties. It centres on four clauses of that agreement which deal with rights of termination. The respondent, Raynor Marketing Ltd (Raynor), says that the clauses exclusively govern the right to terminate and that the appellant, Bobux Marketing Ltd (Bobux), could not bring the agreement to an end by giving a reasonable period of notice in circumstances where Raynor was not in breach of any of its obligations and had ordered the minimum quantities specified in the agreement.
The agreement was entered into in March 1993. Bobux, a New Zealand company, appointed Raynor, an English company owned by New Zealand expatriates, to be its
sole exclusive distributor of "Bobux" Children’s leather booties as produced or dealt in by the Supplier at the date of this Agreement (the "Products") for the Supplier in the United Kingdom and the Republic of Ireland (the "Territory")
Bobux agreed during the period of the agreement not directly or indirectly to supply any person other than Raynor with the products in the territory. Raynor agreed that it would not "during the currency of this Agreement or for a period of 18 months after its expiry" manufacture or distribute in the territory children’s leather booties in competition with the products as manufactured by Bobux at the date of such expiry (cl 1).
The crucial clauses are these:
The initial period of this Agreement shall be a trial period of six months during which no minimum monthly orders shall be required. On expiry of such period, the Distributor or the Supplier may give written notice to the other of them to terminate this Agreement, which notice must be given so as to be received by the other of them within fourteen days from the end of the six month period, failing which there will be no right to terminate this agreement on this ground thereafter.
If this Agreement is not terminated as provided in paragraph 18 above, it will continue for an indefinite period from the date hereof and may only be terminated:-
For the purposes of this Agreement, the "Minimum Quantity" means:-
On termination of this agreement for any reason (unless this agreement is terminated by the Supplier under paragraph 19(b) above) the Supplier will, if required to do so by the Distributor, be obliged to supply to the Distributor on the terms set out in this Agreement a quantity of the Products up to the quantity ordered by the Distributor in the twelve months prior to the date of termination (or if less, the period from commencement of this Agreement to the date of termination) and the Distributor shall be entitled to sell those Products as it sees fit. On any such termination the Distributor shall provide the Supplier with a list of its customers and the Supplier shall not itself and shall procure that any Distributor appointed by it (and it shall be entitled to appoint any other Distributor after termination but subject to this provision) shall not directly or indirectly sell any of the Products to any of the customers mentioned on that list for a period of 12 months following such termination. It is recorded that the basis of this provision is to enable the Distributor to enjoy the fair benefit of any market which it will have been able to build up for the Products.
For the avoidance of doubt, on termination by the Supplier, the Supplier shall fulfil all orders placed by the Distributor before the date of termination unless the Distributor cancels such orders (which it shall be entitled to do without having any liability to the Supplier) and the Distributor shall be entitled to sell its stock of Products after such termination.
This Clause shall survive any termination of this Agreement.
It is common ground that the only booties being produced by Bobux at the date of the agreement were for what is called the 0-2 year-old market.
After the agreement had been operating with apparent success for several years, the parties fell out about extending the product range to include shoes of essentially the same kind for children older than 2. Both firms are now separately marketing shoes for older children in the United Kingdom and Ireland in competition with one another, Bobux doing so under its eponymous brand name and Raynor under its own brand "Sole Mania". (Although there have been allegations of passing off made against Raynor, the present case proceeded on the basis that the competition is not in breach of the agreement relating to booties for the 0-2 year old age bracket.)
On 4 February 2000 Bobux gave Raynor nine months notice of termination of the distribution agreement. The High Court has held that nine months was a reasonable period of notice in the circumstances. Raynor has not sought to cross-appeal that aspect of the judgment. We proceed therefore on the basis that if Raynor had the right to give a notice, then the agreement was validly terminated.
But in his judgment delivered in the High Court at Auckland on 10 October 2000, Morris J found that the terms of the contract were "straightforward and clear". The parties had, he said, expressly provided for termination. They had used the word "only" in cl 19. In his view, to construe the contract as Bobux would have it meant the Court would have to imply into it an overriding provision which would be directly contradictory to the express provision "may only be terminated". That would be to read down the express terms.
Nor could the Judge see any basis for applying the contra proferentem rule against Raynor, whose solicitor had prepared the draft agreement, because, the Judge said, the terms of the contract were "clear and unambiguous and lead to no situation which could be said to offend common-sense". He rejected, in particular, a submission that the words "for any reason" in cl 21 did more than refer back to the rights of termination provided expressly in the agreement:
"It would require for a giant step, indeed a leap, to extrapolate the "for any reason" in this clause to a provision that agreement could be terminated for any reason on reasonable notice. I see no need to take such action when the terms are clear."
For the appellant, Mr Brown submitted that there must be cogent reasons in the nature or terms of the contract before it should be construed as giving a party no right to terminate on reasonable notice. He said that a perpetual distribution agreement was unlikely to have been intended, particularly where the parties were small husband and wife businesses. He submitted further that the absence of a right for Bobux to terminate on reasonable notice makes the contract very one-sided. It provided the product and held the intellectual property rights. Raynor was simply a distributor and had come to the contract without any experience in marketing children’s shoes. Bobux had had to provide advice and assistance on how Raynor should begin to go about the task. Mr Brown emphasised the low level of the annual minimum quantity, together with the absence of any provision for its adjustment or even any express best endeavours performance obligation on the part of Raynor. There were, counsel said, very few obligations upon Raynor, which itself could walk away on four months notice. The current position was said to be that, as a result of sales already made, theoretically Raynor would still meet its minimum quantity obligations, even if it did not place another order for about 21 years. Yet Bobux would, if the contract continued, be unable to make sales in the territory.
Confronting the explicit provisions of cl 19, particularly the proviso to para (a), Mr Brown argued that when the contract was read as a whole there were indications that the express right to give notice was not intended to preclude the normal right to bring a contract for an indefinite period to an end by reasonable notice. Counsel referred to provisions which spoke of the "expiry" of the agreement. He concentrated his argument on the opening words in cl 19 ("On termination of this agreement for any reason…") and the statement in that clause that its purpose was to enable the distributor to enjoy the fair benefit of any market value which it may have been able to build up. He submitted that cl 21 was unnecessary if directed only to a termination under cl 18 or 19. It does not say that it is limited by those provisions. If the termination was on the expiry of the trial six month period or because Raynor had not ordered 1,500 pairs in a three month period, it would be unlikely that Raynor would have built up a market. Raynor itself would be unlikely to give a four months notice under cl 19(a) in circumstances in which it had built up such a market; if it was concerned by a breach by Bobux it would surely seek specific enforcement rather than terminate. Therefore, Mr Brown submitted, cl 21 must have been intended to apply to a termination on reasonable notice.
Counsel for the appellant submitted also that, as the agreement had been prepared by Raynor’s solicitor, the contra proferentem rule should be applied.
Ms Winkelmann, for Raynor, submitted that the termination provisions of the contract are clear and unambiguous, as the Judge had held. She pointed out that the agreement was negotiated over a period of about three months and that Mr Bennett of Bobux had in fact supplied Raynor with documentary material used in Bobux’s United States distribution agreement, which had a similar scheme relating to the rights of termination. It too had provided that Bobux would not terminate as long as the US distributor continued to meet minimum purchase requirements and there was no provision for adjusting the stipulated minimum quantity.
Ms Winkelmann pointed out that the Judge had observed that Mr Bennett was "no babe in arms" when it came to distribution agreements. Bobux had gained a distributor willing to work on a long-term basis to build up the market in the United Kingdom and Ireland. Sales figures were said to demonstrate that it had done so. There was an incentive for Raynor because it was forbidden to sell a competitive product.
Counsel submitted that cl 21 was limited to termination under the express provisions. She said there might well be situations in which Raynor had a market requiring protection after a termination under cls.18 and 19 and while it was making an orderly exit from the business. For the Court to find an unstated overriding right of termination on reasonable notice would be to re-write the parties’ contract.
In Crawford Fitting Co v City Valve & Fittings Pty Ltd (1988) 14 NSWLR 438, 443, McHugh JA said that the question of construction in a case of this kind did not depend only upon a textual examination. It involves consideration also of the subject matter of the agreement, the circumstances in which it was made and the provisions which the parties have or have not agreed.
We feel the force of the observation in one Canadian case, to which Mr Brown referred us, that "the concept of a perpetual distribution agreement is difficult to entertain" (Treen Gloves & Safety Products Ltd v Degil Safety Products (1989) Inc. (1990) 33 CPR (3d) 74, 81). This Court has, however, itself commented in Minister of Education v De Luxe Motor Services (1972) Ltd  1 NZLR 27, 31 that it is doubtful that there is any general presumption in favour of determinability of continuing contracts of no specified duration, but that "most Judges and practitioners…would expect to find cogent reasons in the nature or terms of the particular contract before placing on it the interpretation that there is no right to determine on reasonable notice". We respectfully agree and have approached the interpretation of the contract now before the Court on that basis.
We accept that the mere statement that a contract is to continue " for an indefinite period" or the fact that a contract may contain certain express provisions enabling termination in defined circumstances, such as material breach by the other party, does not preclude the finding of an implicit right also to bring the relationship to an end by a period of notice which is reasonable in the circumstances which exist at the time the notice is given (see, for example, Re Spenborough Urban District Council’s Agreement  1 Ch 139, 153). Nor is it fatal to the possible existence of such a right of termination in one party that the other party is alone expressly given that right (Winter Garden Theatre (London) Ltd v Millennium Productions Ltd  AC 173).
In the end, although in a mercantile or commercial contract the Court will favour an interpretation which enables the relationship to be terminated on reasonable notice, the question remains whether the language actually used by the parties admits of an implication or interpretation to that effect.
The problem faced by the appellant is that the express terms of the agreement very directly address the question of termination. Furthermore, they follow the pattern of the "template" from the US agreement sent by Mr Bennett to Raynor. That fact alone precludes reliance by Bobux on the contra proferentem rule.
Clause 18 is of no direct relevance. The trial period is long since over and the agreement has continued without any notice being given by either party under that clause.
Clause 19 begins with the statement that, in that circumstance, the agreement will continue for an indefinite period and may only be terminated in accordance with para (a) or (b). Para (b) is, again, not directly relevant, although it does spell out that the failure to order the minimum quantity is not a breach. Para (a) provides for termination by either side on four months notice, but that right is qualified by a very explicit proviso which is in two parts. The first part, once more not directly relevant, is that such a notice may only be given after the first year. The second part is that such notice may only be given by Bobux if Raynor has failed to order at least the minimum quantity. Not only, therefore, is the agreement to be continued indefinitely, but notice is expressly not to be given by Bobux if Raynor orders the minimum quantity.
Material breach by Raynor is dealt with under para (b) and, as noted, it does not include failure to order the minimum quantity.
In the face of these provisions, can it be said that where Raynor is not in breach and has duly ordered the minimum quantity (either in the year in question or by application of the provision for carrying forward the benefit of previous orders), there is room for the implication of a right to terminate without cause on reasonable notice? We think not, for it would contradict the express agreement not to give a termination notice if Raynor is maintaining minimum orders.
We have carefully examined the balance of the contract document for indications of a contrary intention, but find only those referred to by Mr Brown, which are so fragile as to provide insufficient support for his argument. References to "expiry" are perfectly capable of being taken to refer to the expiry of a notice under cl 18 or 19.
Clause 21 is intended to protect the distributor against a relatively sudden termination of the agreement. It prevents Bobux dealing with Raynor’s customers for 12 months after termination and requires Bobux during that period to supply an equivalent quantity of product to that which Raynor ordered in the preceding 12 months (or lesser period if the agreement happened to be terminated during the initial year). It enables Raynor to sell those products, along with stock in hand, over a relatively extended period. Raynor would (under cl 1) be unable for 18 months to sell any competitive products and would therefore, to maintain the continuity of its business, require new Bobux product until it was free to begin to sell on behalf of a competitor of Bobux or on its own account.
Although termination under cl 18 and 19 may occur in circumstances in which Raynor may not be particularly concerned to protect a market for children’s booties – determination may have come about because there is little or no market, as evidenced by lack of orders for the minimum quantity – it is also possible that Raynor may have terminated because of breach by Bobux. If the nature of Bobux’s breach were serious, Raynor might not want to continue the relationship. It might contemplate instead beginning again with a competitive product when free to do so, while, in the meantime, preserving its recognition in the market as a supplier of children’s booties. If so, Raynor would need the protection of cl 21. Accordingly, we do not see the opening words of cl 21 ("for any reason") as an indication that the clause is directed at a termination which is not pursuant to cl 18 or 19, and one which would contradict the express words of those clauses.
Nor do we think that a literal reading of the words chosen by the parties necessarily leads to an absurd commercial result. Because of the very absence of a right of termination in Bobux and the fixed nature of the minimum quantities, a Court may well find that to give business efficacy to the contract, it is to be implied that Raynor will use its best endeavours to maximise its sales and therefore its orders. If so, Bobux could terminate by reasonable notice where such endeavours are not made, but could not do so if they were duly made, unless orders fell below the minimum. If the directors of Raynor were to neglect Bobux’s business in favour of pursuing their own competitive interests through another vehicle, that might place Raynor in breach of such an implied term. However, we express no concluded view on this question.
We also do not place much weight on the appellant’s suggestion that an inability to bring the relationship to an end may work a hardship on a husband and wife owned company whose proprietors may at some stage wish to give up the manufacture of children’s booties. We think it more likely that, if the business is still profitable when they wish to retire, they will prefer to sell their shareholding rather than close down the business. If, because of changes of circumstance, they conclude that the manufacturing business is no longer viable, it seems most improbable that the distributor will take a different view of the position at that time. In other words, we think that the problems envisaged for the supplier because of the absence of a "reasonable notice" exit provision are not likely to arise in practice.
For these reasons, we consider that Morris J correctly refused to make a declaration that the agreement was terminated by Bobux on the giving of reasonable notice.
Since this judgment was prepared we have had the opportunity of reading a draft of the judgment of Thomas J. We do not accept that the contract was so lop-sided as to require a modification of what Thomas J concedes is our orthodox approach to contractual construction, assuming that to be possible. Nor do we accept that a reasonable person in Raynor’s position would have understood that Bobux was to have a right to terminate other than as expressly stated, and in a manner broadly consistent with the specimen contract tendered by Bobux. We note that there has been neither a plea of mutual mistake nor any attempt to seek rectification.
We agree with Thomas J that no question of res judicata can arise in relation to any issue of good faith performance, on which we make no comment. Nor does it arise in respect of the matters discussed in paras  and  of this judgment.
In accordance with the views of the majority, the appeal is dismissed with costs of $5,000 for the respondent, which is also entitled to its reasonable disbursements, including travel and accommodation costs, to be fixed if necessary by the Registrar.
Treen Gloves & Safety Products Ltd v Degil Safety Products (1989) Inc. (1990) 33 CPR (3d) 74
New Zealand Shipping Co Ltd v A M Satterthwaite & Co Ltd  AC 154
Carter v Boehm 97 ER 1162
Banque Financiere de la Cite SA v Westgate Insurance Co Ltd  2 AC 249
Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd  QB 433
Philips Electronique Grand Public SA v British Sky Broadcasting Ltd  EMLR 472
Livingstone v Roskilly  3 NZLR 230
Stanley v Fuji Xerox (NZ) Ltd (Unreported, HC Auckland, CP 479/96, 5 November 1997
Crawford Fitting Co v City Valve & Fittings Pty Ltd (1988) 14 NSWLR 438
Minister of Education v De Luxe Motor Services (1972) Ltd  1 NZLR 27
Re Spenborough Urban District Council’s Agreement  1 Ch 139
Winter Garden Theatre (London) Ltd v Millennium Productions Ltd  AC 173
United States of America
Uniform Commercial Code s.1-203
Second Restatement of Contracts 1981, s.205
UNIDROIT Principles of International Commercial Contracts 1994, Art. 1.7
Convention on Contracts for the International Sale of Goods 1980, Art.7(1)
Authors and other references
J P Vorster, "A Comment on the Meaning of Objectivity in Contract" (1987) 103 LQR 274
D W McLauchlan, "Actual Consensus ad idem in Contract – Unnecessary but Surely Sufficient?" (1995) NZLJ 45
The Hon Mr Justice Steyn, "The Role of Good Faith and Fair Dealing in Contract Law: A Hair-Shirt Philosophy?" (1991) Denning LJ 131
Melvin A Eisenberg, "Relational Contracts" in Good Faith and Fault in Contract Law (1995 - Eds, Jack Beatson and Daniel Friedmann)
A F Mason, "Contract, Good Faith and Equitable Standards in Fair Dealing (2000) 116 LQR 66
Johan Steyn, "Contract Law: Fulfilling the Reasonable Expectations of Honest Men" (1997) 113 LQR 433
A D M Forte (Ed), Good Faith in Contract and Property Law (1999), (Eds, Roger Brownsword, Norma J Hird and Geraint Howells)
Good Faith in Contract: Concept and Context (1999) Publishing Co Ltd
H O Hunter, "The Duty of Good Faith and Security of Performance", Jnl of Contract Law (1993) 19
Charles J Goetz and Robert E Scott, "Principles of Relational Contracts" (1981) 67 Virginia L R 1089
H K Lücke, "Good Faith and Contractual Performance" in P D Finn (ed) Essays on Contract (1987)
The Hon Mr Justice T R H Cole, "Law – All in Good Faith" (1995) 10 Building and Construction Law 18
Veronica L Taylor, "Contracts with the Lot: Franchises, Good Faith and Contract Regulation"  NZLRev 459
David Goddard, "Long-Term Contracts: A Law and Economics Perspective"  NZLRev 423
Ian B Stewart, "Good Faith in Contractual Performance and in Negotiation" (1998) 72 The Australian LJ 370
Judith Cheyne "Commercial Good Faith"  NZLJ 245
Eileen Webb, "The Scope of the Implied Duty of Good Faith – Lessons from Commercial and Retail Leasing Cases" (2001) 9 Australian Property Law Journal
Fried, Contracts as Promise (1981)
An Affirmation of the Fiduciary Principle (1996) NZLJ 405
A H Brown and J M Doherty for Appellant (instructed by Bennett Vollemaere & Co, Auckland)
H D Winkelmann for Respondent (instructed by Phillips Fox, Auckland)
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