Contract Law Update - Rectification for common mistake succeeds in the Court of Appeal

Queenfield Pty Ltd v Gordon Finance Pty Ltd [2020] VSCA 282

When disputes between commercial parties emerge, it is common for clients to instruct that the terms of a signed agreement do not reflect the bargain they intended. However, practitioners will be familiar with how narrow the avenues are for rectifying written agreements based on mistake. The Victorian Court of Appeal’s decision last year in Queenfield was an example of a relatively rare decision upholding a trial judge’s determination that a contract of sale should be rectified due to the parties’ common mistake.[1]

The agreement in question was for the sale of an interest in a Motel in Carlton which was operated by the applicant, Queenfield. Before the transaction, Queenfield had made significant “intercompany loans” to the respondents, two entities associated with its then-sole ultimate owner, a Mr Gordon. During negotiations for sale of a 50% interest in Queenfield to a Mr Paolacci, documents exchanged had included a draft term which suggested the loans would be “transferred” to entities of Mr Gordon. However, no such term was included in the documents executed. The question for the Court of Appeal was whether the trial judge had been correct in concluding that, at the time of sale, the parties had each intended that the executed agreement would include a term that the intercompany loans would in effect be written off by assigning them to the respondents but had omitted that term by mutual mistake. The Court of Appeal (McLeish, Niall and Sifris JJA) upheld the trial judge’s conclusion.

Factual Background

Queenfield, as corporate trustee, had operated a Motel in Carlton and owned its property. It had, until the transaction, been entirely owned by Mr Gordon’s company (the second respondent). In 2015, after negotiations over a number of months, a 50% interest in Queenfield was sold to entities owned by Mr Paolacci. In 2017, Mr Paolacci obtained a further interest, giving him control of the trust, at which point he caused Queenfield to call in the loans, and ultimately sued the respondent Gordon companies for their recovery. The Gordon companies denied the loans were held by Queenfield and counterclaimed, seeking a declaration based on a common intention that Queenfield held the loans on trust for the Gordon entities; they sought rectification of the agreement to that effect. Alternatively, they alleged common law estoppel by convention, a claim rejected by the trial judge and not addressed by the Court of Appeal.

The sequence of the sale history proved significant on the appeal. In March 2015, following a Family Court order requiring Mr Gordon to pay his ex-wife a settlement of $7m, Mr Gordon sought to sell the motel business, including its land. From April, Mr Paolacci and his associated entities began negotiating with Mr Gordon. At almost all stages of negotiations, it was anticipated that Mr Paolacci would purchase 50% rather than the whole of the business and land. The parties initially contemplated a purchase of the assets directly, but from 1 June they explored a sale of units in the trust by which Queenfield operated the business. On 9 June, a meeting was held between Mr Paolacci, his accountant, and Queenfield’s accountant (Mr Langmaid) (the June Meeting). Mr Gordon was not present at the June Meeting. Following the June Meeting, Mr Langmaid had formulated a document containing the draft term. Documents containing the draft term were then exchanged several times subsequently between the parties.

What was said at the June Meeting, and its bearing on Mr Paolacci’s likely intentions at the time of executing the final agreement on 1 July proved to be a crucial point of contest at trial. Mr Langmaid’s evidence was that he clearly recalled telling Mr Paolacci and his accountant at the meeting that the intercompany loans would be irrecoverable and would need to be written off prior to the sale.

Mr Paolacci and his accountant gave evidence that at the meeting he had said that the loans made the deal attractive. The trial judge preferred Mr Langmaid’s evidence and rejected that of Mr Paolacci. That was in part because his evidence was inconsistent with evidence he had given during earlier proceedings to set aside a statutory demand, and also because the trial judge considered Mr Langmaid’s recollection to be more consistent with the draft term which had subsequently emerged. Interestingly, Mr Gordon had admitted that he had perjured himself during the trial, and consequently, the trial judge disregarded his evidence except where it was otherwise supported.

The trial judge concluded that the parties did indeed have a common intention, which was reflected broadly (albeit not exactly) in the draft term; namely, that the intercompany loans were to be assigned to one of Mr Gordon’s companies as a term of the sale. His Honour concluded that no estoppel could exist from pre-contractual representations.

Queenfield appealed, arguing, broadly:

• First, that there was insufficient evidence for the trial judge to conclude that the parties held a common intention, and specifically that:
  • The trial judge could not have reached the (high) requisite state of satisfaction regarding any mistake and common intention because only those involved at the time of finalising the signed agreement (i.e Mr Gordon, Mr Paolacci and Mr Paolacci’s accountant), could give the relevant evidence and none had given evidence which had been accepted. Queenfield submitted that the trial judge had erred in placing weight on Mr Langmaid’s evidence regarding the parties’ intentions, given his involvement had not continued after the June Meeting.
  • As Mr Gordon had given evidence that he did not understand the meaning of the draft term, but rather that he had intended to get advice on it from his family accountant, there was no evidence that he intended a term in the form ordered by the judge. It was further submitted that where the Respondent had not led evidence from those from whom Mr Gordon had intended to seek advice or others who were privy to the draft term, an adverse inference should be drawn that such evidence could not have assisted.
  • In relying on considerations of the commercial context, the judge had impermissibly considered (or given excessive focus to) the commercial purpose of the transaction rather than evidence of the parties’ intentions.
• Secondly, that the draft term was insufficiently clear to support a common intention of a term with the necessary precision.

Decision

The Court of Appeal dealt solely with the issue of rectification based on common mistake, finding it unnecessary to address the estoppel issue. There was no disagreement regarding the applicable legal principles. The Court observed that to obtain rectification (at [50]):

1. quoting Simic v New South Wales Land and Housing Corporation (2016) 260 CLR 85 (Gageler, Nettle and Gordon JJ) [103]-[104]:
   1. the respondents needed to establish that:
      1. at the time of the execution of the written instrument sought to be rectified, there was an ‘agreement’ between the parties in the sense that the parties had a ‘common intention’, and that the written instrument was to conform to that agreement;
      2. the written instrument does not reflect the ‘agreement’ because of a common mistake;
   2. that there was no requirement for communication of that common intention by express statement, but that it must have at least been the parties’ actual intentions, viewed objectively from their words or actions, and must be correspondingly held by each party.
2. displacement of the presumption that the executed agreement reflects the true agreement of the parties requires ‘convincing proof’, part of which is that the divergence between the common intention of the parties and the terms of their written agreement must be clearly identified.

The Court of Appeal rejected Queenfield’s contentions. In a joint judgment, the Court concluded that in respect of the issue of common intention:

• The trial judge had been justified in preferring the evidence of Mr Langmaid over that of the applicant’s witnesses. That conclusion was supported not only because of the trial judge’s natural advantages observing the witnesses, but because the evidence of the June Meeting fitted more conformably with the phrasing of the draft term and the commercial context.
• It was artificial to seek, as the appellants did, to confine the relevant evidence to that given by the parties (or others privy to the final agreement). The relevance (and sufficiency) of Mr Langmaid’s evidence (over that of the protagonists involved with the execution version of the document) had to be understood within at least three aspects of commercial context. First, it had always been the parties’ intentions that there would be a sale of 50% of the business (initially a direct sale, but later structured as the sale of trust units). Secondly, the intercompany loans were for ventures unrelated to the motel business making it unlikely the parties had contemplated their inclusion as part of the bargain for 50% of that business. Third, the June Meeting had occurred after the parties had agreed to change the sale structure from a sale of assets to a sale of trust units. Only after that change in structure did treatment of the loans arise as an issue needing to be addressed. Mr Langmaid’s evidence was that it was at that meeting that the transfer of the loans had been discussed and from which the draft term was said to have emerged. In those circumstances, the trial judge had been entitled to use Mr Langmaid’s evidence regarding the June Meeting in the way he had, as context supporting an inference that at the later time of the sale Mr Paolacci had intended that the loans would be written off rather than what he had contended in his evidence.
• The fact that Mr Gordon had wanted accounting advice on the draft term, but that the respondents had led no evidence of that advice being obtained, did not warrant an adverse inference regarding his more general intention that he wanted the loans to be excluded from the sale.

Regarding the second question of whether the term had been identified with sufficient specificity, the Court concluded that the evidence was sufficient to establish an intention to remove the loans from the business and include an offsetting accounting treatment. Their Honours concluded that in the same way that solicitors would give effect to a term in writing, it was open to the Court to do the same. It was not necessary for the evidence to bear out that the precise form of the term made was envisaged by the parties.

Comment

While the case was one which in many respects turned on its specific facts, it is of interest for at least three reasons.

First, it demonstrates how, in circumstances in which recourse to parties’ subjective intentions is admissible (and indeed necessary), evidence across the course of pre-contractual negotiations (including that from persons other than the contracting parties) can be critical in demonstrating the likely intentions at the time of execution.

Secondly, it illustrates that despite the clear authority that an order for rectification requires convincing proof of the common intention, including how it diverged from the terms as written, the level of specificity which the evidence must reach is ultimately a question of fact and degree. As the Court noted, the critical question is whether “in substance and in detail” that intention can be ascertained [82] (citing Crane v Hegeman-Harris Co Inc [1971] 1 WLR 1390). The question in each case will be how much detail will be required. Queenfield illustrates that provided the substance of the bargain can be sufficiently identified, it will not always be necessary to establish that its exact detail was appreciated.

Thirdly, the Court of Appeal did not refer to Ryledar Pty Ltd v Euphoric Pty Ltd (2007) 69 NSWLR 603, a significant intermediate appellate court decision on rectification predating Simic. It may be that their Honours considered that the plurality’s statement in Simic is now the authoritative statement on the extent of the requirement for the common intention to be disclosed (compare Heydon on Contract (2019), 1096 at [30.150], where the author concludes that the plurality in Simic in stating that there “is no requirement for communication of that common intention by express statement” (at [104]) did not intend to contradict the statement of Campbell JA that the subjective intention must be disclosed (at [316]).