Forsgren NZ Limited v Restaurant Brands Limited [2020] NZCA 254 (24 June 2020)

Last Updated: 30 June 2020

IN THE COURT OF APPEAL OF NEW ZEALAND I TE KŌTI PĪRA O AOTEAROA

CA530/2019 [2020] NZCA 254

	BETWEEN	FORSGREN NZ LIMITED First Appellant
	AND	HENRY BARRY FORSGREN Second Appellant
	AND	RESTAURANT BRANDS LIMITED Respondent

Hearing:	2 June 2020
Court:	Miller, Brown and Goddard JJ
Counsel:	ARB Barker QC and A Lenard for Appellants J Carlyon and T H Stuart for Respondent
Judgment:	24 June 2020 at 3.30 pm

JUDGMENT OF THE COURT

1. The appeal is dismissed.
2. The appellants must pay the respondent costs for a standard appeal on a band A basis with usual disbursements. We certify for second counsel.

____________________________________________________________________

REASONS OF THE COURT

(Given by Miller J)

• [1] The appellants (together, Forsgren) and respondent (RBL) were parties to an agreement for the sale and purchase of a group of fast food restaurants. Against the possibility that a roading realignment would strand one of the restaurants, at North Harbour, in a cul-de-sac and force its closure, RBL took a sublease of that site from Forsgren and the parties agreed that part of the price would be held in escrow for a four-year period. As things turned out, the North Harbour restaurant was forced to close, but not in the manner the parties anticipated. Rather than leave it stranded the roading authorities chose to acquire it, and on a going concern basis. RBL suffered no loss.
• [2] Under a side letter recording their agreement about the escrow sum, the parties resolved that it would be paid to RBL if the sublease “is terminated or lapses for any reason” other than the purchaser’s default. If RBL did not become entitled to the money then it would be paid to Forsgren when the escrow period expired.
• [3] The land was ultimately taken by proclamation and vested in the Crown free of all interests, including the sublease.
• [4] The parties now dispute entitlement to the escrow sum. Forsgren, which lost in the High Court,^[1] says that the parties would never have agreed to RBL receiving a windfall gain and the side letter must be interpreted accordingly, or a term implied into it to the effect that the escrow amount would be paid to Forsgren if the restaurant were sold for value. RBL says that the sublease was terminated or lapsed by operation of law, and that the words “for any reason” assigned to Forsgren the risk that termination would happen in a way the parties had not expressly foreseen.

The facts

• [5] The facts are of narrow compass and the parties accept Muir J’s account of them. He summarised the background in this way:

[2] In November 2014, RBL entered into a contract with Forsgren. It provided for RBL to purchase seven Carl’s Jr fast food businesses. The total purchase price was $10,500,000 (comprising the book value of the assets ($9,982,672), an allowance for intellectual property rights ($420,712) and goodwill ($96,526)), plus a valuation of the stock in hand. The seven stores included premises located on the corner of Upper Harbour Highway and Paul Matthews Road, North Shore, Auckland. Of the total book value, $1,710,740 was attributed to this acquisition.

[3] The contract was subject to usual due diligence provisions. During the course of its inquiries RBL learned that the New Zealand Transport Agency (NZTA) planned to realign Paul Matthews Road within two or three years. The proposed realignment would remove access to Paul Matthews Road from Upper Harbour Highway, leaving the store in what was effectively a cul-de-sac and with significantly reduced exposure to passing traffic. That was a serious concern for RBL. It informed Forsgren that it was not willing to proceed with the transaction unless the risk was adequately mitigated.

[4] RBL advanced various proposals to resolve the impasse, including proceeding with the transaction without the North Shore store or proceeding with purchase of all seven stores on terms that address the proposed realignment.

[5] The second of these options involved a proposal that Forsgren remain as lessee of the store and execute a sublease to RBL for a three-year term with four rights of renewal. That permitted RBL to choose not to renew the sublease should there be significant disruption to traffic flow, thereby cutting its losses and leaving the liability under the head lease with Forsgren. The proposal further envisaged a purchase price reduction of $662,000, with $100,000 paid to Forsgren for every year the store remained open.

[6] Forsgren was amenable to a sublease arrangement but not to a reduction in the purchase price. It counter-offered with a proposal that the purchase price remain unchanged, but with $400,000 to be held in escrow and returned to RBL if the sublease was terminated within four years from the transaction completion date. This was broadly acceptable to RBL. RBL and Forsgren then negotiated the Side Letter, which was signed by both parties on or about 2 December 2014.

• [6] After setting out the relevant parts of the side letter the Judge explained how the Crown came to buy the North Shore restaurant business and the land on which it stood:

[9] In late 2017 the Crown notified RBL that it intended to acquire the freehold of the land under the Public Works Act 1981 (PWA) for the purposes of the so called Northern Corridor Improvements Project (Road Works).

[10] Negotiations between RBL and NZTA followed. It was agreed that RBL would be paid the fair market value of the business calculated as a going concern. Experts’ reports were exchanged with both valuers assessing the going concern value at $1.4M.

[11] In arriving at that figure it is common ground that neither valuer took into account the Escrow Amount — that is to say, compensation was not reduced on the premise RBL would also receive that sum.

[12] On 14 May 2018 NZTA and RBL entered into an agreement styled Memorandum of Agreement Pursuant to the Public Works Act 1981 (the Compensation Agreement) which provided for RBL to be paid compensation of $1,418,666.67 for what was identified as its “interest in the Sublessee’s Business”. This sum was structured as follows:

(a) Value of the business assets $851,852.74

(b) Value of the lease terminated $ 48,000.00

(c) Goodwill lost $500,147.26

(d) Disturbance Income $ 18,666.67

[13] The agreement did not contemplate assignment of the sublease to the Crown. Rather it envisaged “termination of the Sublease by the Crown consequent on the Crown’s taking of the land by proclamation or declaration”. In this respect, Forsgren says, and I accept, that the Compensation Agreement exhibits elements of structuring to ensure that a claim by RBL to the Escrow Amount might be preserved. This was further reflected in cl 9.1 of the Agreement, which provided that if the Crown did not complete acquisition of the freehold and head lease and terminate the sublease on or before 3 December 2018 (being the expiration of the Escrow period under the Side Letter), then RBL reserved its position in respect of any loss or damage.

[14] After settlement of the Compensation Agreement, NZTA started a compulsory acquisition process under s 23 of the PWA. However, it did not ultimately acquire any party’s interest in the land through that process. Instead, it issued a Gazette Notice under s 20 of the Act declaring an agreement to have been entered into in respect of the land which “shall vest in the Crown on the date of publication ...”. In terms of ss 20 and 26(3) of the Act, the effect of such declaration was that the land passed to the Crown free of all interests including the head and subleases.

(Footnotes omitted.)

• [7] We add that NZTA also acquired the freehold. It offered to buy Forsgren’s leasehold interest but it seems no agreement was reached. NZTA assessed Forsgren’s compensation at $7,700, reasoning that rent payable under the sublease was identical to that payable under the head lease (by Forsgren) and RBL had a right to ask the lessor for a direct lease on the same terms as the head lease at any time: in short, Forsgren’s leasehold interest had no material value.

The side letter

• [8] For present purposes we are concerned only with the side letter. It is common ground that its provisions were replicated in the sublease, which neither party accordingly addressed in argument.
• [9] The letter was addressed by RBL to Mr Forsgren and Forsgren NZ Ltd. It recited that due diligence had disclosed a potentially significant issue with the North Harbour restaurant. It proposed the following arrangements:

3 ...

(a) Notwithstanding clauses 3.1(b) and 11.2(c)(i) of the Agreement, the lease of the North Harbour Store will not be assigned to the Purchaser at Completion. Rather, the Vendor will retain the lease of the North Harbour Store and will sublease the North Harbour Store to the Purchaser. The terms of the sublease will include the following:

(i) The sublease will run from Completion for an initial term expiring on 18 December 2025 (“Initial Term”).

(ii) The Purchaser may terminate the sublease by notice to the Vendor if at any time prior to 5.00pm on the date that is the fourth anniversary of Completion (“Escrow Period”):

(A) access and egress to and from the road currently called Upper Harbour Highway or Paul Matthews Road is permanently closed; or

(B) there is, or works commence that are reasonably likely to result in, significant disruption to traffic or traffic flow (other than of a temporary nature) in the vicinity of the North Harbour Store.

(iii) After the expiry of the Escrow Period, the Purchaser may terminate the sublease by notice to the Vendor if at any time prior to 5.00pm on the date that is the eight (sic) anniversary of Completion:

(A) access and egress to and from the road currently called Upper Harbour Highway or Paul Matthews Road is permanently closed; or

(B) there is, or works commence that are reasonably likely to result in, significant disruption to traffic or traffic flow (other than of a temporary nature) in the vicinity of the North Harbour Store.

...

(c) Notwithstanding clause 5.1(a) of the Agreement, at Completion the Purchaser shall pay to the Vendor the component of the Purchase Price set out in clause 4.1(a) of the Agreement less the Escrow Amount and less $400,000 (“North Shore Store Escrow Amount”).

...

(f) If at any time prior to the end of the Escrow Period the sublease of the North Shore Store is terminated or lapses for any reason (other than due to the Purchaser’s unremedied default under the sublease), including termination by the Purchaser in accordance with paragraph (a)(ii) or lapse due to the dissolution of the Vendor, then the Purchaser is entitled to payment of the full amount of the North Shore Escrow Amount.

(g) If the Purchaser becomes entitled to payment of the North Short (sic) Escrow Amount, the Purchaser may give written notice to the Escrow Agent requiring payment of the North Shore Escrow Amount to the Purchaser and the Escrow Agent must comply with that notice.

(h) If the Purchaser does not become entitled to payment of the North Shore Escrow Amount by the expiry of the Escrow Period, then the Vendor is entitled to payment of the full amount of the North Shore Escrow Amount.

...

The High Court judgment

• [10] Muir J rejected an argument that termination was confined to termination pursuant to a right vested in a party under the sublease.^[2] The side letter did not say that; on the contrary, it entitled RBL to the escrow amount on termination “for any reason” and carved out only one exception, for the purchaser’s default. To a hypothetical reasonable observer termination would mean “bring or put an end to”.^[3] That was what happened when the Crown took the land free of all interests, including the derivative interest of a sublease.
• [11] The Judge accepted that RBL had received a “windfall” but rejected Forsgren’s argument that a different interpretation must be preferred because no one would have intended that RBL recover the escrow sum when it had already been fully compensated for closure of the North Harbour restaurant.^[4] He characterised the argument as an appeal to commercial absurdity and responded that a court cannot conclude that a contract does not mean what it appears to say simply because it turns out to be unduly favourable to one party; all the more so when the parties are experienced and have expert advisors. He observed that Forsgren too had benefitted by being released from the head lease.
• [12] The Judge did not, however, accept RBL’s argument that “lapses” should also receive a broad meaning.^[5] He accepted that a reasonable person might interpret it in that way, but cited an earlier draft of the side letter for the proposition that “lapses” was originally included for another reason, to cover the possibility that Forsgren would become insolvent, an event which had not happened.

The appeal

• [13] Forsgren contends that it was wrong to rely on a broad dictionary meaning for the words “terminated ... for any reason”; rather, the words ought to be interpreted within the context of the broader purpose of the parties’ agreement. The escrow arrangement was intended to protect RBL from any loss it might suffer if it had to close the restaurant in the first four years after purchase. The parties would not reasonably have intended that it would apply when RBL sold its interest for full value and suffered no loss. The outcome is commercially absurd. Further, if the sublease has come to an end it was as a result of a discharge following a frustrating event (the issue of a proclamation by the Crown), which is not within the ordinary meaning of the word “terminate”. Termination here refers to termination of the sublease in accordance with some right to do so under the sublease itself.
• [14] For its part, RBL adopts the Judge’s reasoning at [10]–[11] above and supports his judgment on another ground, namely that he was wrong to attribute a narrow meaning to the word “lapses”. It contends that the phrase “is terminated or lapses for any reason” covers the full range of possibilities by which the sublease might be brought to an end, apart from the express exclusion of default by the purchaser.

Discussion

• [15] This Court reconciled the leading Supreme Court authorities on contract interpretation in Malthouse Ltd v Rangatira Ltd at [18]–[24].^[6] It is convenient to repeat what we said there:

[18] The correct approach to contractual interpretation has been authoritatively established for present purposes in two judgments of the Supreme Court: Vector Gas Ltd v Bay of Plenty Energy Ltd (Vector),^[7] and Firm PI 1 Ltd v Zurich Australian Insurance Ltd (Firm PI).^[8]

[19] Briefly, these authorities confirm that New Zealand courts take an objective approach to contractual interpretation which does not limit the background material available to interpret the contract. That material must however be reasonably relevant, and it must be objective; evidence of a party’s individual subjective intentions is inadmissible to interpret the contract.^[9]

[20] Vector established that there need not be any ambiguity in the meaning of a contract before regard can be had to extrinsic evidence to shed light on its meaning. That conclusion put to bed the need for counsel to prove that contracts had such ambiguities, and instead emphasised the need for courts to take a contextual approach that inquired into the meaning of contracts against the background information known to the parties.^[10]

[21] As the Supreme Court later clarified in Firm PI, the text of the contract remains “centrally important”.^[11] The Court there noted that:

If the language at issue, construed in the context of the contract as a whole, has an ordinary and natural meaning, that will be a powerful, albeit not conclusive, indicator of what the parties meant.

(Footnote omitted.)

[22] The provisional meaning derived from the language of the contract is cross-checked against the contractual context.^[12] As Tipping J explained in Vector:

[24] In some recent cases it has been suggested that contractual context should be referred to as a “cross-check”. In practical terms that is likely to be what happens in most cases. Anyone reading a contractual document will naturally form at least a provisional view of what [its] words mean, simply by reading them. That view is, in a sense, then checked against the contractual context. This description of the process is valid, provided the initial view is provisional only and the reader is prepared to accept that the provisional meaning may be altered once context has been brought to account. The concept of cross-check is helpful in affirming the point made earlier that a meaning which appears plain and unambiguous on its face is always susceptible to being altered by context, albeit that outcome will usually be difficult of achievement ...

(Footnote omitted.)

[23] It follows that, though there is in principle no limit to the amount of “red ink” a court can use in interpreting a contract (as Lord Hoffmann famously said in Chartbrook Ltd v Persimmon Homes Ltd),^[13] there is a practical need for the party seeking to rely on the red pen to point to clear evidence justifying its use.^[14] As Tipping J explained in Vector, the exercise “is and remains one of interpretation”.^[15] There are limits to what the courts can do under the guise of interpretation, and words can only be construed with meanings that they can reasonably bear (subject, as Tipping J recognised, to considerations of rectification, private dictionary use by the parties, and similar).^[16]

[24] Finally, the authorities also establish that, where there is a natural and ordinary meaning to the term in issue, departing from it for reasons of commercial common sense should only occur “in the most obvious and extreme of cases”.^[17] It also bears emphasis, as the Supreme Court noted in Firm PI, that the commercial context may increase the weight to be placed on the provisional view formed from the words of the contract. That is because many commercial contracts have features that ordinary language lacks (particularly that they are negotiated in a detailed and formal manner that attempts to record consensus), may be relied on by third parties, or because of the nature of the particular contract at issue (such as a security document or an insurance contract).^[18]

• [16] On that approach a court does not begin, as Forsgren urges, with the question of what the parties would have done had they known how things would turn out. It begins with the contract’s language. The provisional meaning having been identified, the court checks it against the context when the contract was entered.

“is terminated or lapses for any reason”

• [17] Turning to the side letter, we make several points by way of overview of its relevant provisions. First, it is expressly envisaged in cl 3(a)(ii) and (iii) that road works might permanently close the restaurant’s ingress from and egress to the Upper Harbour Highway and specified that RBL might terminate the sublease if that event were to occur within eight years. It did not expressly envisage that roading authorities might acquire the restaurant on payment of compensation.
• [18] Second, the letter specified in cl 3(f) what would happen to the escrow sum in the event the sublease was terminated or lapsed for other reasons, within the escrow period. RBL’s right to claim the escrow sum was not confined to the expressly‑envisaged situation where it exercised a contractual right to terminate because realignment had closed ingress from and egress to Upper Harbour Highway. Rather, it became entitled to the escrow sum if the sublease “is terminated or lapses for any reason” other than its own default.
• [19] Third, unless RBL became entitled to payment of the escrow amount within the four-year escrow period it would be paid to Forsgren.
• [20] Differing in this respect from Muir J, we think that the words “is terminated or lapses for any reason” in cl 3(f) should be read as a single phrase. We do not share the Judge’s view that “lapses” should be read down, by reference to a previous draft of the side letter, to connote only lapse by reason of Forsgren’s insolvency. As a matter of grammar, the words “for any reason” modify both verbs. When read in that way, the language suggests that the parties intended to encompass the ending of the sublease by any means whatsoever, apart from the express exclusion for termination or lapse by RBL’s default. To adopt the Judge’s term, the words should be given a functional meaning rather than a technical one.
• [21] We accordingly reject Mr Barker QC’s submission that “terminate” encompasses only termination pursuant to a right in the sublease. The side letter provided expressly for termination should a road realignment leave the restaurant stranded, so the words “is terminated ... for any reason” must refer to a broader range of circumstances. Mr Barker did not identify any termination right that the parties might have had in mind. His interpretation appears to leave the words “for any reason” with very little, if any, work to do.
• [22] Turning to the context, we accept, as Muir J did, that the parties did not contemplate that NZTA would acquire the restaurant, compensating RBL for closure and so eliminating the risk that the side letter was intended to address. They certainly anticipated that a roading realignment could force the restaurant’s closure, but they did not contemplate that it would happen in the way that it did. They envisaged rather that RBL might be left holding a stranded asset.
• [23] However, the side letter was not silent about the risk that the restaurant might close for other reasons. On the contrary, the language used in cl 3(f) expressly assigned to Forsgren the risk that the sublease would be terminated for reasons other than those the parties had in mind at the time.
• [24] Nor is this a case where the context supplies a contrary answer. The evidence rather reminds us that this was a commercial agreement between experienced parties with expert advisors and the side letter was a mechanism agreed to overcome an obstacle to the overall transaction. It responded to Forsgren’s insistence that the price not be adjusted to reflect the risk that the North Harbour restaurant would have to close. To get the deal across the line, the parties adopted a blunt mechanism that bore no direct relationship to the losses RBL might incur in that event. The outcome may not have been one that Forsgren would have negotiated had it foreseen what NZTA would do. It has resulted in RBL being compensated for a loss that was never suffered. But it was not commercially absurd at the time and hindsight cannot be permitted to make it so. We return to this point below, when addressing the implied term argument.

Did the sublease terminate or lapse?

• [25] It is common ground that the sublease ceased to exist when the Crown took the land on which the restaurant stood free of all interests. Mr Barker conceded that RBL cannot use the site and the sublease does not bind the Crown, so in that sense there is no sublease. His argument was that no one formally terminated the sublease, which subsisted as a private contract between RBL and Forsgren. On his analysis, the sublease was frustrated because the Crown’s proclamation made performance impossible.
• [26] We have already foreshadowed our response. We accept that as between parties to a lease the concept of termination would ordinarily refer to the exercise of a right to bring the lease to an end, but this was a side letter negotiated in circumstances where the leased premises might be forced to close through the actions of a third party. The side letter does not require that termination occur by an act of one or other party to the sublease, and as noted above its language is apt to capture what happened. There no longer exists any interest in law which permits RBL to carry on business on the land.

No scope for an implied term

• [27] Forsgren pleaded in the alternative an implied term that cl 3(f) does not apply when RBL sells its interest in the sublease for value or its interest is compulsorily acquired and compensation is paid.
• [28] It will be apparent that we find this implied term incompatible with the language of the side letter. We add that, as already explained, the side letter was negotiated in circumstances where Forsgren was unwilling to adjust the price for the risk of closure and the mechanism adopted in the side letter bore no direct relationship to losses, if any, that RBL might suffer. The proposed implied term is an attempt to revise the terms of the side letter because, as it turns out, RBL actually benefitted from closure.
• [29] The implied term would also result in Forsgren receiving the escrow amount even if RBL was not fully compensated. By way of illustration, Forsgren would take the money if NZTA had deducted $400,000 from the compensation it paid RBL and paid that sum to Forsgren. Mr Barker disclaimed any right to the resulting windfall, but it is what would have happened under the implied term pleaded had NZTA chosen to allocate compensation in that way. The larger point is that any implied term would have to address what happened if RBL was paid less than full compensation and it is far from self-evident how that would be done. The Court would have to make it up.

Decision

• [30] We consider that Muir J was correct, although for slightly different reasons. The appeal is dismissed.
• [31] The appellants must pay the respondent costs for a standard appeal on a band A basis, with usual disbursements. We certify for second counsel.

Solicitors:
Burton & Partners, Auckland for Appellants
Meredith Connell, Auckland for Respondent

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^[1] Restaurant Brands Ltd v Forsgren NZ Ltd [2019] NZHC 2375 [High Court judgment].

^[2] High Court judgment, above n 1, at [57].

^[3] At [52].

^[4] At [41]–[42] and [58]–[62].

^[5] At [46].

^[6] Malthouse Ltd v Rangatira Ltd [2018] NZCA 621.

^[7] Vector Gas Ltd v Bay of Plenty Energy Ltd [2010] NZSC 5, [2010] 2 NZLR 444 [Vector].

^[8] Firm PI 1 Ltd v Zurich Australian Insurance Ltd [2014] NZSC 147, [2015] 1 NZLR 432 [Firm PI].

^[9] Vector, above n 7, at [19]–[20] per Tipping J; and Firm PI, above n 8, at [60] per McGrath, Glazebrook and Arnold JJ.

^[10] Vector, above n 7, at [5]–[6] per Blanchard J, [22] per Tipping J and [56]–[57] per McGrath J.

^[11] Firm PI, above n 8, at [63].

^[12] Vector, above n 7, at [24].

^[13] Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38, [2009] AC 1101 at [25].

^[14] As Tipping J noted in Vector, above n 7, at [26], the parties could also contract such that, for them, “black means white”, but the likelihood of them doing so “will no doubt be a powerful factor when it comes to questions of proof”.

^[15] At [23].

^[16] At [23].

^[17] Firm PI, above n 8, at [93] per McGrath, Glazebrook and Arnold JJ.

^[18] At [62] per McGrath, Glazebrook and Arnold JJ.