Passing the pub test – what happens when circumstances change during the sale of a business

The High Court of Australia has clarified in a recent decision that carrying on a business in the usual and ordinary course would generally include an obligation to do so while following the law.

In March 2023, the High Court determined in Laundy Hotels (Quarry) Pty Limited v Dyco Hotels Pty Limited [2023] HCA 6 (Laundy Case), that if a seller stopped business activity because the law prevented them from doing so, that didn't necessarily mean that the seller was not carrying on the business. The case explored what it means when a business is sold on an ongoing basis, and reinforces the need for buyers and sellers to be prepared if circumstances change to avoid costly disputes.  

Buyers and sellers in sale transactions, particularly relating to businesses requiring licences or authorisations to operate like hotels/pubs, certain retail, professional services or security businesses, should be aware of how 'conduct of business' obligations will impact them, particularly when operating under such a licence or authorisation is affected by unusual circumstances like COVID-19.

Background

The Laundy Case concerns a dispute between Laundy Hotels (Quarry) Pty Limited (Seller), and Dyco Hotels Pty Limited (Buyer), regarding the sale and purchase agreement for The Quarryman's Hotel in Pyrmont, entered into between the parties on 31 January 2020.  

Under the agreement, the Seller was required to "carry on the business in the usual and ordinary course as regards its nature, scope and manner" until completion, which was to occur on 30 and 31 March 2020.  Such clauses are common practice in sale agreements for various reasons, including that the business is sold as a 'going concern' with the sale being GST-free.

Prior to completion, a public health order was issued in response to the COVID-19 pandemic that restricted the operation of hotel licensees to the sale of takeaway food and beverages only.  

The Seller complied with this order by selling only takeaway alcohol and food until 1 June 2020, when it was able to reopen subject to customer number restrictions as directed by subsequent public health orders.  

Prior to completion, the Buyer informed the Seller that it would not complete the contract. It alleged that the Seller's compliance with the public health order meant that the Seller had failed to carry on the business in the usual and ordinary course, and therefore was not ready, willing and able to complete the contract.  

After further correspondence including a notice to complete served by the Seller, the Buyer commenced proceedings.  

On 21 May 2020 the Seller served a notice of termination on the Buyer for failing to complete the agreement. The Buyer treated this as a repudiation of the contract and accepted it, to try and bring the sale agreement to an end on its own terms.

The usual and ordinary course of business

The question was heard in the first instance by the Supreme Court of New South Wales, where the Court determined that the contract was not frustrated by the public health order.  

The Court also found that the Seller had complied with its obligations under the sale agreement to carry on the business to the extent possible in accordance with the law.

However, the Court of Appeal disagreed, finding that the public health order was a supervening event that suspended the Seller's contractual obligation to carry on the business in the usual and ordinary course.  The Court of Appeal then determined that, by serving the notice of termination, the Seller had repudiated the agreement.

The High Court's view

Ultimately, the case was appealed to the High Court. In considering this question, the High Court held that the Seller's obligation to "carry on the business in the usual and ordinary course as regards its nature, scope and manner" inherently obliged the Seller to do so to the extent that it was compliant with laws in force at that time.  

The Buyer was aware that the hotel business comprised a liquor licence; and operating under that licence would vary depending on the law.  

Thus, in complying with the public health order, the Seller was in fact 'ready, willing and able to complete the sale', and had not defaulted on its contractual obligations.  

Accordingly, the High Court agreed that the Buyer's failure to complete was a breach of the sale agreement entitling the Seller to terminate and claim damages.

Effect of the decision

The High Court aptly summarised the issue: "carrying on a business is a dynamic concept which can change according to the changes in circumstances."

In its judgment, the High Court noted: "It is well established that the terms of a commercial contract are to be understood objectively, by what a reasonable businessperson would have understood them to mean, rather than by reference to the subjectively stated intentions of the parties to the contract."  

Therefore, parties negotiating sale agreements must anticipate and adequately contemplate the potential for change and ensure that the contracts clearly account for how changes in the legal or regulatory environment may affect the transaction and the conduct of business.  

In the context of the Laundy Case, it was the public health order that altered the circumstances. However, changes to licence conditions, amendments to existing legislation or the introduction of new regulations could also modify the presumed circumstances in which a business operates.

Beyond Laundy

The Laundy Case has several lessons and reminders for parties transacting on M&A activity:

• Businesses must remain vigilant and adapt in order to continue operating in accordance with their contractual obligations whilst managing potential risks and consequences that may arise.
• Prospective buyers should be conscious of the risks involved in businesses that are subject to a changing legal and regulatory landscape.
• Parties to a sale agreement should consider negotiating contingency plans – whether it be as purchase price adjustments or conditions precedent – to ensure the deal responds to any potential changes in circumstances that could impact the transaction.
• In any sale transaction involving the sale of a going concern, buyers should be aware that external events adversely affecting the operation of the business may not breach the seller's obligations or frustrate the contract, unless express clauses are included to deal with such material adverse changes. Parties should also not always assume that the obligation on a seller to operate the business in accordance with the law needs to be expressly set out.

Authors

Arjunan Puveendran | Partner | +61 2 8248 3494 | apuveendran@tglaw.com.au

Francesco Mazzitelli | Lawyer | +61 2 8248 5863 | fmazzitelli@tglaw.com.au

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