Commercial agreements often include provisions that give one of the parties exclusive rights to supply the other party’s requirements for particular goods or services. But what if the agreement does not expressly deal with this? Can exclusivity be inferred or implied? A recent case shows that it can. This is an important development because exclusivity is such a key commercial term that it would ordinarily be expressly dealt with in the contract if the parties intended it to apply. The case is particularly important because it demonstrates that exclusivity can be inferred without meeting the well known (yet relatively hard to satisfy) requirements for implying terms set out by the High Court in Codelfa. Overall, in our view there now appears to be a greater risk that exclusivity will be found to exist.
Who needs to know?
Anyone who is involved in drafting, negotiating or advising on commercial contracts. This includes supply agreements, distribution agreements, licensing arrangements and umbrella type master arrangements.
Recent Case
The recent case of Rehau Pte Ltd v AAP Industries Pty Ltd [2018] NSWCA 96arose from a supply agreement between AAP (a manufacturer of plumbing products ) and Rehau (a wholesale supplier of plumbing products).
The agreement was entered into in September 1999. It was in the style of a 5 page letter agreement to which Rehau’s standard terms and conditions of purchase were attached.
The agreement applied to 9 different plumbing products each with its own fixed price. The agreement had an initial term of one year. The agreement would automatically renew for successive years unless a party gave a termination notice 3 months prior to expiry of the then current term. The agreement did not contain any exclusivity provisions or any minimum purchase or ‘take or pay’ requirements. Nor did it lock in any purchase orders from Rehau or even indicate the quantities that might be involved. Rather, the agreement simply contemplated that purchase orders could be issued “under” the agreement and that the terms of the agreement would then apply to each order (including “call-off” or blanket orders).
Nevertheless, the agreement did contain the following salient features:
- the agreement stated that Rehau “shall purchase” the plumbing products from AAP;
- AAP was required to “reserve production capacity” to meet Rehau’s requirements;
- AAP was required to maintain a minimum buffer stock of 2 months;
- Rehau was entitled to make covering purchases to maintain production if AAP failed to supply; and
- Rehau was required to provide AAP with tooling so that it could manufacture the products. AAP was obliged to keep the tooling “up to date with revisions to drawings” and “always keep it ready for use”.
As it Eventuated
It appears that the agreement applied for many years until 2012 when Rehau approached AAP seeking possible price reductions. AAP did not agree to this. Rehau continued to place orders until July 2013 but did not place any orders after that. It appears that Rehau then started purchasing from a different manufacturer or began making the products in-house. AAP claimed that Rehau had repudiated the agreement and claimed damages.
Proper Interpretation Required Exclusivity
The trial judge held that exclusivity was required as a matter of construing the actual words used in the agreement when viewed as a whole. The Court of Appeal agreed with this.
The main reason for reaching this decision was that, in the Court’s view, many of the agreement’s salient features (see above) would have been unnecessary if Rehau was entitled to purchase products from other sources. Looked at from a different perspective, the Court found that in order to give effect to the actual words of the agreement, it was implicit that exclusivity applied even though this was not expressly stated in the agreement.
Implied Terms – Bypassing the Codelfa Principles?
Apart from finding implicit meanings by construing the actual words used in a contract, it is also possible to imply terms on the basis of the principles stated by the High Court in Codelfa Construction Pty Ltd v State Rail Authority(1982) 149 CLR 337. From a legal perspective, this is a different approach but the outcome is essentially the same. Under the Codelfa principles, an implied term can be completely separate from and does not need to be implicit in any of the express words used in the contract. So long as the implied term is not contrary to an express term of the contract, and other requirements are satisfied (see below), a term can be implied. Implied terms are often used to ‘fill in’ gaps or supplement the express terms of a contract.
In this case, the trial judge held that exclusivity was implied on the basis of the Codelfa principles. The trial judge concluded that, without the exclusivity term, the agreement “would for all purposes be ineffective” as the supply agreement would impose no obligation on Rehau.
One of the requirements for implying terms under the Codelfaprinciples is that the implied term must be “necessary for business efficacy”. This is normally a high threshold to satisfy. It must be more than just reasonable to imply the term. It must be such that the contract will not be workable without out it i.e. no term can be implied if the contract can work without it.
Another requirement for implying terms under the Codelfa principles is that the term must be “so obvious that it goes without saying”. In the present case, there was unfortunately no evidence of the circumstances surrounding the formation of the agreement in 1999, and it predated all of AAP’s current employees. In our view, exclusivity is a fundamental and often sensitive matter in commercial negotiations. It of course depends on the circumstances, but many parties would pause to seriously consider whether exclusivity should apply rather than give an immediate and unequivocal “Why, of course! That’s so obvious we didn’t think we needed to say that”. This is particularly relevant for terms about exclusivity because they restrict the freedom that a party would otherwise have.
Since the Court of Appeal agreed that exclusivity was implicit as a matter of construing the actual words of the agreement, the Court of Appeal did not go on to also consider whether the trial judge’s application of the Codelfa principles for implying terms was correct.
Observations
While the actual words of each contract will always be crucial, this case serves as a reminder that contractual terms can be implicit even if the relatively high requirements of the Codelfa principles are not satisfied. There can be a fine distinction between recognising a term on the basis of construction and implying terms on the basis of the Codelfa principles. Neither approach allows the court to simply rewrite the contract or to insert terms that the parties could have but did not include.
However, in our view, upholding a term of exclusivity based on construction without satisfying the Codelfa principles may set the bar too low unless there are very clear indications from the express terms of the contract that this is what the parties intended. That is what the Court of Appeal in this case essentially held. That said, the salient provisions of the agreement relied on by the Court of Appeal are, in our view, relatively common in many supply contracts across many industries where parties do not intend these to be exclusive arrangements. Is a supply contract exclusive just because special tooling is involved or the supplier is required to hold buffer stock or reserve production capacity? Do these features by themselves and in the absence of any other evidence really suggest exclusivity? Do these features really make it, to use the Court of Appeal’s language, a “sufficiently clear case” for implying exclusivity? In our view, they do not. Despite these being common commercial terms, we think that there is now a greater risk that exclusivity will be found to exist even where the contract operates effectively without the term being inferred or implied.
Umbrella Agreements
Rehau contended that the agreement should be understood as an umbrella agreement designed to be supplemented by call-off orders which Rehau might make from time to time. Rehau characterised the provisions as “reasonable commercial terms … negotiated to ensure [Rehau] received the product quality and quantity it required” without involving any exclusivity. The Court rejected this. The Court found that exclusivity was implicit and that the agreement did not make “commercial sense” without it.
In our view, umbrella arrangements of the type argued for by Rehau can be workable. Moreover, they are widely used across many different industries and have been for many years. They may be biased in favour of the purchaser but that is a matter for the supplier to negotiate (e.g. include an exclusivity clause or a minimum purchase commitment etc).
Practical Points to Take Away
- When drafting commercial agreements, consider whether exclusivity may be implied. Based on this case, it appears prudent to deal with exclusivity by an express clause which sets out the parties’ intentions (even if those intentions are that no exclusivity applies). This appears particularly important for umbrella agreements.
- When considering exclusivity, also consider minimum purchase and ‘take or pay’ type arrangements in lieu of (or possibly in addition to) exclusivity. It should be noted that including a clause to the effect that there is no minimum purchase commitment from the purchaser would not necessarily be inconsistent with exclusivity being implied.
- Rather than risk breaching the supply agreement like Rehau, consider exercising termination rights as a way of transitioning to a new (non-exclusive) agreement or an entirely separate supply arrangement with different suppliers. For example, if Rehau had given AAP a notice of termination 3 months prior to the annual renewal in September 2012, Rehau would then have been free to source or itself manufacture the products as it saw fit for the rest of 2012 and onwards. It appears that no termination notice was ever given, hence the agreement automatically renewed resulting in Rehau being in breach when it stopped purchasing form AAP in July 2013.