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Supreme Court prefers substance over form

A recent Supreme Court decision confirms that all the circumstances of a business relationship, whether written or not, may be relevant in determining contractual rights and obligations between parties. In Deng v Zheng [2022] NZSC 76, the Court looked through formally documented corporate and contractual structures, preferring to recognise that a loosely documented partnership arrangement defined the legal relationship between two business people.


The key piece of evidence was a set of internal accounts which could not be explained in any way other than that profits were intended to be shared equally.


This case illustrates the importance of taking into account the full picture of any business relationship, regardless of what is recorded in writing. Accountants also need to be aware that internal accounts, even though not filed publicly, may still be considered by the Court, especially when determining the existence of a partnership.

In addition, the Supreme Court, while encouraging the idea parties can explain their own behaviour by way of their social and cultural background, cautioned against explaining other people’s behaviour by reference to the same information. To do so, it held, would be stereotyping.


What happened in this case?

Mr. Zheng and Mr. Deng were property developers. From 2008, Mr. Deng and Mr. Zheng became involved in a development in Gulf Harbour, north of Auckland. In order to obtain funding, they entered into a short written agreement in Mandarin with Mr. Jiang. That agreement referred to the rights and obligations of the “Orient Group” or “Orient Company”.


Mr. Zheng claimed that the “Orient Company” was a partnership between him and Mr. Deng. Over time, other companies became involved in the development, and sections were transferred to third party buyers, but were still treated as being part of the development.


From 2010, internal accounts were prepared on a bi-monthly basis for Mr. Zheng and Mr. Deng. These accounts recorded the amalgamated asset position of what appeared to be a single enterprise. It detailed a running account of the contributions and drawings each party made to the amalgamated asset position, and the expenses and revenue for all current projects. They were calculated on a basis which looked through the structure of the various companies and revealed an intention to share profits equally.


By 2015, the business relationship between Mr. Zheng and Mr. Deng was under strain, and they decided to separate their affairs. The parties then prepared an agreement called “Principles in Separation” which also looked through the various companies and allocated equally the benefits and burdens of the various projects.


Common understanding

Litigation ensued. Mr. Zheng claimed that there was a partnership between him and Mr. Deng, or alternatively a joint venture. Mr. Deng claimed that his relationship with Mr. Zheng was defined by the various corporate and contractual structures, in which no overarching partnership or fiduciary elements were recorded. Mr. Zheng lost in the High Court but succeeded in the Court of Appeal. Mr. Deng then obtained leave to appeal to the Supreme Court.


The Supreme Court found that the common understanding between Mr. Zheng and Mr. Deng as to their participation in the development could only be explained if they were participating personally as partners, with their companies acting effectively as nominees. Mr. Zheng and Mr. Deng dealt with each other in a way that differed substantially from the way in which ownership interests in the companies were recorded. The internal accounts, which the Court was satisfied were authentic, could not be read in any other way. The accounts recorded, on a running basis, the existence of a partnership and departed from what was recorded in the written agreements between the parties.


Overall, the case does not represent a shift in the law since it has always been the case that business agreements can be informal, and contracts can be supplemented or amended orally over time to change what has been agreed in writing. It is also not uncommon for partnerships to operate through trading companies, with the shares in those companies being partnership assets. However, it is a timely reminder that the Courts will seek to enforce the actual bargain struck between the parties, even if that is not reflected in the formal documentation.


Dealing with cultural aspects

As the case concerned a relatively informal agreement between two Chinese gentlemen, the Supreme Court also invited submissions on the cultural context to the case. This was largely on the significance of guānxi, which the Court described as “interpersonal connections”, “social capital” or the “set of personal connections which an individual may draw upon to secure resources or advantages when doing business or in the course of social life”.


Ultimately, the Court’s decision did not turn on the cultural aspects as it considered that Mr. Zheng and Mr. Deng’s relationship was sufficiently clear from the documents themselves. But the Court made useful observations on how to deal with the cultural overlays in the future.


The key point made is that, while it is open for the parties to explain their own conduct by reference to their own social and cultural background, there ought to be caution when trying to introduce social and cultural frameworks to explain the conduct of another party. This would be tantamount to stereotyping, as people who share a particular ethnic or cultural background should not be treated as a homogeneous group.

 

If you have any questions or comments about this post, please get in touch with Kerry Puddle or Grace Im, our resident litigators.

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