Gallaher International Ltd v Tlais Enterprises Ltd (Rev 1)

A contractual obligation to comply with an incorporated trading policy may require a distributor to secure compliance by its sub-distributors, not merely to give them instructions. Where the policy requires due diligence and control of downstream sales, signing the policy alone is insufficient.

Material and continuing failures to control diversion, keep proper accounts and records, investigate customers, and maintain effective contractual safeguards may justify termination where the breaches cannot be remedied within the contractual period. A contractual discretion to terminate for suspected impropriety must nevertheless be exercised rationally and not arbitrarily.

Gallaher supplied cigarettes to Tlais Enterprises Ltd under an exclusive distribution agreement covering specified brands and territories. The agreement required compliance with Gallaher’s International Trade Policy, proper accounts and records, evidence of shipment to the intended territories, and responsible customer selection.

Gallaher terminated the agreement on 4 March 2005 after extensive seizures of cigarettes, evidence of sales outside the territories, inadequate records, and failures to investigate or control downstream distributors. TEL counterclaimed substantial damages, including loss of profits and compensation for damaged stock. Gallaher also claimed payment for goods supplied on 365-day credit and enforcement of Mr Tlais’s personal guarantee.

1. Termination. Gallaher lawfully terminated the TEL Agreement. TEL was in serious and continuing breach of its obligations to comply with the International Trade Policy and to procure compliance by its distributors. The evidence included substantial seizures, the Adam Trading Schedules, sales into non-contractual territories, and the absence of adequate tracking and due diligence (paras [603]-[645]).
2. The obligation to procure compliance was onerous. TEL had to secure the result that its distributors complied with the policy, including making inquiries sufficient to establish that customers would behave responsibly. Signing the policy and giving general instructions were insufficient (paras [594]-[595], [620]-[621]).
3. TEL was also in material breach of the obligation to keep full, proper and accurate accounts and records. Those records had to identify orders, customers, prices, intended destinations, stock movements, locations, outstanding payments, and the brand and flavour mix. TEL’s reconstructed customer accounts did not satisfy the obligation (paras [661]-[706], [728]).
4. Failures concerning shipment documents and estimated demand did not independently justify termination. The shipment-document breaches were either waived or not sufficiently material in context, and the evidence did not establish that sales exceeded a reasonable estimate of demand (paras [764]-[780], [839]-[850]).
5. Gallaher was entitled to terminate under the International Trade Policy where TEL was shown to have behaved improperly, or where Gallaher had reasonable grounds for believing that TEL might have done so, provided the decision was not arbitrary, capricious or irrational. That test was satisfied (paras [646]-[658]).
6. The red-card procedure did not itself relieve Gallaher of liability, since termination remained within Gallaher’s control. The termination was nevertheless lawful on the contractual grounds established (paras [990]-[991]).
7. Gallaher was entitled to recover $3,239,450 for the 365-day goods. The agreement to apply a $10 supplement to Sovereign purchases was a payment mechanism, not an agreement extinguishing the underlying debt if Sovereign ceased to be supplied (paras [1090]-[1098]). Mr Tlais was liable for $4 million under his guarantee (paras [1152]-[1161]).
8. TEL recovered $6,659,538 for agreed or established compensation relating to damaged Dorchester and Arabic-warning stock. After set-off, judgment was entered for Gallaher for $579,912, together with interest. TEL’s counterclaim was dismissed (paras [1194]-[1195]).