Clause with teeth: Rights of First Refusal and Liability Caps

Right of first refusal clauses are by no means uncommon in commercial contracts.  But they are relatively rarely litigated.  What legal clout do such clauses have?  Are they no more than unenforceable agreements to negotiate?  The recent judgment (21 June 2011) of AstraZeneca v Albemarle indicates that the Courts will enforce such rights.  As the judge put it: "Where parties have troubled to put a specific clause in their contract, then so far as possible the Court should strive to give it some meaning commercially."  Flaux J’s decision also provides some useful pointers on the interpretation of liability caps.

The Propofol Deal

The case related to a contract for the supply of the anaesthetic propofol (the drug said to have led to the demise of Michael Jackson), sold by AstraZeneca ("AZ") under the brand name Diprivan.  Albemarle had supplied AstraZeneca for many years with the active ingredient DIP, from which propofol is distilled.  It was a term of the DIP contract that, if AZ decided to purchase propofol instead of DIP, then Albemarle would have the "first opportunity and right of first refusal to supply propofol to AZ, under mutually acceptable terms and conditions".

AZ indeed decided to switch to buy propofol and invited Albemarle to participate in the tender process.  AZ viewed Albemarle's tender price as too high and decided to award the propofol business to a competitor supplier called Sochinaz.  Albemarle’s case was that this was a breach of the right of first refusal: that AZ could not proceed with Sochinaz without giving Albemarle the further opportunity to match the third party offer.  There were protracted negotiations but AZ never gave Albemarle the chance to match the Sochinaz terms, relations having deteriorated in the meantime with a dispute over DIP supplies.  Albemarle then terminated the DIP contract and matters turned litigious. 

What the clause meant

AZ's first position was that the right of first refusal clause was too uncertain to be enforceable.  That was, Flaux J said, an unattractive argument.  The Court should try to give it some commercial effect. 

AZ's next argument was that the clause at most gave Albemarle the opportunity to negotiate with AZ as part of the tender process.  That, though, was inconsistent with the words "first refusal", which suggested something more than participating in a tender process.  "First refusal", the judge decided, meant that Albemarle should be offered an opportunity to accept or refuse a contractual offer on the same terms which AZ was minded to accept from a third party.  That, in turn, entailed AZ making full disclosure of the terms of the competing deal so that Albemarle could understand the terms it was entitled to match.

The words "under mutually acceptable terms and conditions" did not mean that the clause was ineffective.  The words simply meant that, once the right of first refusal had been exercised, further matters may need to be resolved before a binding propofol contract could be tied up.

Lastly, there was an issue as to when AZ's obligations under the right of first refusal clause were triggered.  AZ maintained that this could only be when AZ was about to enter into the final supply contract.  Again, the Court held that that made no commercial sense.  Since there would be a lengthy lead time (at least 18 months) for regulatory approval before the contract could be finalised, it would be nonsensical for Albemarle's rights only to be triggered once the regulatory process had run its course.  Here, there was a breach as soon as AZ decided that Albemarle would not receive the propofol business.

Did the cap fit?

A second key area of interest in the decision is the interpretation of limitation clauses.  First, the contract provided that in no case should "AZ or Albemarle be liable for loss of profits".  Hardly an unusual clause.  Albemarle's claim for breach of the right of first refusal, though, was precisely that: lost profits on the propofol contract.  Flaux J agreed that the limitation clause could not apply in that way; it would strip the right of first refusal of any commercial effect.  The clause should be read therefore as referring to the loss of profits on the sale and purchase of DIP, not the loss of profits on a propofol contract at all. 

There was a further limitation point.  During the course of the negotiations on the right of first refusal, Albemarle had failed to deliver all of the DIP ordered by AZ, concerned (correctly as the Judge found) that AZ was prolonging negotiations as a ploy simply to secure DIP which AZ could stock pile before switching to buy propofol from the new supplier.  The limitation clause capped AZ's claim to "the purchase price of the product in respect of which damages are claimed".  Having decided that this meant that AZ’s claim was in principle capped at the purchase price of the undelivered DIP, not the (very much higher) price of replacement DIP, Flaux J went on to consider AZ's argument that Albemarle could not rely on the limitation clause anyway since it had deliberately breached the agreement in failing to supply DIP. 

The Judge found that there was no deliberate breach by Albemarle, but in any event he dealt at some length (obiter) with the recent case of Internet Broadcasting v Marhedge (2009).  That case had held that there was a "strong presumption" against exemption clauses being construed so as to cover a deliberate repudiatory breach.  The case has invited a fair amount of comment:  it appeared to suggest that if a party chooses not to perform its contractual obligations for whatever reason, limitation provisions will fall away. 

Flaux J was unimpressed with the decision, describing it as "heterodox and regressive and does not properly represent the current state of English law".  The judge was clear that whether a limitation clause bites is simply a question of construing the clause - strictly, but with no presumptions either way.  There is no special case for a deliberate breach. 

Conclusions

As the Courts are always at pains to point out, all contractual disputes turn on the wording of the particular agreement.  Nonetheless, this case is stark illustration that rights of first refusal are not toothless clauses. 

As AZ discovered, it is not so easy to manoeuvre around a clause to deprive it of its commercial effect.  And that extends to the interpretation of limitation clauses.  Of course, the emphasis on commercial effect does all highlight the importance of being able to convince the court of the purpose of the provision in the first place, a task so often dependent on the clarity of the original drafting. 

As to limitation clauses, the case is an example of caps by reference to the amounts paid under the contract being upheld even where the losses are several multiples higher.  Marhedge is a case often trotted out in negotiations on the enforceability of caps where there is a suggestion of deliberate breach of contract.  It is a decision which appeared to misconstrue the case law on fundamental breach (Photo Production v Securicor (1980) etc); it did little to help parties judge the risk of limitation clauses holding up in Court.  The AZ case usefully resets the balance. 

Lawyers Andrew Howell

Andrew Howell is a partner in the Commercial Disputes team at Taylor Wessing LLP.  Andrew acts for Albemarle in the AstraZeneca litigation.