England and Wales Court of Appeal (Civil Division) Decisions

IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM QUEEN'S BENCH DIVISION
LEEDS MERCANTILE COURT
His Honour Judge McGonigal

		Royal Courts of Justice Strand, London, WC2A 2LL
		15 October 2001

Lord Justice Waller :

1. This is an appeal from the decision of HH Judge McGonigal given on 26 June 2000. On the construction of a clause in an exclusive supply agreement between the parties, he ruled that the defendants were not released from their obligation to buy exclusively from the claimants. He then calculated damages and gave judgment for the claimants in the sum of £1,163,198.30.
2. The appellants challenge the judge's view on construction. If they were right then an issue might still arise as to whether the appellants were released depending on the effect of following their suggested construction. The appellants also seek to amend their notice of appeal to pursue certain other points. On one they seek to argue a further point on construction of the relevant clause. If the appellants were allowed to argue that point, and if the argument was successful, then that would also lead to the conclusion that they were released. (I will call this the manufacturers' point for reasons which will become apparent). In addition, the appellants seek to argue certain points on the basis that the judge's view on construction is accepted. If they were allowed to argue these points, and were successful, the appellants suggest that would lead to the conclusion that they were released even on the basis of the judge's construction.
3. As we began to explore with Mr Stadlen QC, who represented the appellants, what might flow from the view as to construction that he was advocating, it became clear that the exercise was quite a complex one and that we might not have all the material. It was also possible that there were disputes on the evidence which would need dealing with, either by us, or by the matter being remitted back to the judge. It seemed sensible therefore to take the main points on construction, rule on them first, then consider how to deal with the consequences of that ruling.
4. Accordingly this judgment will deal with the point on construction on which the judge ruled in favour of the respondents, and will deal with the question whether the manufacturers' point is one that the appellants should be entitled to raise, and, if so, with the merits of the point.
5. The appellant I shall call RPUK, the respondent I shall call Horstine, and the affiliated company of RPUK in the USA, I shall call RPUSA.
6. Horstine was a company formed by two individuals who formerly worked for a subsidiary of RPUK, that subsidiary at that time being called Horstine. The two individuals bought the assets of the RP subsidiary in a management buy-out and transferred them to Horstine. One of the important assets was the patent rights in something called the "Surefill valve". This valve was used in what was called the Surefill closed transfer system. Prior to the buy-out the RPUK subsidiary, whose primary interest was in the selling of agricultural chemicals, was seeking to expand its market using the Surefill system. One market into which it was anxious to expand was the US market, but there RPUSA held a licence from American Cyanamid in a different closed transfer system known as Lock 'n' Load which incorporated the Lock 'n' Load valve. Before any buy-out some efforts were being made by RPUK to convince the RP Group that, comparing system to system, the Surefill system was better than the Lock 'n' Load system.
7. In his judgment the judge very helpfully set out the description of the valves from the Surefiill UK Patent Application so as to make clear precisely what the valves were used for. I will do the same.

"The present invention relates to a valve device for use in connecting a container filled with a flowable material such as fertiliser, pesticide or the like to an applicator device for dispensing the said material. When sowing seeds in a field it is often a requirement to apply a fertiliser or pesticide along with the seeds.. . . . Increasingly it is considered desirable for agricultural workers to avoid direct contact with certain agricultural treatment agents such as fertilisers and pesticides. These agricultural treatment agents are usually stored ready for use in sealed containers which must be opened and emptied into the relevant hopper on the planter applicator device.. Inevitably such a procedure involves at least some exposure to the agricultural treatment agent. European Patent A 10389919 [This is the American Cyanamid Patent for its valve] discloses a valve system for controlling the flow of a flowable agricultural treatment agent from a container for the material to a receiving chamber or hopper. The container has a material dispensing valve and the chamber or hopper has a material receiving valve. The dispensing valve and the receiving valve are adapted to be completed and uncoupled so that on being coupled both valves are opened to allow material to flow from the container to the hopper and on being uncoupled both valves are biased to a closed position. The valve system is so designed that material will not flow from the container into the hopper until the container is properly mounted on the hopper. Furthermore, the dispensing valve interacts with the receiving valve in such a way as to introduce a time delay between the opening and closing of the valve to ensure a free flow of material and prevent any leakage of material before the container is removed from the hopper. The valve system of European Patent A 10389919 is very effective at preventing the escape of an agricultural treatment agent both as it is emptied from a container into a hopper and after. However, it is very complex in design, requiring as it does a dispensing valve for the container and a receiving valve for the hopper. As a consequence it is relatively expensive. The system is made even more expensive by providing each container with its own dispensing valve as envisaged in the aforementioned prior art document. It is an object of the present (Application) to provide a relatively simple valve device for coupling a container filled with a flowable agricultural treatment agent to a hopper which valve device allows the container to be removed from the hopper while still partially filled with material without any material escaping."

8. The management buy-out occurred in February 1996, and as part of that arrangement Horstine (then called Springcount Limited) entered into the exclusive supply agreement for Surefill valves with RPUK. It is the terms of that agreement, and, in particular, one term, clause 2.3.3, which fall to be construed.
9. No agreement can be construed in a vacuum, and, as part of the background, I will expand a little on what seems to have been going on just prior to the management buy-out and close to the time of the buy-out. Efforts were clearly being made by RPUK to convince other members of the RP Group that the Surefill valve and the Surefill Closed Transfer system was better value than the Lock 'n'Load valve and Closed Transfer system. If one looks at pages 171 and 172 of the appeal bundle, there are documents dated 12 and 16 October 1995 i.e. before the buy-out. They were produced by a Mr Aldridge who was Global Product Manager for the chemical Temik. He was at RPUK at the time, and it seems that the documents were shown to Mr Allan who was one of the individuals who ultimately bought out the assets of the former Horstine in the management buy-out. They show a comparison being made between the two systems. There are certain things to note. First, the assumption was (and no one at the trial suggested that the assumption should be otherwise), that each valve could only be used with its other components i.e. there was no question of the Surefill valve being incorporated into the Lock 'n' Load system. Second, on the comparisons, the assumed price of the valves alone indicated that the Surefill valve was considerably more expensive than the Lock 'n' Load valve. If the Surefill system was to be better value that was as a result of factors such as the royalty which had to be paid to use the Lock 'n' Load valve, and other factors.
10. There is then a letter of 8 December 1995 from Mr Allan in which he seeks to persuade others as to the benefit of the Surefill system. That letter confirms that so far as the price of the valves alone are concerned, Surefill are much more expensive than Lock 'n' Load. It is factors such as the life of the valve and the royalty to be paid for Lock 'n' Load on which he relies in suggesting that the Surefill system is "competitive".
11. Then finally, on 20 February 1996, Mr Aldridge of RPUK made a presentation to an international conference of RP Global Management (page 173). At page 175 again one sees a comparison being made system to system, and one sees first that the price of the Surefill valve alone was greater by a very considerable margin than the Lock 'n' Load valve alone, but what makes a difference is the royalty and other costs that must be paid in using the Lock 'n' Load system.
12. I stress that these documents and presentations were not being done in the context of negotiating the agreement to which I am about to turn. They were being done for the purpose of comparing the two systems in a marketing context. But, the point they exemplify is that it was not possible to use the Surefill valve other than in the Surefill system, and it was not possible to use the valve other than in the Lock 'n' Load system. Accordingly, they help to confirm the way in which one would expect commercial minds to work insofar as the valves were concerned. Considering which valve to use involved choosing which system to use and thus it was not just the cost of the valve, or indeed its individual quality, but the knock-on cost and the knock-on effect on quality which might itself affect cost, which had to be weighed up when considering which of the two systems should be chosen.
13. The relevant terms of the agreement are the following:

"Whereas:

A. [Horstine] is the owner of all Intellectual Property rights in the Products (as defined below)

. . . .

C. RP has agreed to finance the application/registration/prosecution/defence costs of the Products in the World and has agreed to purchase all its requirements for the Products from [Horstine] unless otherwise agreed in this agreement

. . . .

1. Definitions

. . .

"Products"

the Products known as 'Surefill' consisting of a granules valve device used for agricultural purposes

. . . .

2.

Supply of Products

2.1 [Horstine] shall manufacture and supply Products to RP for use or resale in the Market, and RP and [Horstine] agree to act subject to the terms and conditions of this Agreement

2.2 [Horstine] shall not without the prior written consent of RP supply to any other person, firm or company in the Market any of the Products, whether for use or resale and shall forward to RP any enquiry or order it may receive for the Products within the Market

2.3 Subject to clause 2.3.3 below RP shall not:

2.3.1 obtain the Products (or any goods which compete with the Products) for resale from any person, firm or company other than [Horstine];

2.3.2 be concerned or interested, either directly or indirectly, in the manufacture or distribution in the Market of any goods which compete with the Products;

2.3.3 if [Horstine] is unable to manufacture the Products upon competitive terms as to price, quantity, quality and delivery with manufacturers of valve systems performing the same or a substantially similar function then RP shall be entitled to purchase similar products from third parties. However, as soon as [Horstine] commences manufacturing on competitive terms as to price, quantity, quality and delivery the restrictions at 2.3.1 above shall once again apply subject to the completion of any current order made by RP in respect of its substitutional purchases under the provisions of this clause

2.3.4 the Parties also agree to make any Improvements available to the other as soon as reasonably practicable after such Improvement has been made

2.3.5 The quantities of Products required and the ordering procedures shall be agreed in writing by RP and [Horstine] from time to time

.. . . .

3 Prices

3.1 The price applicable to each order placed by RP will be negotiated on an annual basis save that should the cost of raw materials and labour taken together increase by more than 10% in the interim period RP and [Horstine] shall meet to negotiate in good faith any consequential adjustment to the previously negotiated price

. . . .

7 Warranties

7.1 [Horstine] warrants that all Products shall be manufactured, packaged and stored in accordance with procedures and standards established by [Horstine] which comply with good manufacturing practices and that they will be fit for the purpose for which they were supplied

. . . .

15 Dispute Resolution

Any controversy, claim dispute or litigation arising out of or in relation to this Agreement shall be settled through good faith negotiations between the parties. Only if such efforts are not successful shall any controversy, claim or dispute be resolved by arbitration

. . . .

28 Affiliates

RP shall cause its Affiliates to comply with the Terms of Agreement "

14. The key issue relates to the proper construction of clause 2.3.3. Horstine say that the question to be determined in considering whether RPUK or its affiliate is bound to buy exclusively Surefill valves from Horstine is not simply whether the price at which Horstine is offering the valve is less than the price that another valve i.e. the Lock 'n' Load valve can be purchased. The question is whether looking at the system as a whole the purchasing of the Surefill valve and the use of that valve in the Surefill system, compete with buying the Lock 'n' Load and using that valve in the Lock 'n' Load system.
15. Before the judge, Mr Davies for Horstine argued that the word "Products" in clause 2.3.3 included not just the Surefill valve but the whole system. The judge at page 4, lines 11-16 ruled against that submission. The argument reappeared in the Respondent's notice on this appeal, but was abandoned by Mr Davies as Mr Stadlen went through term after term of the agreement, applying them against the undoubted fact that Horstine did not manufacture or supply any other parts of the Surefill system. Thus for example, the warranty in clause 7 simply could not work unless the warranty was limited to that which Horstine supplied i.e. the valve. Clearly therefore the word "Products" was limited to that which Horstine manufactured and supplied.
16. Furthermore, the words in 2.3.3 themselves preclude a widening of the ambit of the word "products" in that clause. The words are "if [Horstine] is unable to manufacture the Products". Horstine do not manufacture anything but the valve. The word "Products" defined in the agreement as "a granules valve device" must still mean the valve in clause 2.3.3.
17. The judge thought that the use of the words "valve systems" in the third line assisted an argument that what the clause was concerned with was a comparison of the cost of one closed transfer system with another. I cannot share that view. We were shown places in the Surefill European Patent application where the phrase "valve system" was used which clearly related to the valve itself and not the whole closed transfer system. There was no instance to which Mr Davies could point where those words were being used between the parties so as to show they had some special meaning i.e. that they were a reference to the whole closed transfer system. But again, it is the language of the clause which precludes the argument that "valve systems" goes wider than the valve itself. The clause contemplates comparison between Horstine as a manufacturer of the Surefill valve (not the system) with another manufacturer of "valve systems performing the same or a substantially similar function" i.e. as it seems to me a valve, not a closed transfer system.
18. Does it follow therefore that RPUK must be right in their contention that in considering whether "the terms as to the price, quantity, quality and delivery" of the Surefill valve are competitive, one simply concentrates on the price charged for the valve and its quality as an individual item, without regard to how it affects the whole closed transfer system. Or does the word "competitive" indicate that a wider consideration is involved?
19. I have not found this an easy question. There is great force in the arguments of Mr Stadlen based on the wording of the clause. He points to clause 2.3.1 to emphasise that the restriction on his clients relates to the obtaining of the Products or any goods that compete with the Products from anyone but Horstine i.e. the restriction relates to valves. He then analyses the wording of 2.3.3 and emphasises that it is concerned with Horstine's ability to manufacture valves upon competitive terms and emphasises that the competition is with manufacturers of other valves. So, it is submitted, Horstine could simply have no influence on the other items in the system, and the clause precludes comparison between the prices, quantities, qualities or delivery of other parts of the system.
20. One difficulty however that this analysis confronts, in my view, is that taken to its logical conclusion the knock-on effect of placing the valve in the systems would play no part in the equation. Let it be assumed for example that the price of the Surefill valve was $1 less than the Lock 'n' Load valve, but its efficiency was such that it was necessary to have a different size of container which cost more, or its life was less and thus many more had to be bought. Now Mr Stadlen, I think, accepted that because competitive as to quality would include competitive in terms of efficiency, such a factor could be brought into the calculation. Indeed, as I understand how the arguments developed before the judge, the efficiency of valves was a factor used in calculating the relative "prices" or "costs" of the valves (see the judge's judgment pp 5-6 where the life of the respective valves is dealt with as a factor reducing their respective "prices" for comparison purposes). Furthermore, if buying one valve for a system involved paying a royalty whereas buying the other did not, it would make no commercial sense not to take into account that payment when calculating for comparison purposes the price of the respective valves. If all that is right, it seems to me that it must be very difficult to gauge the competitiveness of the terms on which the valve is supplied without looking at the whole system and the actual commercial result of purchasing one valve as compared with another.
21. It seems to me that if one manufactures something to be part of an identified whole i.e. its purpose can only be to be used as part of some greater whole, the effect of incorporating the item into the whole may well have cost implications in relation to the whole. In that situation it is not unnatural to use the phrase "the terms as to price or quality are uncompetitive". Furthermore, where a royalty has to be paid for the use of one valve, that may make "the term as to price" of the other valve competitive.
22. In this instance neither valve could be used other than as part of a whole. There was no circumstance in which RPUK or RPUSA was simply going to buy the Surefill valve. Indeed, if the Surefill valve was in fact cheaper than the Lock 'n' Load valve, but the Surefill system as a whole was more expensive, then RPUK would clearly themselves be wishing to say "you cannot force us to take the valves alone simply because that part of the system is cheaper when we all know that it is the system that is important". They would be saying the price of the valve is still uncompetitive, because it does not make the system cheaper than the Lock 'n' Load system. If taking the Surefill valve involved having to pay a royalty which rendered it more expensive than the Lock 'n' Load valve to the purchaser, RPUK again would be saying, in assessing the competitiveness of the term as to price, account must be taken of that fact.
23. Mr Stadlen had an argument that if one assumed that his clients were able to reduce the costs of those parts of the system not supplied by Horstine, the result would be that on the construction by the judge, Horstine would be able to increase the price of the valves and still force RPUK to take them. There is an air of unreality about this contention in the context of an arrangement between entities that acted in good faith with each other. But he insisted that it was not simply a matter of good faith. He accepted that the terms of the agreement relied on by Mr Davies provided an answer to any attempt to increase the price in bad faith; e.g. clause 3 which requires prices to be negotiated on an annual basis and the arbitration clause that existed if there was a dispute. But Mr Stadlen's point was that there would in such circumstances not be the pressure on Horstine to keep their costs low which was one purpose of clause 2.3.3. This again has an air of unreality about it because it assumes a degree of knowledge as to the cost of producing the two systems present in the mind of those taking decisions which they would not have, and assumes that Horstine would not wish to strive to keep their prices as low as possible in case savings were being made on the Lock 'n' Load which they did not know about.
24. In my view, commercial common sense dictates that both parties to this agreement would never wish to consider the price of the valve in isolation in considering whether it was the right valve to buy. If the valve was to be bought then the Surefill system had to be adopted. One could not tell whether the Surefill valve could be supplied upon competitive terms as to price, quantity and quality without comparing the systems as a whole, and, in particular, without comparing the knock-on effect on the systems as a whole of using one valve as opposed to the other and the royalties that would have to be paid. Although I cannot adopt the same reasoning as the judge, the construction of clause 2.3.3 adopted by the judge was, in my view, the correct one.
25. I now turn to the manufacturers' point. Mr Stadlen wishes to argue in this court for the first time that because the Lock 'n' Load valve was manufactured by certain entities and the royalty was paid to American Cyanamid, on the proper construction of clause 2.3.3 it should not be taken into account in comparing the price of the two valves because it was not a manufacturing cost. On the construction of the clause which I have held to be correct, the point seems to me to be bad on any view since the payment of royalty was certainly a cost flowing from the adoption of the Lock 'n' Load valve and thus the Lock 'n' Load system. But, in any event, it was common ground in the court below that some account should be taken of the royalty payment, and it does not seem to me to be right to allow such a point to be taken for the first time in this court.

Lord Justice Dyson:

26. I agree.

Mr Justice Wilson:

27. I also agree.
28. Taken on their own, the words of clause 2.3.3 of the Supply Agreement strike me, unfortunately, as unclear. This litigation is a monument to the poor drafting of the clause. There is the puzzling switch of reference from "Products" or "valve devices" to "valve systems". But, in the end, I agree that that was probably a red herring to which the judge placed inapt attention. But then, crucially, the hypothesis is defined as an inability to manufacture the Products "upon competitive terms as to price, quantity, quality and delivery" with those of other manufacturers. I understand the force of the argument that, if the references to "quantity", "delivery" and perhaps even "quality" focus just upon the rival valves, the reference to "price" will focus likewise. But that sort of symmetry is mathematical and so can be blind, in particular to reality.
29. What is the proper answer to be given to the question "is the price of this article competitive?" I have no doubt that it must sometimes be reached by reference to costs beyond the simple prices charged by the rival manufacturers or suppliers. Is not a royalty which a purchaser becomes liable to pay to a patent-holder when he buys a product from one of the rival manufacturers (and uses it in his business) relevant to that answer? I cite that example because, until less than a month before the hearing of the appeal, when it first took the "manufacturer's point", RPUK had always conceded its validity. Unavoidable collateral costs, unrelated to quality, in the case of only one of the two rival articles are not part of its "price" but, unless its price is lower than the price of the other article by an amount equivalent to them, I consider that that price is uncompetitive.
30. But RPUK still makes concessions which in my view are highly significant. It agrees that, in determining "competitive terms as to price" for the purpose of the clause, the cost of the purchase from third party manufacturers of the spring and cap which are necessary to the functioning of the Lock 'n' Load device should be added to its cost, just as the cost of the purchase from third party manufactures of the steel clip necessary to the functioning of the SUREFILL device should be added to its cost. Let me not present this as some surrender on the part of RPUK to common sense: the concession is self-serving in that the cost of the spring and cap is about 10% of the cost of the clip. But the concession remains significant because it undermines the argument that Horstine's construction of the clause is unrealistic in putting it at the mercy of suppliers of other parts of the SUREFILL system whose high charges could deprive it of its rights against RPUK. The concession means that the charges made by the manufacturers of the clip might in any event have that precise effect. A party who surrenders his rights in the event that his price becomes uncompetitive will never in any realistic sense be the master of his fate. This unusual shorthand provision must be viewed in the context of an agreement between companies directed by former colleagues, still on good terms. The contract anticipated their close continued co-operation over five years in securing, to mutual advantage, the maximum flow of pesticides produced by RPUK and its affiliates through Horstine's valves into the soil.
31. In my view therefore the language of the clause falls far short of compelling the construction for which RPUK contends. In such circumstances it is in my view appropriate, indeed necessary, for the court to take account of the manner in which, at around the time of the contract, the parties were analysing the price competitiveness of SUREFILL with Lock 'n' Load. Thus:

(a) In October 1995 Mr Aldridge, global product manager in a company within the RP group, produced a schedule and, four days later, a revised schedule, both entitled "Comparative Costs of the SUREFILL." The schedules seem to have been circulated to Mr Allan, who was soon to become a director of Horstine; and the presentations were of the rival costs of the two systems, including on each side what Mr Aldridge apparently suggested to be the unavoidable collateral costs of choosing the rival valves.

(b) In December 1995 Mr Allan, still then working within the group, sent Mr Aldridge a memorandum which adopted the system by system comparison, made various suggestions as to the figures properly to be brought into it and concluded by suggesting that SUREFILL was "competitive".

(c) On 20 February 1996, being either four days after or one day prior to the entry into the contract which is the subject of these proceedings, Mr Aldridge distributed, but perhaps not to Mr Allan or any of his new colleagues, a written presentation about SUREFILL, including a "Cost Comparison" with Lock 'n' Load. The comparison, which Mr Aldridge sought to refine in a fuller presentation in June 1996, was again of system with system.

(d) In November 1996 Mr Aldridge wrote to Mr Allan, alleging that the high cost of the SUREFILL valve made that system uncompetitive with that of Lock 'n' Load, to the costs of all the components of which he made express reference. The scope of his purported analysis was as wide as it had always been.

32. With respect, I do not consider that it is good enough for RPUK to dismiss the width of these presentations of rival costs on the basis that they represent an exercise different from that required by the clause. That is only to state as fact what it seeks to argue. It proceeds to suggest that the clause could have been so drawn as to make clear that the requisite comparison was between the price of the systems and not merely of the valves. But it is the converse point which appeals to me. The exchanges in October and December 1995 made it incumbent on the parties to spell out in the clause, if such was their intention, that the requisite comparison was on an entirely different basis. I am of the view that such was not their intention. The commercial reality which consistently underlay the presentations of Mr Aldridge and Mr Allan, namely that what matters is the overall cost of each system, also underlies the clause and informs its proper construction.
Order: no order made today; counsel to lodge further written submissions (to inculde argument as to costs). (Order not part of approved judgment)