Court Applies Words in Royalty Audit Clause Not Another Common Sense Interpretation
The wording in commercial contracts can sometimes be disputed, particularly if it is not clearly drafted. An audit clause in a royalty agreement can be pored over when the parties are in dispute and the contract is pulled out of the drawer.
In the case of Pixdene Ltd v Paddington & Co Ltd, the High Court had to examine the words used and in the context of business common sense.
What Was in the Audit Clause?
In one sense, the audit clause was quite normal - allowing a third party representative to carry out an inspection for the claimant during normal working hours on prior written notice.
The clause:
- Did not give the claimant themselves a right to inspect or receive copies of the inspected documents. It only referred to the 'third party auditor'.
- Provided for physical inspection to be at a place under the defendant's control.
- Restricted audits to 'not more than once per every two year period'.
What Did the High Court Say About This Clause?
- The reference to the inspection being by the third party auditor was clearly chosen to ensure the auditor's independence and keep the claimant themselves away from the defendant's documents. If the parties had intended for the claimant themselves to inspect the documents, that wording would have been used. An implied term giving the claimant inspection rights would undermine the language actually used. The claimant could only receive limited information from the auditor, being their conclusion on the defendant's contract compliance.
- As regards the inspection being at a place under the defendant's control, while there was no need to imply a requirement for the auditor to be supervised by the defendant, there was an implied term that the auditor could take copies of inspected documents.
- Restricting the audit to once every two year period clearly meant that once a two year period had been inspected, it could not be reaudited. This wording actually used could not be displaced.
- There was nothing in the wording that gave the defendant an implied right to redact any documents (other than where legally privileged), nor to withhold any third party records within its possession or control.
What Are the Take-Aways from This Case?
Like every case, this is fact-specific. The decision turned on the particular facts and the wording used in the contract. The Court interpreted the audit clause by applying well-established principles relating to contract interpretation and implied terms.
Despite best intentions, parties do not always make everything clear in their commercial contracts. A 2011 Supreme Court decision (Rainy Sky v Kookmin) showed that where drafting is unambiguous, it must be applied; but where more than one reading of a clause is possible, the court can prefer the interpretation most consistent with business common sense.
However, in this case, the judge stressed that commercial common sense must not undervalue the actual contract drafting.