UPDATED: Fonterra considers options, including appeal, after losing supply contract case

Fonterra [NZX: FCG] is considering its options, including an appeal, after losing a High Court case taken by former suppliers to the failed New Zealand Dairies milk processing plant who challenged the legality of inferior supply contracts they were offered by the dairy giant.

The nub of the case was whether Fonterra, which bought the Studholme plant from the receivers in 2012, was lawfully able to offer the former suppliers to the plant so-called "growth contracts" on inferior terms in order to placate its existing farmer suppliers.

In a written decision, Justice Matthew Muir says Fonterra's reasons for doing so stemmed from a "perceived need to assuage internal politics within its supplier base and included also an element of 'messaging' for the benefit of other farmers who might in the future be persuaded to leave Fonterra and support an independent."

Mike Cronin, Fonterra's group director governance and legal, says the cooperative is disappointed with the outcome and is now reviewing the reasoning as well as the implications of the decision.

"The judgment refers to complex and difficult issues about special contracts with farmers outside the co-op," he says.

"Fonterra's acquisition of the former NZDL plant benefited both Fonterra and the supplying farmers who'd been left out of pocket by NZ Dairies, enabling significant retro-payments owed to them to be paid and ensuring on-going milk collection."

The former NZ Dairies suppliers were owed more than $20 million for the previous season's milk from the receivers and Fonterra's $50 million offer to the receivers to buy the failed Studholme plant was conditional on all of them signing the six-year supply contracts. The farmers wouldn't have been paid in full for the retro-payments under alternative offers.

Fonterra told the court it is lawfully entitled to offer the inferior contracts, which included a 5c per kilogram of milk solids price discount and a one-year bar on buying shares, despite provisions under the Dairy Industry Restructuring Act that require new entrants to be treated on the same terms as existing shareholder suppliers.

The court decision comes as the Commerce Commission seeks submissions this month on its draft report on the state of competition in New Zealand's dairy industry which found that Fonterra could charge too much for its milk if the industry is deregulated. It found there is still insufficient competition at both the farmgate and factory gate to fully remove the DIRA regime.

The High Court case included claims under the Fair Trading Act and the Contractual Remedies Act arising from statements allegedly made by Fonterra representatives at various meetings before the 20 plaintiffs –dairy farmers in South Canterbury and Otago, signed the growth contracts.

The judgment cited Kelvin Wickham, now Fonterra's managing director Global Ingredients, in an internal email saying that the former NZDL shareholders shouldn't be allowed to "share up" (buy shares against their production) until potentially the end of the first year so there is a "differential milk price penalty for at least a year – they can't just expect to waltz back in and get full milk price if they share up."

The plaintiffs argued the fact Fonterra was able to make a "take it or leave it" offer and impose "penalties" for essentially internal political purposes was evidence of an uncompetitive market for milk supply.

Fonterra's defence was that the DIRA clause on treatment of new entrants only applied to share-backed supply and it wasn't precluded from offering special terms for contract supply.

Justice Muir says he had difficulty with the plaintiff's argument conferring them new entrant status but he found Fonterra couldn't treat an applicant outside of the stated application period for supply as a new entrant for some of their supply and not the balance, essentially creating a subcategory of new entrants with inferior rights.

"Fonterra retains a discretion in terms of whether it accepts such entrants into the shareholding farmer "fold" but why, having elected to do so, it should be able to discriminate against the individuals concerned in a way not possible in respect of timely applicants seems to be a proposition which struggles for a basis in principle," he says.

The judge accepted the plaintiffs argument that no factors provided justification for a difference in terms and he also concluded that Fonterra breached the Fair Trading Act and the Contractual Remedies Act by giving an overriding impression to the new suppliers that the reason they weren't being allowed to share up was because they were outside the application period.

"The overall message was that the suppliers were not being treated differently from other Growth Contact suppliers in relation to sharing up when in fact they were," he says.

A further hearing is to be held to determine what losses the plaintiffs have incurred and the question of legal costs.

Read the judgment here.

(BusinessDesk)