A reminder that acquisition of a business does not mean all the business' contracts go with it

An Australian Federal Court case illustrates the difficulties associated with assigning rights of existing business contracts to the new owners. Here we are reminded that some terms of contracts are incapable of assignment because they are "personal" to the original contracting party.

The issue

In Pacific Brands Sports & Leisure Pty Ltd v Underworks 1, Pacific Brands appealed a decision preventing it from terminating a sub-licence that granted Underworks the exclusive right to use two clothing trademarks in Australia.

The main question was whether the critical provisions of the sub-licence agreement, including the right to terminate, were assignable to Pacific Brands without Underworks' consent.

The facts

Pacific Brands had become the assignee of the sub-licence through a complicated series of transactions. The trademarks had originally been held by a US company (Saramar) which had granted a licence to use the trademarks to a related company in Australia, Sara Lee Apparel (Australasia) Pty Ltd (Sara Lee).

Sara Lee, in turn, had granted an exclusive sub-licence to Underworks for a five-year period with an option for a further five years in November 2000. Under the terms of this licence, Sara Lee had a right to terminate the sub-licence if Underworks failed to submit appropriate marketing plans, reports and audits to Sara Lee.

In February 2001, Sara Lee sold its Australian apparel business operations and certain assets to Pacific Dunlop. As part of this sale, it was agreed that the sub-licence agreement would be assigned by Saramar to Pacific Dunlop. This was effected in March 2001, subject to the rights of Underworks as sub-licensee.

A few months later, Pacific Dunlop sold several of the assets it acquired from Sara Lee (including the licence to Underworks) to Pacific Brands, a competitor of Underworks.

Both Pacific Brands and Sara Lee attempted to have the sub-licence novated but Underworks refused to consent to the novation on the terms offered.

After a period of time, a dispute arose between Pacific Brands and Underworks. Pacific Brands alleged that Underworks was in breach of the terms of the sub-licence (in particular to submit marketing plans to Pacific Brands) and that as the assignee of Sara Lee's rights under the sub-licence they were entitled to cancel the sub-licence.

The outcome of the trial

In a controversial decision, the Federal Court (in 2005) held that Pacific Brands was not entitled to cancel the licence with Underworks because:

• the alleged breaches of the contract involved rights of Sara Lee that were incapable of assignment because they were "personal" to Sara Lee and could not be enforced by another party; and further
• a sub-licensor could not validly assign the right to terminate a sub-licence without the consent of the sub-licensee since the right or power to terminate a contract also had an element of personal confidence about it and was not capable of assignment.

The Full Court decision

On appeal, the Australian Full Federal Court upheld the trial judge's decision that the sub-licence obligations alleged to have been breached by Underworks had not been successfully assigned to Pacific Brands.

However, the Full Court rejected the trial judge's approach to differentiating between various rights and powers of a party, and of giving to some the character of assignable property while denying that character to others especially in relation to the court's treatment of a sub-licensor's right to terminate.

In the view of the Full Court, the proper approach was to:

• start with the premise that all of the party's contractual rights are assignable: and then
• determine whether in a given case there is a reason why they or some of them are unassignable. Such reasons include statutory or contractual prohibition of assignment, or where the identity of the original contracting party is material to the contractual relationship.

This final point was significant in the outcome of the case. The court put considerable weight on the fact that the sub-licence required significant co-operation between the Underworks and Sara Lee.

Underworks had agreed to such an arrangement with Sara Lee who was not a competitor. The assignment of the sub-licence to a competitor would significantly alter the deal for Underworks.

While the sub-licence contained no express prohibition on assignment of rights by Sara Lee, the court noted that Sara Lee was defined as the sub-licensor rather than "Sara Lee and its assigns".

This would have signified a contractual intent that Sara Lee's rights under the contract could be assigned. As it was, the Court deemed that there were sufficient indications in the contract that the sub-licensor could not be changed without Underworks' consent.

On the facts, the court was not prepared to find that Underworks had consented to the assignment even though the parties had been operating under the terms of the licence for over two years.

Practical implications

This case serves as a reminder of the varied issues that can arise in the sale of a business. Sometimes it is impossible to achieve the desired outcome of the contracting parties especially where a third party does not want to engage in business with the acquirer.

Also it is unwise to assume that a contract that is silent as to assignability can always be assigned.

The court commented that much of the confusion in this case would have been avoided if the sub-licence had been drafted more clearly to start with. An express provision dealing with assignment and whether consent is or is not required will generally be decisive.

 

1 Pacific Brands Sport & Leisure Pty Ltd v Underworks Pty Ltd [2006] FCAFC 40

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