Is an HoA intended to be legally binding or simply a non-binding roadmap to reach agreement? If a binding HoA is contemplated, what is the nature of the parties' obligations? Is the HoA the substantive contract or merely an agreement to negotiate? These types of questions were recently considered by the Hamilton High Court in Ecowize Ltd v AFFCO New Zealand Ltd.
What was the case about?
Ecowize was engaged by AFFCO to clean a new meat processing plant operated by AFFCO near Hamilton, beginning at the start of 2006. The engagement required Ecowize to incur significant expenditure installing an open plant cleaning system (OPCS) to facilitate cleaning during construction. However, there was a need to defer agreement on the final pricing for cleaning system until the new plant was operational to allow the accurate assessment of the extent of work involved.
To deal with these matters, the parties entered into the HoA on or around October 2005. Among other things, the HoA stated that 'It is hereby agreed that the cleaning contract will be awarded to Ecowize Limited'.
It also provided that the relevant contract would have 'a contract period with a 48 month period from the commencement date' (which was left blank). The level of pricing was agreed in the HoA but with the proviso that 'Ecowize will review the current charge rates once the new plant is operational and a new charge rate will be submitted'. The HoA was silient on whether the new charge required the agreement of AFFCO or what was to occur if no agreement could be reached.
The HoA stated that 'the heads of agreement will remain binding and enforce [sic] until such time that the Service Agreement is signed by both parties'. Again, the HoA was silent on what would occur if a service agreement could not be agreed.
After the new plant became operational in January 2006, Ecowize submitted revised charges to AFFCO. Various discussions and revisions took place with the ultimate result that no agreement was reached in respect of the revised charges and AFFCO took over the cleaning itself from 3 July 2006. While a draft service agreement was prepared, it was never agreed to by the parties.
Ecowize alleged that the HoA was repudiated by AFFCO, entitling Ecowize to damages upon cancellation of the contract. AFFCO disputed this and counterclaimed over what it considered to be over-charging by Ecowize.
What did the High Court say ?
The main issues for the Court was whether a binding agreement between AFFCO and Ecowize existed and, if so, what were its terms.
In answering this question, the Court turned to the leading case of Fletcher Challenge Energy Ltd v Electricity Corporation of New Zealand Ltd [2002] 2 NZLR 433, where the Court of Appeal stated:
AFFCO contended that the terms of the HoA had no binding effect as notions of commitment were all expressed prospectively and material terms needed for any agreement were not concluded.
The Court, in part, agreed with AFFCO in finding that the HoA was not a substantive contract for cleaning with a 48 month term. Rather, it was an agreement to review the level of charges once the contractor had some experience of what was involved after the plant became operational. Also, many other terms were not agreed to in the HoA, such as a mechanism for price revision and an indemnity or penalty for failure to return the plant on time and completely clean.
However, the Court did find that the HoA was a so called 'process contract', in that it was an agreement to agree on a longer term contract. To give the contract effect, the Court was willing to imply in the contract a requirement for the parties to use reasonable endeavours to agree revised pricing and a range of other terms. If agreement could not be reached the 48 month term would not apply but Ecowize would be compensated for prior commitments it had made on a longer term basis not being recoverable. AFFCO was also required to give reasonable notice before bringing the arrangement contemplated by the HoA to an end (in this case, three months).
The Court held that AFFCO breached the process contract and was required to pay compensation, including certain establishment and disestablishment costs. However, because the Court found no substantive contract existed, compensation did not extend to loss of net profits that Ecowize would otherwise have earned during the balance of the 48 month term.
Lessons from the case
The case highlights how important it is to consider the legal status of HoAs and the consequences if subsequent agreement on more detailed matters cannot be reached. Failure to adequately address these issues leaves the parties at the mercy of the Court in the event of a dispute. In these circumstances a Court will do its best to give effect to the commercial intent of the parties but ultimately neither party may leave the courtroom satisfied.
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