By: Jeremy Johnson
Published: 4/10/2013
Introduction

For the first time in New Zealand, the issue of "subject to director's approval" clauses has come before the Courts.  This raised the question of how such clauses would be interpreted. In particular, would the Courts approach the clauses as "conditions precedent" or "conditions subsequent"?

Contracts may be subject to conditions. A condition precedent is a condition that needs to be fulfilled before a contract is binding on both parties. It is essentially the same as an option for one party to bind the other at their complete discretion. Conversely, under a condition subsequent, substantial performance of a contract is not required until the condition is fulfilled. There is usually an obligation on one or both sides to attempt to ensure the condition is fulfilled. Common examples include "subject to solicitors approval' and "subject to finance" clauses.

If the latter interpretation is preferred by the Court, the issue then becomes what requirements would be imposed on directors to satisfy the condition?

Background

On 24 December 2007 Arcadia Homes entered into an agreement with More to this Life To purchase a residential property in Wanaka for $2 million.  The agreement was in the standard REINZ/ADLS 8th Edition 2006 form except in three respects, one of which is material.

In the box making provision for further terms of sale, there was a clause stating that the agreement was subject to and conditional upon director's approval.  The clause also stated that "this condition is inserted for the sole benefit of the Purchaser."

On 6 January 2008 Arcadia entered into an agreement to purchase another property.  On 9 January Acardia's solicitors faxed the vendor's solicitors stating "following inspection, valuation advice and ancillary due diligence investigations the directors are unfortunately not satisfied as to the purchase property and accordingly the Agreement is at an end."

The vendors did not accept that Acardia was entitled to avoid the agreement.  They served a Settlement notice, which was rejected.  Accordingly, they cancelled the agreement, resold the house for $1.41 million and commenced proceedings in the High Court for the difference between the price in the Agreement and the sale price.

The High Court held the clause to be a condition subsequent and that the director of Arcadia had not satisfied this condition.  The purchaser appealed this decision. 

The starting point in contract law

Both the High Court and the Court of Appeal recognised that as an issue of contractual interpretation the starting point is the law espoused in the Supreme Court decision of Vector Gas Arena Ltd v BOP.1 This decision held that contractual interpretation requires an assessment of the relevant clause in the context of the contract and, more widely, the "commercial or other context in which [it] was made."  This requires an assessment of all the facts and circumstances known to and likely to be operating on the parties' minds.

This should not be confused as implying a subjective test, i.e. the Courts interpreting the contract based upon what the parties say their intentions were.  The Court will assess the objective intention within the context of [the contract.  In other words, what would an objective and reasonable party to the contract have believed the intention was given the particular circumstances - there is no room for people who interpret the circumstances unreasonably!  This approach provides for contractual certainty, an essential ingredient in a market economy.

The Court's approach means that precedent-setting cases like this one are of vital importance.   How the Courts interpret a 'subject to director's' clause in this case will likely affect many others entering agreements for sale and purchase ("ASP") with subject to director's approval clauses.

Condition Subsequent

In dismissing the appeal, the Court of Appeal held that the condition was a "condition subsequent."  Several reasons for this interpretation were based upon the particular facts of the case; in particular, the conduct of the purchaser after the agreement was signed.  However, some of the most crucial reasons turned on the contractual construction:
  1. The use of the REINZ/ADLS form of agreement, which includes above the signature spaces the words:
WARNING         … This is a binding contract. Read the information set out on the back page before signing.
  1. The condition referred to "this agreement" being subject to director's approval;
  1. The agreement included a clause which stated that all conditions in the agreement were a condition subsequent "unless otherwise expressly provided"; and
  1. The clause stated the condition was for the purchaser's sole benefit, entitling Acardia to bind the vendors by waiving the condition.
These reasons provide useful guidelines for those who are drafting and interpreting ASPs.

Reasons (1) and (2) suggest that the condition was a condition subsequent because they indicate that the agreement was a binding contract and not simply "an option" to contract.

Reason (3) is self-explanatory, and it is worth noting that this is a standard clause in the ADLS and REINZ agreements.  Therefore, if the purchaser intends the contract to be "an option" the condition must be explicit.

Finally, reason (4) suggests that the agreement is a condition subsequent because its standard interpretation is that the purchaser has the right to waive the condition.  The result is that the condition is inconsistent with an option because a party does not need to waive an option.

What does the condition require from directors?  

Given the likelihood that subject to director's approval clauses will be interpreted as conditions subsequent, the question then arises as to how this condition is satisfied.  The most obvious but potentially unhelpful response is that directors must consider the sorts of matters directors would usually take into account when considering the acquisition of a major asset.  More specifically, the Court found that at the very least a director ought to:
  1. Report in good faith to other directors to the extent required for those directors to make a bona fide independent decision on the merits of the purchase based on objective consideration; and
     
  2. Make the following further investigations:
    1. a guaranteed title search;
    2. a LIM report; and
    3. valuation by a registered valuer.
In terms of the parameters of "matters that directors able to consider", the Court has stated that "the scope of the matters able to be considered by [directors] would be broader than say, the matters which a solicitor is able to take into account under a 'subject to solicitors' approval clause.  Beyond this, it remains to be seen how the case law develops but clearly the scope of matters that can be considered must be within the confines of what one would usually expect a director to undertake in the commercial context.

A sole director

The decision also touched upon the issue of whether a "subject to director's approval" clause is ever operative if the sole director is the individual who signs the ASP as the purchaser.

In the High Court judgment, French J held that as the sole director an individual has the power to enter contracts that bind the company and by signing the ASP in their capacity as a director they communicate their approval.  The Judge held that it made no sense to interpret such clause as affording a sole director an opportunity to approve what they have already agreed to. On the particular facts of this case the argument held potency as the appellant signed his name and wrote "director" next to it – as if to emphasise that the director was agreeing to the purchase.

The Court of Appeal acknowledged that there is some merit in this argument as it is arguable that the point of such clauses is to satisfy third party directors of the merits of the purchase.  Ultimately, the Court rejected the argument on the basis of a distinction between an individual signing an agreement as agent/director for the company and their approving it as director.  The result is that as the law stands signing will not constitute approval.  A sole director may sign as director and then fulfil the condition at a later date.

Conclusion

This case marks an important decision in contractual interpretation.  After all, it is a well-known fact that New Zealanders are very enthusiastic about using company and trust structures when it comes to acquiring property.

The Court's finding casts a wide net over the interpretation of Agreements of Sale and Purchase and directors clauses because a number of the key reasons for the decision include standard clauses in the ADLS and REINZ agreements used by solicitors.

If you are a purchaser who wishes to have an open ended "opt out" then the contract needs to explicitly include an "option to purchase" condition.  Alternatively, if you are the purchaser with a condition subsequent (i.e. a Subject to director's clause) then you need to have at the forefront of your mind the parameters of your discretion and the "boxes" you need to tick.

Finally, it is important to note that as a vendor, if the sole director of a company is signing an agreement with a subject to director's approval clause, the clause is still "live" and the ASP is not unconditional.

1 [2010] 2 NZLR 444
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