Conditional payments - are you sure you will be paid?
01 July 2020
Consider this scenario: you enter into an agreement to design some plush new downtown apartments. Everyone knows they will sell like hotcakes when they’re completed. Little do you know that an economic downturn is around the corner, and instead of selling out in weeks, your beautifully designed apartments become luxury rentals instead.
Not a problem, correct? There’s no difference to the service you, the designer, has provided, and so shouldn’t you be paid? Unfortunately, for the designer in Yoo Design Services Ltd v Iliv Realty that wasn’t the case. If you agree to payment being triggered by specific conditions, such as the sale of apartments, the court is likely to be reluctant to help you if you cannot ensure those conditions are fulfilled.
Conditional payments can arise in a number of agreements as a flexible way to share risk and profit. In addition, by making payment of any agreed fees conditional on the realisation of sale proceeds, the paying party is able to delay that expenditure. By doing so, the paying party may be able to afford to pay a higher fee to draw in top talent. Alternatively, the use of a conditional payment may help the service provider win the work.
Here, Yoo Design was a well-known designer, whose involvement in the project was expected significantly to increase the apartments’ value. The payment provisions established that part of the ‘Retainer Fee’, accounting for Yoo Designs’ license of their concept, and their services, would occur only on the sale of the apartments. On its face, the agreement appears geared towards the sale of the apartments. Alongside payment provisions contingent on the sale, there were numerous clauses focused on the marketing of the apartments for sale. However, when Iliv Reality came to market the apartments, the financial downturn meant that the apartments would not sell for anywhere near the intended price. Instead of pursuing an extensive marketing campaign and quick sales regardless of profitability, as Yoo Design expected, Iliv Reality chose to rent the apartments.
The court was asked to consider whether terms could be implied into the agreement that would require Iliv Reality to market and sell the apartments expeditiously. Yoo Design argued that a failure to imply these terms would render the agreement illogical: not only would there be a chance they would never be paid for the use of the licence and the services that had been completed, but any such obligation to assist with marketing could continue indefinitely. However, the court found for Iliv Reality. To argue that Iliv Reality should be obliged to sell in a depressed market so as to ensure that Yoo Design earned its fee, which amounted to a small proportion of the overall costs, would not give business efficacy to the contract.
There are some important reminders:
- Understand each other’s goals – understand your counterparty’s goals and fears, and take the time to ask all the right questions. Here, while Yoo Design simply (in its mind) expected the apartments to be sold regardless of circumstance (as they just wanted to be paid), Iliv Reality needed to make a return on its investment and wasn’t prepared to sell at any price. There had been a clear misunderstanding. Courts are reluctant to imply terms.
- Make sure the agreement reflects your needs – is contingent payment really appropriate? If it is, think about dates and timing of obligations. A point made by the judge, was that there had been ample opportunity to include a backstop date in the agreement or the sale. This is also very relevant where parties have ‘agreements to agree’.
- Hope for the best but plan for the worst – it can be tempting to ignore an issue thinking it won’t arise or to ‘kick the can down the road’ with ‘agreements to agree’ or agreements to have ‘good faith’ discussions at a future time. In this case, the parties clearly didn’t spend enough time talking beforehand about the obligation to sell the apartments, by when or at what price (and the consequence of not doing so). Sometimes, not having these discussions or not articulating obligations in detail is fine, especially if you are the party consciously keen to avoid the obligation, but this may well not be appropriate if you need an obligation fulfilled by a certain date.
This case reminds us that Courts are reluctant to intervene. It also reminds us as to the value of taking to the time to think about the ‘what ifs’ and of asking difficult questions. One of the most valuable parts of a commercial lawyer’s job is to facilitate this process, so that both parties enter the contract with their eyes wide open, which is all the more valuable in these uncertain times.