PERMTEK LTD v. CHINA RESOURCES MACHINERY & EQUIPMENT CO LTD

Headnote

Construction of inconsistent provisions in a commercial contract. Construction adopted which:-

(1)    most closely reflected the parties' intentions objectively assessed - observations upon use of factual matrix.

(2)    produced the most reasonable and commercial result.

(3) was adverse to the proferens - the party whose last minute addition to the contract created the inconsistency.

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J U D G M E N T

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Hunter, J.A.:

1. On 9th January 1989, after a trial of the issue of liability, Barnett J dismissed the plaintiffs' claim made in this action for damages for breach of contract. From that dismissal the plaintiffs now appeal.

2. The material facts shortly are these. The plaintiffs carry on business as designers and suppliers of water treatment plant. The defendants appear to act as a buying authority for a number of Chinese entities carrying on business in the People's Republic. In this instance they were negotiating with the plaintiffs in the interests of the Shen Zhen Brewery. That brewery was proposing to instal new brewery plant. Such plant would, include a water treatment plant. They were considering whether to buy such plant separately or as part of a package for the purchase of both brewery plant and water treatment plant.

3. It appears that in November 1965 a proposal was put to them by the plaintiffs for supply of a separate water treatment plant. Nothing transpired on that until 20th August 1966 when the plaintiffs representative, a Mr Lam, visited Shen Zhen, and there saw Mr Zhang who was acting in respect of the commercial aspects for the defendant. The defendants ants plainly showed an interest at that meeting in the technical aspects. As soon as it was over, the plaintiffs returned to Hong Kong, made certain alterations to their specification and almost at once returned to Shen Zhen on 22nd August. On that date, there were further discussions as to price and delivery. Two things in particular happened. Both parties signed what is called a "letter of agreement". The original was written in Chinese I understand by Mr Zhang himself. The letter reads in these terms:

"Through friendly negotiations between the two parties, we confirmed to buy from Permtek Limited an unused 150 cu.m./br water treatment system, including spare parts, at a total CIF SHENZHEN price of US$160,000.00(say United States Dollars One Hundred and Sixty Thousand Only).

Formal contract will be signed in Hong Kong within 10 days".

The parties then went on to consider the terms of the formal contract. A draft of the defendant's common form print was produced. The negotiations proceeded to this extent that all but two of the ultimate terms of the contract were apparently then agreed.

4. Mr Zhang in evidence explained that he only signed this document because Mr Lam pressed him that he wanted something to produce to his boss. But he never asserted at any time that the document was intended to deceive the boss or was in fact false.

5. The contract itself was not signed until 10th September. It was then signed in Shen Zhen not in Hong Kong. It was on the defendant's usual print. The heading is "contract". The parties are identified the plaintiffs as sellers the defendants as buyers. The print goes on:

"WHEREBY IT IS AGREED that the Sellers undertake to sell and the Buyers undertake to buy the undernoted goods on terms and conditions stipulated herebelow:-"

Clause (1) identifies the waver treatment plant by a general description and by reference to two appendices which were attached to the contract and contain detailed specifications. Clause (2): "Total Contract Value CIF Shen Zhen China USD160,000.00, including packing''. Clauses (3) to (6) deal with shipping instructions and marks. Clause (7) "Delivery: Within 4 month after receipt the L/G, the Sellers will despatch the goods in one lot form Hong Kong to Shen Zhen, China by train or truck". Clause (8) provides for insurance to be covered by the sellers. Clause (9) "payment", is important:

"The Buyers shall open an irrevocable Letter of Credit of 100% contract value in favour of PERMTEK LTD before end of Oct 1986 and to be payable negotiation as follows:

(1) 90% paid against the shipping documents as stipulated on the reverse of this Contract:

(2) 10% paid against the certificate ... after commissioning of the plant".

So it is 90% against shipping documents, 10% on completion and performance certificate. Clause (10) deals with the technical service. Clause (11) is "Other Terms & Conditions". Sub-clause (1) picks up the print on the reverse of the contract which included a stringent penalty clause in the event of delaye8 delivery. Sub-clause (2) made appendices 1 and 2 and integral part of the contract. Sub-clause (3) provided for exchange or replacement free of charge of defective parts. Sub-clause (4), which is the most important one in the case, is in these terms:

"The Contract shall come into force beginning after receipt of the L/C of the Buyer".

Then in manuscript is clause (12) "Taxation all taxes required by the Chinese Government are to be covered by the Buyer's end user".

6. Now as I indicated the evidence was that all the clauses down to (11) (3) had been orally accepted on 22nd August. The only additions on 10th September are the term relating to taxation, which is immaterial, and (11) (4) which is crucial.

7. There can be little doubt, that if you look at clause (9) alone, it is a promissory condition, the sort of condition which is normally described as a condition precedent to the obligation of the sellers to deliver. In other words a failure by the buyer to open a letter of credit in accordance with its provisions would entitle the seller to decline to deliver and to treat the contract as repudiated. This indeed is the ordinary commercial function of a letter of credit. Equally if clause stood alone and this is the defendant's contention, there would be considerable force urging that was a condition precedent to the whole contract, a condition precedent to the formation of the contract. Accordingly until such time as a letter of credit was in fact received by the buyer, there would be no binding no binding contract at all.

8. In support of their respective arguments both parties rely upon the analysis of contractual terms such as these, appearing in the judgment of Denning LJ in Trans Trust SPRL v Danubian Trading Co Ltd [1952] 2 QB 297 at p 304. Equally they might have relied upon paragraph 752 of the 25th edition of Chitty on Contracts where the authors prefer to distinguish between promissory and contingent conditions. The same statements of law can be found in vol 9 of Halsburys Laws the volume on Contract, at paragraph 264. There is not much issue as to the effect of these terms read individually. The problem in this case is to marry them together and see their combined effect.

9. In this context, I think, perhaps a more useful analysis, because it deals particularly with conditions precedent in a context like this is that of Diplock LJ (as he then was) in United Dominions Trust (Commercial) Ltd v Eagle Aircraft Services Ltd [1968] 1 WLR 74 at p 82. This is one of the judgments where Lord Diplock drew the distinction between what he called "synallagmatic" contracts on the one hand, (I can avoid the use of that word and call them bilateral because we only have two parties here) and unilateral contracts on the other." The bilateral contract is one which imposes obligations on both, parties. In relation to that type of contract he says at p 83:

"The mutual obligations of parties to a synallagmatic contract may be subject to conditions precedent, that is to say, they may not anise until a described event has occurred; but the event must not be one which one party can prevent from occurring, for if it is, it leaves that party free to decide whether or not he will enter into any obligations to the other party at all".

By contrast he goes on to deal with unilateral or "if" contracts and says:

Under contracts which are only unilateral - which I have elsewhere described as "if" contracts-one party, whom I will call "the promisor", undertakes to do or to refrain from doing something on his part if another party, "The promisee", does or refrains from doing something, but the promisee does not himself undertake to do or to refrain from doing that thing. The commonest contracts of this kind in English law are options for good consideration to buy or to sell or to grant or take a lease, competitions for prizes, and such contracts as are discussed in Carlill v Carbolic Smoke Ball Co ([1892] 2 QB 484; 8 TLR 680 CA). A unilateral contract obligation on the part of either party to do or to refrain from doing anything except possibly an obligation on the part of the promisor to refrain from putting it out of his power to perform his undertaking in the future. This apart, a unilateral contract many never give rise to any obligation on the part of the promisor; it will only do so upon the occurrence of the event specified in the contract, viz, the doing (or refraining from doing ) by the promisee of a particular thing. But it never gives rise to any obligation upon the promisee to bring about the event by doing or refraining from doing that particular thing".

That analysis underlines the real issue of construction between the parties in this s case. The choice is between a construction which produces a bilateral contract and a construction which produces a wholly unilateral contract indistinguishable from a contract of option.

10. The trial itself took a course about the legitimacy of which I have considerable reservations. The problem facing the trial judge was that the defendants pleaded in paragraph 3 of the Defence certain oral agreements said to have been reached between Lam and Zhang. They went on to use those oral agreements in the pleading as an aid to construction or as establishing "collateral terms". So they were trying to use these oral agreements both as an aid construction, perhaps as part of the factual matrix, but equally as effective binding terms in themselves. The result was that detailed evidence was given by Lam and Zhang as to the negotiations and particularly as to their intentions. Lam asserted that from first to last he was intending to make the contract in the interests of himself, and his employers, and in particular was quite unconcerned with (11) (4) when he saw it for the first time on 10th September. Zhang on the other hand emphasized that he was never prepared to make any commitment at all even on 22nd August. He wanted to be free to decide whether he was going to buy this water plant separately or as part of the package of plant from some other brewery machinery supplier. He only signed in order to protect his position whilst he continued to negotiate, with the brewery suppliers on both alternative bases.

11. I have very considerable whether this was a legitimate process at all. Much of this evidence was, in my view, inadmissible and directly led, as I see it, for the purpose of adding varying or altering the written contract. The pleading was a pleading of oral "collateral terms" not a pleading of oral collateral warranties gives rise to quite different considerations. But I need not say any more about that because the judge in fact preferred the evidence of Lam to that of Zhang and there is no issue about that.

12. A variation of that approach is still advanced before us because much of what was led in evidence is sought to be relied upon by the defendants as part of the factual matrix as a guide to construction. I think it is apparent from the argument which has been advanced before us that there are some doubts as to the true limits of the use of evidence of surrounding circumstances as re-defined by Lord Wilberforce in two speeches; the first in Prenn v Simmonds [1971] 1 WLR 1381, and the second in Reardon Smith Line Ltd v Haknsen-Tangen [1976] l WLR 989. In Prenn v Simmonds the principle re-stated by Lord Wilberforce appears on p 1385 where he says this:

"In my opinion, then, evidence of negotiations, or of the parties' intentions, ought not to be received, and the evidence should be restricted to evidence of the factual background known to the parties at or before the date of the contract, including evidence of the "genesis" and objectively the "aim"of the transaction".

Those two words "genesis" and "aim of the transaction?were derived form a judgment of Cardozo J in the New York Court of Appeals in Utica City National Bank v Gunn in 1918.

13. Earlier in that speech Lord Wilberforce having cited from Lord Blackburn said: that judgment "provides ample warrant for a liberal approach" Those words have given rise to ambiguity. In their context it is quite clear to my mind that all Lord Wilberforce was saying was that a court could look beyond the four corners of the documents and that it did not have to revert "to any modern anti-literal tendencies" So a liberal approach entitles a court to look beyond the words of the document. The phrase cannot be construed to mean that it can look liberally at the facts which are relied upon as part of the factual matrix. This may have been the view, in a slightly ambiguous passage, taken by the trial judge.

14. In Reardon Smith Lord Wilberforce explained particularly what he meat by "objectively the aim". The material passage in that decision is at p 996F:

"When one speaks of the intention of the parties to the contract, one is speaking objectively - the parties cannot themselves give direct evidence of what their intention was - and what must be ascertained is what is to be taken as the intention which seasonable people would have had if placed in the situation of the parties. Similarly when one is speaking of aim, or object, or commercial purpose, one is speaking objectively of what reasonable person would have in mind in the situation of the parties".

The issue here is the aim, object or commercial purpose of these parties. Was is to make a bilateral contract of sale or was it to enter into a unilateral contract or to grant an option?

15. The only material which is relevant for this purpose is that which objectively casts light upon those two contrasting aims. Of all the material that was put before us as bearing upon that, the only evidence which I regard as being of any value is that relating to the letter agreement of 22nd August. Objection was taken to the receipt or the use of that evidence in this context as being part of the negotiations. I do not agree. It was a fixed known stage in the negotiating process which is very similar to a letter of intent. As I read it, viewed objectively, it is clear then that both parties were expressing an intent of continuing down a path upon which they had already started, which was to conclude an agreement of sale and purchase. Any subjective reservations which Mr Zhang may have entertained at that time where both irrelevant and inadmissible.

16. One particular matter has been pressed upon us as part of the matrix which the judge accepted as being part. This was the defendants desire at this time to protect their rear and to have a free hand to negotiate with suppliers of brewery material unincumbered by any existing obligation to buy a water plant. In relation to that matter the only objective fact which might be relevant here is the introduction of clause (11)(4) for the first time on 11th September. The question then arises as to what brought about the apparent change in front between 22nd August and 10th September. Everything else in relation to this seems to me essentially subjective. How, in what form, and from whom the defendants bought various items of plant is a matter purely for them. It is entirely a matter of subjective choice. In those circumstances, save for the letter agreement of 22nd August, I can extract no relevant facts from this matrix. With that rather extended introduction, I turn to the question of construction of the contract.

17. Here there is a major between the position before the judge position argued before this Court. The judge was persuaded conclusion that there was no conflict between clauses (9) and (11) (4). He said:

"I do not find there to be any inconsistency or repugnancy between clauses 9 and 11(4)".

Earlier in his judgment he records that he was persuaded to that conclusion by Mr Fung's argument. Mr Fung's argument to that effect was repeated to the Court. I think it was perhaps less well received. The result was that in the process of the debate which then took place, the point that he was seeking to urge before the trial judge was not pressed. The position reached that there was an admitted repugnancy between clause (9) and clause (11)(4). That admission seems to me to be inescapable. There is no way that one can reconcile the absolute obligation to open a letter of credit before a certain date in clause 9, with the absence of any obligation at all in clause (11) (4) until such time as the letter of credit was opened. There is a head-on conflict between the two.

18. So one or other has to be modified. Again there is not a great deal of dispute between the parties as to what the modification has to be one way or the other. If clause (9) falls to be modified, what has to be qualified, indeed reversed, is the existing absolute obligation. Instead of the clause reading the buyer "shall open" two variants have been suggested which amount to variations on the same theme. One is that the buyer "shall have the option to opens"; or the buyer "may, if it so elects, open". In some way or other the existing absolute obligation has to be emasculated if clause (11) (4) is to prevail. Conversely if clause (9) is to prevail, clause (11)(4) has to be read along such lines as this: not "The contract shall come into force beginning after", but "contract performance shall commence after". The real issue with which this Court is faced is which of these clauses should prevail, and which should be modified. Speaking for myself, I have come to a clear conclusion, for three reasons, that it is clause (9) which should prevail, and clause(11) (4) which should be modified.

19. My first reason is that this conclusion seems to me most closely to mirror the apparent intention of the parties objectively assessed, and to do less violence to the language of the document. There I am seeking to apply the principle of Ford v Beech [1848] 11 QB 852, to which we were referred, to an objective assessment of the parties' intentions. I start with the document of 22nd August, which as I have already indicated, seems tome on any objective assessment to indicate that both parties were then proceeding towards a bilateral contact of purchase. When one comes to the contract itself, the same is true of every clause down to (11) (3). The heading is "contract" not "option". The print refers to an undertaking to sell and an undertaking to buy. It is perfectly true that that is qualified by "on terms and conditions". But the almost inevitable meaning of terms and conditions in that context is not conditions precedent, but promissory condition. Everything that follows is only consistent with a mutual reciprocal contract until you come to sub-clause (11) (4). This is then said to be effective to turn everything before upside down. I think that something much clearer than that is necessary to achieve that purpose. I think that the amendment which must be made to clause (11)(4) to bring about this conclusion is less drastic than the total reversal of clause (9). Therefore in my judgment the apparent intention of the parties objectively assessed were to enter into a bilateral contract of sale and purchase.

20. Secondly, this result seems to me to produce a commercial conclusion and to avoid a wholly unreasonable result. That phraseology echoes the language in Schuler v Wickman Machine Tool Sales Ltd [1974] AC 235, of Lord Reid at p 251, and of Lord Kilbrandon at p 272. The result contended for by this defendant would really be quite remarkable in a commercial document. First, condition (11)(4), for the reasons given by Diplock LJ, is not a condition capable of being incorporated in a reciprocal contract. Secondly the condition makes this contract as wholly unilateral as any contract could possibly be. There is no way in which any restraint or restriction upon the defendants' freedom of choice opening of a letter of credit could be read in. The effect is to grant these defendants a free option, the benefit of standing offer, for nearly two month, whilst they negotiated, which benefit they obtained, as I see it, without any consideration at all. One of the problems of a unilateral contract, as Diplock LJ pointed out, is that because it is unilateral there has got to be good consideration. I can see nothing there which amounts to consideration. An expectation of contract is said to suffice. If that is sufficient to constitute consideration, it should be true of every option. The result is a free option without consideration. Finally during the time of that option, the potential seller was at least on risk of having to start work by ordering the special stainless steel parts called for by this contract. The position described by Lam and accepted by the judge was that they would have had to have started upon that process before the end of October. I agree that the evidence as to whether the defendants were aware of that was equivocal. But I am impressed here by the fact that Mr Zhang felt required to say (in this context he was not believed) to Mr Lam several times that he should not start buying anything until the letter of credit had been opened. So that to describe this as a risk seems to me to be no more than accepting the position adopted by Mr Zhang. This would produce, in my judgment at least, a very uncommercial and unreasonable result.

21. My third reason is I think an echo of the contra proferentem rule. This was the defendants draft contract. The defendants advanced this clause, without apparent explanation, at the last minute. Treating the expression of intention in the letter of 22nd August as genuine, this strongly suggests a change of mind between 22nd August and 10th September, and a desire to downgrade the document from contract to option. In my view, a party, who having behaved as these defendants had up to that point, and who wishes to bring about such a drastic change of result, must do two things. First of all he must put forward a clause which in itself is unequivocal and clear. Secondly that clause must be one which is clearly consistent with everything else in the rest of the document. In my judgment it is really quite insufficient to add a clause like (11)(4) and seek to say that that turns what up till that point was plainly a reciprocal contract, into a unilateral option. A party wishing to achieve that result has got to manifest his purpose very much more clearly than these defendants succeeded in doing.

22. For these reasons I would allow this appeal, and enter judgment for the plaintiffs on the issue of liability for damages for breach of the contract of 10th September 1986 to be assessed.

Clough, JA:

23. I agree.

Macdoughall, JA:

24. I agree with that Lord Hunter has said. For the reasons that he has given I too would allow this appeal he had indicated