The Court of Appeal considered the correct interpretation of related contracts and the business efficacy test for implying a term in the context of an alleged breach of confidentiality provisions in an intellectual property licence. The decision is a good reminder that the language of contractual provisions is not to be devalued by over-reliance on commercial common sense and background; only background knowledge known to all parties will be admissible. One contracting party’s wider business purpose is not relevant to whether a term should be implied to give business efficacy to a contract: Kason Kek-Gardner Ltd v Process Components Ltd [2017] EWCA Civ 2132
Kemutec Powder Technologies Ltd (KPTL) owned certain intellectual property rights (IP) relating to its businesses, including rights relating to the assembly and sale of certain industrial machines and the use of trade names associated with those machines.
KPTL went into administration and its administrators entered into an asset sale agreement with Process Components Ltd (PCL) (the claimant) for certain parts of KPTL’s business. Ten days later, the administrators entered into a second asset sale agreement with Kason Kek-Gardner Ltd (KGL) (the defendant) for the remaining parts of the business (including the parts of the business relating to the machines). Each asset sale agreement included the sale of IP used in the “Business”, but the agreements were unclear as to exactly what was meant by this.
PCL and KGL entered into a licence agreement whereby PCL licenced the use of IP relating to the machines to KGL. KGL was subsequently acquired by a competitor of PCL and, as part of the due diligence exercise, KGL disclosed a copy of the licence agreement to the competitor. PCL then terminated the licence agreement for breach of its confidentiality provisions. PCL argued that KGL no longer had the right to make use of the IP to which the licence related. KGL argued that it had never needed the licence to use the IP in question because it had acquired it under the terms of its agreement with KPTL’s administrators and, alternatively, the licence agreement had not been validly terminated by PCL.
The appeal turned on the following two key issues:
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whether, under the terms of its asset sale agreement, KGL had acquired any (and, if so, what) IP formerly belonging to KPTL (this question, in part, depended on what IP PCL had acquired under its asset sale agreement); and
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whether PCL had validly terminated the licence agreement.
Extrinsic evidence relevant to interpretation: related contracts
KGL argued that the two asset sale agreements should be read together so that PCL acquired the IP needed to operate the parts of the business it had bought and KGL acquired the IP needed to operate the parts of the business it had bought. KGL reasoned that, as the administrators had an obligation to realise all KPTL’s assets for the best possible price, it must have been obvious that to sell parts of the businesses without the necessary IP to carry on those businesses would seriously depreciate their value. In such circumstances, the reasonable reader of the PCL agreement would not have understood it to transfer to PCL the IP that went beyond that necessary for the parts of the business PCL had bought. PCL’s primary position was that the natural reading of its asset sale agreement was that it covered all IP owned by KPTL as existed at the date of that agreement and, alternatively, the PCL agreement should be interpreted as including the IP relating to the machines.
Lewison LJ gave the leading judgment, explaining that the general rule is that the subsequent conduct of the parties to an agreement cannot affect the true interpretation of the agreement, much less the subsequent conduct of those not party to the agreement. As such, the second asset sale agreement (to which PCL was not a party) had no bearing on the interpretation of the first asset sale agreement. Lewison LJ also made reference to the Supreme Court decision of Arnold v Britton, stating that admissible background is limited to the facts that were known or reasonably available to both (or all) parties; it is not right to take into account facts known only by one of them.1
KGL accepted that there was nothing in the language of the PCL agreement that would lead a reasonable reader to conclude that the IP to which it referred was to be divided by purpose. Instead, KGL’s interpretation relied on commercial common sense and background. Lewison LJ emphasised that these factors “should not be used to devalue the importance of the language of the provisions to be interpreted”. This lead the Court to conclude that PCL had acquired all of the relevant IP under its asset sale agreement.
No implied term in the confidentiality agreement
KGL argued that the confidentiality clause in the licence agreement was subject to an implied term that KGL was permitted to disclose the licence agreement “for reasonable business purposes”, which would include disclosure to a prospective purchaser. Lewison LJ outlined the test for implying terms in commercial contracts: the term must be necessary to give the contract business efficacy or it must be so obvious that it goes without saying.2 He went on to say that “[t]he necessity required by the test is necessity for the business efficacy of the contract; not some wider business purpose of a contracting party”.
The business purpose of the licence agreement was to enable KGL to operate its parts of the business. A sale of KGL’s shares by its shareholders was not a necessary business purpose of the licence. Lewison LJ concluded that the implied term was not necessary to give business efficacy to the licence nor was it so obvious that it went without saying.
The breach was “material”, justifying termination
KGL also argued that the termination provisions in the licence agreement provided that only a material breach of the confidentiality clause gave rise to PCL’s right to terminate immediately, not any breach.
The Court found that KGL’s interpretation required the position of the word “material” in the termination provisions to be shifted so that only a material breach of the confidentiality obligations was a non-remediable breach, whereas the clause actually read that a breach of the confidentiality clause was a non-remediable, material breach. The Court also stated that a material breach of a confidentiality clause was likely to be incapable of remedy; and that, where a contract expressly provides for rights of termination, it is irrelevant whether the events on which those rights are exercisable amount to repudiatory breaches or not. Accordingly, KGL’s breach of the confidentiality clause constituted a non-remediable, material breach and PCL had validly terminated the licence agreement.
Comment
This decision serves as an illustration (and perhaps a helpful reminder) of how the courts are applying recent case law on contractual interpretation and the approach being taken to implying terms in detailed commercial contracts. In summary, the language of the contractual provisions is not to be devalued by over-reliance on commercial common sense and background. Only background knowledge known to all parties will be admissible; and a contracting party’s wider business purpose is not relevant to a consideration of whether a term should be implied to give business efficacy to a contract.
Footnotes:
1 Arnold v Britton [2015] UKSC 26, [2015] AC 1619.
2 Marks and Spencer plc v BNP Paribas Securities Services Trust Co (Jersey) Ltd [2015] UKSC 72, [2016] AC 742.
