COVID-19 and contractual obligations – The inn dispute topic

In the recent decision of Dyco Hotels Pty Ltd v Laundy Hotels (Quarry) Pty Ltd, ¹ the NSW Supreme Court considered whether a party’s inability to carry on its business due to COVID-19 restrictions caused the seller to be in breach of its contractual obligations or the contract to be frustrated.
 

The Facts
Dyco Hotels Pty Ltd (Seller) and Laundy Hotels (Quarry) Pty Ltd (Buyer) entered into a contract for the sale and purchase of The Quarrymans Hotel in Pyrmont, Sydney (Business) on 31 January 2020 (Contract).  The Contract included, among other things, the transfer of the freehold hotel property, the business and its related licences.  Settlement under the Contract was due to occur at the end of March 2020.

The Contract contained a number of boilerplate clauses for contracts of this nature, including, relevantly, clause 50.1, which imposed an obligation on the Seller to "carry on the Business in the usual and ordinary course as regards its nature, scope and manner" from the contract date until completion of settlement.

On 23 March 2020 the Public Health (COVID-19 Places of Social Gathering) Order 2020 (Order) was made by the NSW Government and took effect from noon of that same date.  Among other things, the Order forced the closure of all licensed premises, including hotels such as the Business, except for the purposes of providing takeaway food or beverages for consumption off-premises or to a person using the hotel for accommodation.  

In compliance with the Order, the Seller ceased operations of the Business at noon on 23 March.  However, in order to maximise sales and remain in operation as far as the Order permitted, the Seller re-opened for takeaway food and beverage sales and delivery on 26 March 2020.

Following these events, the Buyer claimed that:

• the Seller breached the Contract for failure to comply with the obligations imposed by clause 50.1 of the Contract; or in the alternative
   
• the Contract had been frustrated as a result of COVID-19 and the restrictions imposed by the Order, namely, the Business was only allowed to provide takeaway services, modified the Business’s operations.
   

Did the Seller breach the Contract?
Central to the case was to what extent, if any, clause 50.1 obliged the Seller to carry on the Business in a manner contrary to the Order, particularly as the Order was made after the contract was entered into.

In determining the scope and effect of clause 50.1, the Court considered what a reasonable business person in the position of the parties would have understood the clause to mean by reference to the wording of the clause, the surrounding circumstances known to them and the commercial purpose or objects to be secured by the Contract.

The Court found that:

• Both parties had considerable experience in the operation of hotels in Sydney and so could be taken to have knowledge of the nature of the legal and regulatory environment within which hotels, such as the Business, operate, for instance the right for the relevant authority to cancel or suspend licences, impose various penalties and interfere with hotel operations under the Liquor Act 2007.
   
• The obligation imposed by clause 50.1 required the Seller to carry on the Business in the usual and ordinary course (by reference to its nature, scope and manner) as far as it remained possible to do so in accordance with the Order and the law.  Operating the Business in an unlawful manner would likely diminish the goodwill of the Business and place the Business’ licences (and so the future operation of the Business) in jeopardy.

For the above reasons, the Court held that the Seller complied with its obligations under clause 50.1 and so did not breach the Contract.

Had the Contract been frustrated?
The Court considered whether the Order and the pandemic resulted in a fundamental commercial difference between the actual and contemplated performance of the Contract, or a fundamentally different situation, such that it would not be just to hold the parties to the Contract.

Applying the extrinsic evidence principal in Codelfa Construction Pty Ltd v State Rail Authority of New South Wales,² the Court found that:

• The essential nature and purpose of the Contract was a sale and transfer of the assets and the business of the Business for an agreed price. 
   
• As all of the components of the Contract remained transferable (notwithstanding the temporary alteration in the nature of trading during the pre-settlement period), the obligations to carry on the Business must not be ‘regarded as of cardinal significance’, but rather ancillary to the principal promises to sell and transfer the Business for the agreed price.  
   
• Further, the Court noted that the Seller had not given any warranties guaranteeing the future financial performance of the Business, and so the reduction in value of the Business was a type of risk the Buyer had accepted.

For the above reasons, the Court held that the Contract had not been frustrated and the parties remained bound by the Contract.

Lavan Comment
Some of the key takeaways of this case are:

• for those with existing contractual arrangements – as illustrated by this case the pandemic and its implications may now be expected to be considered as part of the usual and ordinary course of business, making it difficult to argue that general business operation covenants have been breached due to interruptions caused by COVID-19; and
   
• for those negotiating contracts – parties should be alive to and contemplate a reasonable range of scenarios that may arise.  

In particular:

• a seller should seek to include carve-outs in its pre-settlement conduct obligations to allow it to take any reasonable action to the extent required by a public health order, the law or a government authority; and
   
• a buyer should look to shore up its rights under any material adverse change or force majeure clauses to mitigate their risk in the event that the nature of the subject asset/business changes in the pre-settlement period to an extent that is unacceptable to it.

If you would like to discuss how you might deal with COVID-19 implications in your contractual arrangements, please do not hesitate to contact us.