Australian Contract Law: A recent case study – SAS (Vic) Pty Ltd v Urban Ecological Systems Ltd  VSCA 335
This decision of the Victorian Court of Appeal considered the ongoing controversy as to what regard the courts may have to surrounding circumstances when interpreting a contract. In dismissing the appeal, their Honours confirmed that the circumstances that a contract addresses, and the commercial purpose or objects to be secured by it, can ordinarily be identified by reference to the contract alone. It also, again, shows the importance of clear and unambiguous drafting of terms, including the need to clearly define key terms or phrases.
The respondent, Urban Ecological Systems Ltd (UESL) is a food technology business that developed ‘Blue Farm Technology’; a sustainable food production system, involving the growth of vegetables and fish in a glasshouse at the same time. The waste produced by the fish is transformed into fertiliser for the vegetables. UESL holds the patents and intellectual property rights for Blue Farm Technology.
In 2010, UESL entered into a joint venture with an investor, Steelco Developments Pty Ltd (Steelco), establishing Green Camel Pty Ltd (Green Camel). In July 2010, UESL granted Green Camel an exclusive licence to exploit Blue Farm Technology in Australia royalty free (Australian Licence). Soon after, Green Camel established a farm in rural New South Wales and began utilising Blue Farm Technology for food production. Green Camel was initially successful and secured a supply contract with Coles Supermarkets Australia Pty Ltd (Coles). However, Green Camel was not able to reliably supply Coles with quality produce and Coles subsequently novated the agreement to another supermarket.
By 2012, relations between UESL and Steelco had broken down. Steelco allegedly reneged on an agreement that allowed UESL to appoint a majority of the directors on its company board, and took for itself the board seats that it had previously allocated to UESL. These events are currently the subject of litigation in the New South Wales Supreme Court, where UESL is contending that the Australian Licence is no longer on foot.
By 2015, Green Camel had become what the trial judge described as ‘a major obstacle’ for UESL. It was in 2015 that the applicant, SAS (VIC) Pty Ltd. (SAS), emerged seeking to assist UESL with its Green Camel ‘problem’ and invest in its Blue Farm Technology. In 2016, SAS agreed to invest $100,000 in UESL by way of funding its legal fees incurred during the dispute with Green Camel.
The Principal Agreement
In June 2017, UESL entered into a second agreement with SAS (Principal Agreement). The overarching purpose of the Principal Agreement was for SAS to ‘fix UESL’s Green Camel problem’ in return for the Australian Licence. If SAS was able to reach certain defined Milestones, UESL would be required to terminate the Australian Licence with Green Camel and grant it to SAS. The Principal Agreement also granted SAS an exclusive and unconditional licence to exploit Blue Farm Technology in New Zealand (New Zealand Licence).
Appendix 1 of the Principal Agreement outlined the intent of the parties as follows:
The underlying intent of the Milestones is that SAS and UESL will work together to remove the current impediments to the business and set the business on a successful path in the Australian Territory and Additional Territory. This may involve a change in control of Green Camel, a change in ownership or a combination of both of these.
Clause 2 of the Principal Agreement conditionally provided for the termination of the Australian Licence granted to Green Camel and the granting of this licence to SAS. Under clause 2, SAS would be granted the licence only if it achieved either ‘Milestone 2’ or ‘Milestone 3’, which were described as follows:
- Milestone 2 required SAS to pay UESL a portion of royalties from profits generated by the Australian Licence or the New Zealand Licence
- Milestone 3 required SAS to introduce a new investor in order to effect the sale or change of control of Green Camel.
The royalty payment
On 19 July 2019, SAS entered into a sub-licence agreement with a related New Zealand company, SAS (NZ) Limited. On the same day, SAS deposited $5,001 into UESL’s bank account. SAS contended that it had received $2,500 of this payment from SAS (NZ) Limited and that it therefore represented a ‘royalties payment’ under Milestone 2. Accordingly, SAS claimed that it was entitled to the grant of the Australian Licence by virtue of having achieved Milestone 2, despite the fact that SAS (NZ) Limited had not constructed any farms that utilised Blue Farm Technology and therefore had not generated any revenue from use of the New Zealand Licence.
UESL did not consider that SAS had achieved Milestone 2, as the monies paid by SAS did not originate from the revenue of the Blue Farm Technology. SAS brought proceedings in the Victorian County Court, seeking specific performance of the transfer of the Australian Licence, arguing that the $2,500 payment was a ‘royalties’ payment for the purposes of the Principal Agreement.
How did the Court of Appeal construe the Principal Agreement?
The courts, at first instance and on appeal, rejected SAS’ argument that the July 2019 payment constituted a royalties payment under Milestone 2. The courts accepted UESL’s argument that the Principal Agreement contemplated that such royalties would arise from ongoing use and production of Blue Farm Technology. The courts emphasised the importance of an objective approach to construing commercial contracts, seeking to give effect to what a reasonable business person would have understood the terms of the contract to mean. The courts regarded SAS’ contention (that its payment constituted the fulfilment of Milestone 2) as resulting in a commercial nonsense, as the primary objective of the contract (being SAS ‘fixing the Green Camel problem’) had not been achieved.
This case is a sound warning to parties to commercial contracts, to ensure that your contracts are drafted clearly and precisely. The Court of Appeal was particularly critical of the drafting of the Principal Agreement, noting that it was ‘difficult to read, and contains obvious errors’.
While the courts will attempt to give contracts a businesslike construction, you should not assume that the courts will interpret vague terms in a way that favours your commercial interests. Rather, when drafting contracts, you should explicitly state the commercial purpose of the agreement clearly within the text. In this case, a clear definition of what constituted ‘royalties' would have avoided the ambiguity and the dispute.
This decision stands as a reminder that courts will construe vague terms in a way that a reasonable business person would understand the meaning of the actual terms of the contract, not in a way that a reasonable business person believes the terms should be interpreted in order to make (subjective) commercial sense.
When drafting contracts, ensure that all terms are clear and key terms are clearly defined. If you are party to a commercial contract and encounter disagreement with the other party regarding a particular term, you should, at the earliest opportunity, review the contract and seek to make a variation that clarifies the intended meaning.
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