Cepia HK Ltd v The Character Group Plc

An option agreement referring to an existing distribution agreement may be construed by reference to the parties’ established course of dealing. That course may comprise an arrangement under which a distributor is given an opportunity to bid for new products, rather than a conventional obligation to supply or purchase products. The court must give the wording its objective meaning in its commercial context. A failure to negotiate further after a bid does not necessarily end the course of dealing where the distributor had been given an opportunity to bid and the bid was substantially uncompetitive or unsuitable for the supplier’s wider requirements. However, clear communication that the relationship has ended, reinforced by conduct, may prevent the course of dealing from continuing. An option conditional on that course continuing cannot then be validly exercised.

The claimant, a Hong Kong toy company, granted the defendant, a UK distributor, an option to subscribe for shares. Exercise was conditional on an exclusive distribution agreement concerning the claimant’s toy products continuing in existence. No comprehensive written distribution agreement existed. The parties disputed whether the condition referred to a conventional exclusive distribution contract, an agreement made at a meeting in Shenzhen, or their established pre-existing course of dealing.

The claimant exercised the option in July 2015. The defendant refused to issue the shares, relying principally on the claimant’s conduct in ending the commercial relationship in October 2014 and failing to invite the defendant to subsequent toy fairs. The court also considered the defendant’s failure to send the original option agreement and the adjustment of the number of option shares.

1. Construction of the condition. The reference to the “Distribution Agreement” was construed objectively against the parties’ background dealings. It referred to the prior course of dealing under which the defendant was given an opportunity to bid for the claimant’s products and could become exclusive distributor on acceptable commercial terms. It did not require a conventional long-term distribution contract or an unconditional exclusive right over all future products.
2. The discussions in Shenzhen formed part of the negotiations and were not admissible to determine the meaning of the written agreement, except so far as they evidenced the relevant background. In any event, the alleged agreement for unconditional exclusive distribution of all future products had not been proved and would have been commercially improbable.
3. The course of dealing continued when the defendant was invited to bid for The Happys and its bid was considered in good faith. There was no obligation to engage in further negotiation where the claimant required a European distribution arrangement which the defendant could not provide, and the defendant’s bid was substantially below competing bids.
4. The claimant’s email of 15 October 2014, read in context with the rescission of the defendant’s invitation to a toy fair and its exclusion from a later fair, communicated that the relationship had ended. The course of dealing therefore ceased at that time. Later communications expressing a contrary view did not restore it.
5. Since the course of dealing had not continued until the purported exercise of the option on 22 July 2015, the condition was unsatisfied and the defendant was not obliged to issue or allot shares. The objection based on failure to provide the original agreement failed because the original had probably never been despatched. The separate issue concerning adjustment of the number of shares was unnecessary to the result; the agreement permitted adjustment after exercise but before allotment and issue, with the auditors acting as experts in good faith.

Not stated in the judgment.