TUV v CHIEF OF NEW ZEALAND DEFENCE FORCE [2020] NZCA 12

TUV v CHIEF OF NEW ZEALAND DEFENCE FORCE [2020] NZCA 12 [11 February 2020]NOTE: EMPLOYMENT COURT ORDER PROHIBITING PUBLICATION OFNAME AND IDENTIFYING PARTICULARS OF APPELLANT REMAINS INFORCEIN THE COURT OF APPEAL OF NEW ZEALANDI TE KŌTI PĪRA O AOTEAROACA4/2019[2020] NZCA 12BETWEEN TUVAppellantAND CHIEF OF NEW ZEALAND DEFENCEFORCERespondentHearing: 31 October 2019Court: French, Courtney and Goddard JJCounsel: A J Douglass and M J Taylor-Cyphers for AppellantJ G Drayton and J P A Boyle for RespondentJudgment: 11 February 2020 at 2.00 pmJUDGMENT OF THE COURTA The appeal is dismissed.B We answer the questions of law submitted for determination by the court:(a) Does s 149(3) of the Employment Relations Act 2000 operate asa statutory bar to the setting aside of certified s 149 agreements?No.(b) Does the test in the Privy Council decision of O'Connor v Hart,subsequently applied in other courts of New Zealand, apply inthe employment jurisdiction (and to certified s 149 agreements) beingthat a contract cannot be voidable for mental incapacity unlessthe other contracting party has knowledge (actual or constructive) ofthe incapacity, or equitable fraud is established?Yes.C There is no order as to costs.____________________________________________________________________Table of contentsPara NoIntroduction and summary [1]Background [7]ERA determination [11]Employment Court judgment [13]Effect of s 149 [14]Capacity to enter into settlement agreement [16]Unconscionability and duress [21]Leave to appeal to this Court [23]First issue: Does s 149 preclude setting aside the settlement agreement? [25]The issue [25]Employer's submissions in relation to s 149 [27]Discussion [37]Second issue: Approach to incapacity in the employment context [50]The issue [50]Employee's submissions on appeal in relation to effect of incapacity [52]Discussion [57]The balance struck by the orthodox approach to capacity [57]No sufficient reason to depart from the orthodox approach [62]The United Kingdom caselaw is not relevant [67]The employee's alternative arguments [70]Decision on the second issue [78]Conclusion [80]Result [83]REASONS OF THE COURT(Given by Goddard J)Introduction and summary[1] Many employment disputes are settled. The employee and the employer enterinto a settlement agreement which resolves the differences between them. This appealconcerns the enforceability of a settlement agreement entered into by an employeewho lacked capacity to enter into that agreement as a result of mental illness.The employee wants to bring proceedings before the Employment Relations Authority(ERA). The employer, the Chief of the New Zealand Defence Force, says the claimhas been settled and cannot be reopened.[2] The first issue raised by the appeal is whether s 149 of the EmploymentRelations Act 2000 (Act) prevents the employee from challenging the settlementagreement on the basis that she lacked capacity to enter into it. Where an employmentdispute is resolved, the parties may ask a mediator employed or engaged bythe Ministry of Business, Innovation and Employment (MBIE) to sign the agreedterms of settlement under s 149. Section 149 sets out certain procedural steps thatmust be taken by the mediator. It goes on to provide that where the agreed terms ofsettlement are signed by a mediator, those terms are final and binding on, andenforceable by, the parties. The terms may not be cancelled under ss 36 to 40 of theContract and Commercial Law Act 2017.1 Except for enforcement purposes, no partymay seek to bring those terms before the Employment Authority or the Court, whetherby action, appeal, application for review, or otherwise.2[3] The Employment Court held, and we agree, that s 149 does not preventa challenge to a settlement agreement on the grounds of incapacity.3 If a settlementagreement is set aside because the employee lacked capacity to enter into it, there areno agreed terms of settlement to which s 149 could apply.[4] The second issue raised by the appeal is whether the test for setting asidea settlement agreement in relation to an employment dispute on the grounds ofincapacity is different from the test that applies to contracts generally. Under thegeneral law of contract, a contract is voidable if:4(a) one party lacked capacity to enter into that contract as a result of mentalillness; and(b) the other party knew of that incapacity, or ought to have known of it.1 Employment Relations Act 2000, s 149(3)(ab).2 Section 149(3)(b).3 TUV v WXY [2018] NZEmpC 154 (Employment Court judgment).4 O'Connor v Hart [1985] 1 NZLR 159 (PC); GE Custodians v Bartle [2010] NZSC 146,[2011] 2 NZLR 31; Westpac New Zealand Ltd v Map & Assocs Ltd [2011] NZSC 89,[2011] 3 NZLR 751; and Gustav & Co Ltd v Macfield Ltd [2008] NZSC 47, [2008] 2 NZLR 735.[5] We do not consider that a different test should apply to agreements settlingemployment disputes. In this case, the Employment Court held that the employer didnot know of the employee's incapacity and had no reason to suspect it.5The Employment Court was right to find that in these circumstances, the settlementagreement was not voidable. It is binding on both parties. The dispute has beensettled, and cannot be reopened before the ERA.[6] We set out our reasons for these conclusions below.Background[7] The relevant facts can be stated very briefly.[8] The employee was employed by the employer for many years. Issues arosewhich led to an employment dispute. The employee sought medical attention, and wasabsent from work on stress leave for an extended period.[9] Discussions and correspondence took place between a lawyer acting forthe employee and the employer's director of human resources, with a view to resolvingthe parties' differences. These exchanges resulted in the preparation of a writtensettlement agreement which was signed by the parties on 1 December 2015.A mediator employed by the Chief Executive of MBIE was contacted, and asked tosign the agreement under s 149 of the Act. The mediator spoke to the plaintiff overthe telephone. The mediator signed the agreement on 15 December 2015.[10] The employee subsequently filed a claim in the ERA alleging that she had beenunjustifiably constructively dismissed. Her claim alleged discrimination andworkplace bullying. The employer argued that the claim was precluded bythe settlement agreement. The Authority dealt with this as a preliminary issue.5 Employment Court judgment, above n 3, at [69].ERA determination[11] The ERA declined to set aside the settlement agreement.6 The ERA found thatthe employee did not lack the capacity to enter into the agreement.7 The ERA alsofound that there was no material indication to the employer which would havereasonably led it to conclude that the employee lacked capacity to enter intothe settlement agreement.8[12] The ERA also held that the bargain reflected in the settlement agreement wasnot unconscionable, and that the employee did not enter into the settlement agreementas a result of duress.9Employment Court judgment[13] The employee appealed to the Employment Court, which reheardthe preliminary issue de novo.Effect of s 149[14] Chief Judge Inglis found that s 149 does not prevent the Court from inquiringinto a settlement agreement on the grounds of mental incapacity.10 The Chief Judgeconsidered that s 149 is directed at limiting the circumstances in which parties canrevisit their agreements by seeking to bring the terms of settlement before the Court.11It is not directed at deeming validity of the agreement itself.12[15] The Chief Judge set out her conclusions on this issue as follows:[46] if the plaintiff can establish that she did not have the requisitemental capacity to enter into the settlement agreement in this case, thens 149(3) would not be engaged. That is because the fundamentals ofcontractual formation would not have been made out and there would be noagreement for s 149(3) to leverage off. Such cases are likely to be rare becauseof the hurdles that must be overcome in establishing, for example, lack ofmental capacity, knowledge and unconscionability.6 TUV v WXY [2017] NZERA Christchurch 222 (ERA determination).7 At [69].8 At [70].9 At [73]–[74] and [80].10 Employment Court judgment, above n 3, at [46].11 At [45].12 At [45].(Footnote omitted.)Capacity to enter into settlement agreement[16] The Chief Judge found that the employee was more likely than not mentallyincapacitated when she signed the settlement agreement and when she subsequentlyspoke to the mediator over the telephone. She also accepted that it was more likelythan not that the employee lacked capacity to instruct her lawyer.13[17] The Chief Judge went on to consider whether the employer had knowledge ofthe employee's mental incapacity at the relevant time. The Chief Judge was notsatisfied that the employer knew or ought reasonably to have known that the employeelacked the mental capacity to enter into the settlement agreement.14[18] The Chief Judge noted that the decision of the Privy Council in O'Connor vHart establishes that a contract is voidable for lack of capacity only if one party lackscapacity to enter into it, and the other party knows or ought to have known of thatmental incapacity.15 In this case, the employee was mentally incapacitated, butthe employer did not know, and could not reasonably have known, about her lack ofcapacity.16[19] The Chief Judge expressed some hesitation about whether, in the context ofemployment settlement agreements, the "second limb" of the O'Connor v Hartapproach — the requirement that the other party knew or should have known ofthe incapacity — should apply. She said:[65] I have considered whether the second limb of the O'Connor approachis a necessary step in this Court's inquiry, and is fatal to the plaintiff's claim.The two-limb approach, requiring a plaintiff to establish mental incapacity andprovide evidence that the defendant had knowledge (actual or imputed),appears to have developed in the commercial context, emphasisingthe desirability of contractual certainty. While contractual certainty isdesirable, in the employment sphere it might be said to apply with less force,including having regard to the underlying objectives of the Act. I seea potential danger, given the special nature of employment relationships andthe unequal bargaining power implicit in them (as expressly acknowledged in13 At [54].14 At [64].15 At [55], referring to O'Connor v Hart, above n 4, at 167.16 At [69].s 3 of the Act), in simply assuming that employment settlement agreementsreached via mediation ought to be treated in precisely the same way as other(including purely commercial) contracts. Indeed, the fact that Parliamentlegislated to preclude cancellation in certain circumstances may be said toreinforce the fact that s 149 settlement agreements stand apart from regularcontractual arrangements. And, as has been confirmed in many Court ofAppeal cases, employment law is a specialist jurisdiction which is focussedon resolving problems between parties to an employment relationship, ratherthan on strict contractual principles.[66] Under s 189 the Court has, for the purpose of supporting successfulemployment relationships and promoting good faith behaviour, jurisdiction todetermine all matters in such manner and to make such decisions and orders,not inconsistent with the Act or any other Act, as "in equity and goodconscience it thinks fit." It might be argued that setting aside an agreemententered into with a party lacking the requisite capacity, whether or notthe employer knew or ought to have known of it, would lead to a resultconsistent with equity and good conscience, even weighing the countervailingpolicy consideration of certainty of contract. The point might be even morestrongly made where the mental incapacity was actually caused or triggeredby the employer's unjustified actions or inactions during the course ofthe employment relationship. To put it another way, it may be relevant thatone party (in breach of their employment obligations, including to act in goodfaith) has driven the other party to the point of mental incapacity.[67] The outcome in this case, of limiting the inquiry to limb one, wouldbe that the defendant, a large government sector organisation, would face theprospect of an employment claim that it acted unlawfully in the way in whichit dealt with performance issues involving the plaintiff that it thought it wouldnot have to confront. There is no other evident prejudice involved, other thanthat generally associated with the passage of time. The flip side is thata person assessed as lacking sufficient mental capacity at the time they signedaway their legal rights to access the employment institutions, would be ableto pursue those rights in circumstances where no other right of challenge,appeal or judicial review is available.[68] The Court of Appeal has not yet had the opportunity to considerthe extent to which s 149 acts as an impenetrable shield to the pursuit of claimsand (if not) whether the generally applied approach to mental incapacityapplies to employment settlement agreements. However, given the clearapproach currently adopted by the courts, including the Court of Appeal, tothe second limb test for mental incapacity, I feel constrained to approach thiscase in the same way.(Footnotes omitted.)[20] Applying the orthodox approach, the settlement agreement was not liable to beset aside because the employer did not know, and could not reasonably have known,of the employee's incapacity.17Unconscionability and duress[21] The Chief Judge found that the agreement was not unconscionable. She said:[73] The reality is that the plaintiff was represented by an experiencedemployment lawyer who negotiated an unremarkable settlement agreementbased on conventional terms that were reasonably evenly weighted.The agreement was fair and reasonable, and falls well short of representingan unconscionable bargain.(Footnote omitted.)[22] The Chief Judge also found that the employee had not signed the agreementunder duress.18Leave to appeal to this Court[23] The employee sought leave to appeal to this Court. The employer acceptedthat the appeal raised issues of general and public importance and consented tothe application for leave to appeal. The Court granted leave to appeal on the followingquestions:19a. Does s 149(3) of the Employment Relations Act 2000 operate asa statutory bar to the setting aside of certified s 149 agreements?b. If the answer to a. is no, does the test in the Privy Council decision ofO'Connor v Hart, subsequently applied in other courts ofNew Zealand, apply in the employment jurisdiction (and to certifieds 149 agreements) being that a contract cannot be voidable for mentalincapacity unless the other contracting party has knowledge (actual orconstructive) of the incapacity, or equitable fraud is established?[24] We address each of those issues in turn below.17 At [69].18 At [80].19 TUV v WXY CA4/2019, 8 February 2019.First issue: Does s 149 preclude setting aside the settlement agreement?The issue[25] Section 149 provides:149 Settlements(1) Where a problem is resolved, whether through the provision ofmediation services or otherwise, any person—(a) who is employed or engaged by the chief executive to providethe services; and(b) who holds a general authority, given by the chief executive,to sign, for the purposes of this section, agreed terms ofsettlement,—may, at the request of the parties to the problem, and under that generalauthority, sign the agreed terms of settlement.(2) Any person who receives a request under subsection (1) must, beforesigning the agreed terms of settlement,—(a) explain to the parties the effect of subsection (3); and(b) be satisfied that, knowing the effect of that subsection,the parties affirm their request.(3) Where, following the affirmation referred to in subsection (2) ofa request made under subsection (1), the agreed terms of settlement towhich the request relates are signed by the person empowered to doso,—(a) those terms are final and binding on, and enforceable by,the parties; and(ab) the terms may not be cancelled under sections 36 to 40 ofthe Contract and Commercial Law Act 2017; and(b) except for enforcement purposes, no party may seek to bringthose terms before the Authority or the court, whether byaction, appeal, application for review, or otherwise.(3A) For the purposes of subsection (3), a minor aged 16 years or over maybe a party to agreed terms of settlement, and be bound by thatsettlement, as if the minor were a person of full age and capacity.(4) A person who breaches an agreed term of settlement to whichsubsection (3) applies is liable to a penalty imposed by the Authority.[26] The first question before us is whether a settlement agreement that has beensigned by a mediator under s 149 can be challenged before the Courts on the groundsthat a party lacked mental capacity to enter into that agreement.Employer's submissions in relation to s 149[27] The employer says that the meaning of the words in s 149(3)(b) is plain:"except for enforcement purposes, no party may seek to bring those terms beforethe Authority or the Court, whether by action, appeal, application for review, orotherwise".[28] The employer also notes that under s 152(2)(a) a s 149 settlement agreementcan be challenged or called into question on the grounds that the mediator failed tocomply with the procedural requirements in sub-sections (2) and (3) of s 149.The employer says that settlement agreements can be challenged on these proceduralgrounds, but not otherwise.[29] The employer put some emphasis on the legislative history of s 149.Section 88(2) of the Employment Contracts Act 1991 provided for settlementagreements to be signed by a mediator only where the settlement resulted fromthe provision of mediation services. It read:(2) Where a member of the Tribunal provides mediation services withinthe adjudication jurisdiction of the Tribunal, and as a result the partiesconclude a settlement or agree to the member making a decision,the parties may request the member to sign the terms of settlement andin any such case those terms of settlement shall be final and bindingon the parties.[30] The expansion of the role of mediators to include signing settlementagreements that had not been reached as a result of mediation services provided underthe Act was consistent with the Act's focus on:20 the prior resolution of problems by the parties themselves, who will haveaccess to a wide range of resources, through information provision, structuredor unstructured mediation and other services to voluntarily resolve matters atan early stage.20 Employment Relations Bill 2000 (8-1) at 8.[31] The employer also emphasised that at the Committee of the Whole House stageof the Employment Relations Bill, an amendment to the Bill was proposed bythe Opposition. The amendment would have inserted an additional subsectionproviding for settlements to be challenged on the grounds that they areunconscionable. The Government voted against the proposed amendment.The employer submitted that the rejection by Parliament of the proposed amendmentshowed a clear Parliamentary intention that there would be a statutory bar to the settingaside of s 149 settlement agreements on the grounds of unconscionability, or otherequitable doctrines.[32] The employer also drew our attention to a 2004 amendment to the Act. InHunt v Forklift Specialists Ltd, a case decided under the Employment Contracts Act1991, the Employment Court found that settlement agreements entered into pursuantto s 88 of that Act could be cancelled by the innocent party under the ContractualRemedies Act 1979 if the other party failed to comply with the agreement.21 Afterthe Act was enacted in 2000, several decisions of the ERA adopted the same approachin relation to s 149 settlement agreements.22 Section 149 was amended bythe Employment Relations Amendment Act (No 2) 2004 by inserting s 149(3)(ab),which provided that the terms of an agreed settlement "may not be cancelled undersection 7 of the Contractual Remedies Act 1979".23 The employer submits thatthe insertion of para (ab) was a response to the ERA decisions following Hunt, andreflected a policy of preventing challenges to s 149 agreements.[33] The employer says that this statutory history confirms that s 149(3)(b) shouldbe read as preventing challenges to settlement agreements that have been signed bya mediator under s 149 on any grounds, except perhaps actual fraud.[34] The employer submits that there are strong policy reasons supporting thisapproach, in particular certainty for parties entering into s 149 agreements. If s 149agreements can be set aside on grounds of mental incapacity, or other grounds, that21 Hunt v Forklift Specialists Ltd [2000] 1 ERNZ 553 (NZEmpC).22 CN v H ERA Christchurch CEA 102/03, 28 November 2003; and House v Samuel Miller FilmsLtd ERA Christchurch CEA 189/02, 17 July 2002.23 Employment Relations Amendment Act (No 2) 2004, s 51(1). That Act also added s 149(4), whichprovides for a party who breaches an agreed term of settlement to be liable to a penalty.would undermine public confidence in s 149 settlements. It would meanthat the "floodgates would be wide open" and settlement agreements would be setaside in many cases.[35] The employer says that the UK decisions finding that the UK EmploymentTribunal has jurisdiction to set aside a settlement agreement on the grounds ofmisrepresentation or lack of capacity, which were referred to in the Employment Courtjudgment, provide no assistance in New Zealand.24 There are significant differencesin the statutory frameworks.[36] The employer drew our attention to Bagley v Deloitte Ltd in which the ERA,in reliance on the Employment Court judgment in this case, found that a settlementagreement entered into under s 149 was not valid on the grounds ofmisrepresentation.25 The employer submitted that that decision was clearly wrong,having regard to the specific exclusion of cancellation for misrepresentation ins 149(3)(ab); but it illustrated the level of uncertainty and confusion generated bythe Employment Court judgment.Discussion[37] The meaning of s 149 must be ascertained from its text in light of its purpose.26Even if the meaning of the text appears plain in isolation from purpose, that meaningmust always be cross-checked against purpose. In determining purpose the Courtmust have regard to both the immediate and general legislative context. The social,commercial or other objectives of the enactment may also be relevant.27[38] We consider that the conclusion reached by the Chief Judge is consistent withboth the text and the purpose of s 149.24 Glasgow City Council v Dahhan UKEAT Edinburgh UKEATS/0024/15/JW, 11 May 2019; andIndustrious Ltd v Horizon Recruitment Ltd (in liq) [2009] UKEAT London UKEAT/0478/09,11 December 2009.25 Bagley v Deloitte Ltd [2019] NZERA 427.26 Interpretation Act 1999, s 5(1).27 Commerce Commission v Fonterra Co-operative Group Ltd [2007] NZSC 36, [2007] 3 NZLR767 at [22].[39] Section 149 refers to the "agreed terms of settlement". It is those agreed termsof settlement that cannot be challenged before a Court. But the existence of agreedterms of settlement depends on there being a valid contract between the parties inwhich those terms are incorporated. If a settlement agreement is voidable becausea party lacked capacity, and is set aside, there is no contract and the parties are restoredto their pre-contract position. So there are no "agreed terms of settlement".[40] Further textual support for this approach is found in s 149(3A), which providesthat a minor aged 16 years or over may be a party to agreed terms of settlement andbe bound by that settlement as if the minor were a person of full age and capacity. Ifs 149 precluded challenges to an agreement based on lack of capacity, subsection (3A)would not be necessary: a minor aged 16 years or over would not have been able toraise issues of capacity in any event. And it is implicit in this provision that so far asminors aged under 16 are concerned, the general law applies and they are able tochallenge a settlement agreement on the grounds that they lacked capacity. Therewould be no point in drawing a line at the age of 16 in subsection (3A) if the positionwas the same for minors above or below that age as a result of s 149(3).[41] Similar inferences can be drawn from s 149(3)(ab) in relation to cancellationunder ss 36–40 of the Contract and Commercial Law Act (formerly s 7 ofthe Contractual Remedies Act). This provision, which as noted above was inserted inthe Act in 2004, precludes cancellation on the basis of misrepresentation, seriousbreach, or repudiation. This provision would not be necessary if s 149(3)(a) and (b)precluded a challenge to agreed terms of settlement on any basis whatsoever.The express exclusion of the ability to cancel a settlement agreement under specifiedprovisions of the Contract and Commercial Law Act also strongly suggests thatthe ability to challenge agreed terms of settlement under other provisions of that Act— for example, s 24 in relation to relief for mistake, or s 73 in relation to illegalcontracts — is not affected by the general language in s 149(3)(a) and (b).[42] That is not a surprising conclusion. The purpose of s 149 is to preventthe reopening of a valid settlement agreement. But Parliament did not in our viewintend the limited procedural safeguards in s 149 to override the important protectionsfor individuals and for the public interest reflected in the law relating to validity ofcontracts. Facilitating settlement of employment disputes is an important objective.So too is certainty. But these objectives do not trump the policy objectives and basiclegal values reflected in the law relating to capacity, and in the law concerning othergrounds for finding that a contract is void or is liable to be set aside.[43] Consider, for example, a settlement agreement between an employer and anemployee with significantly impaired mental capacity. The employer knows ofthe employee's incapacity, and deliberately exploits it to secure an agreement that isvery disadvantageous to the employee. We cannot identify any sensible policyrationale for enforcing such an agreement against the employee. Doing so could notbe reconciled with fundamental principles of the common law. Nor could it bereconciled with the values of good faith and redress of power imbalances that underpinthe Act itself.28[44] The same reasoning applies in relation to other grounds on which an agreementis liable to be set aside, such as duress, undue influence or unconscionability. It wouldbe abhorrent for a settlement agreement that an employer had procured by duress tobe enforced merely because it had been signed by a mediator under s 149. Yet thatwould be the consequence of the employer's argument in this case.[45] We are confident that Parliament did not intend s 149 to override the lawrelating to capacity, duress, unconscionability or other grounds for finding thata contract is void or voidable at its inception. The purpose of s 149 does not requiresuch a far-reaching and surprising result. The broader purposes of the Act reflected inss 3 and 4 point very much the other way.[46] Different policy considerations arise in relation to cancellation of an agreementfor serious breach or repudiation, where no issue arises about the validity ofthe agreement at the time it was entered into. In circumstances where one party hasfailed to perform the agreement, or has made it clear that they do not intend to performtheir obligations, there is no unfairness in holding the parties to their (valid)agreement: the parties' interests can be fully protected by enforcing the agreement orawarding damages for breach. Section 149(3)(ab) appears to be intended to ensure28 See in particular Employment Relations Act, ss 3 and 4.that in these circumstances settlements remain effective, and the original employmentdispute is not reopened — it was validly settled, and should remain settled. There isa clear and principled distinction between this scenario and the scenarios discussedabove where a contract is void or voidable at its inception.[47] We note in passing that s 149(3)(ab) may have the surprising, and presumablyunintended, consequence of preventing cancellation of a settlement agreement thatwas procured by fraud. We cannot see any policy justification for holding either party— employer or employee — to a settlement agreement that was procured by afraudulent misrepresentation made by the other party. Yet that appears to be theconsequence of s 149(3)(ab) precluding cancellation under s 37(1)(a) of the Contractand Commercial Law Act. Similar, though less acute, concerns arise in relation to asettlement agreement that is procured by a misrepresentation that is not fraudulent.This is an issue that Parliament may wish to consider in the context of any futurereview of the Act.[48] The first question in relation to which leave to appeal was granted is:Does s 149(3) of the Employment Relations Act 2000 operate as a statutorybar to the setting aside of certified s 149 agreements?[49] The answer is no.Second issue: Approach to incapacity in the employment contextThe issue[50] As the Privy Council confirmed in O'Connor v Hart, a contract is voidable atthe option of a party to that contract if at the time of entry into the contract:29(a) that party lacked the mental capacity to enter into the transaction; and(b) the other party knew or ought to have known of that lack of capacity.29 O'Connor v Hart, above n 4, at 174.[51] The second question in respect of which leave to appeal to this Court wasgranted is whether, in circumstances where an employee lacks capacity to enter into asettlement agreement, that agreement is voidable only if the employer knows or oughtto know of their incapacity. In other words, does the second limb of the test set outabove apply to settlements of employment disputes? Or is there a different rule in thiscontext?Employee's submissions on appeal in relation to effect of incapacity[52] The employee submitted that in the employment context, a settlementagreement entered into by an employee who lacked the necessary capacity to do so isvoid, or in the alternative voidable, whether or not the employer knows of thatincapacity. The employee emphasised the inherent inequality of power in employmentrelationships, recognised in s 3(a)(ii) of the Act, and the requirement in s 4 thatthe parties to an employment relationship must deal with each other in good faith. Sheargued that it would be unfair and oppressive to hold an employee who lacked capacityto an agreement that they had entered into in circumstances where they could notproperly appreciate its implications. Because the employee lacked capacity to enterinto the settlement agreement, there was no consensus ad idem or meeting of theminds. So there was no genuine agreement.[53] The employee argued that the common law test as it applies to commercialcontracts ought not to apply in the employment jurisdiction. In the commercialcontext, she submitted, a premium is placed on certainty. In the employment context,greater emphasis should be given to protection of the vulnerable party fromdisadvantage. The Employment Court is a court of equity and good conscience.30 Itwould be contrary to equity and good conscience to enforce a settlement agreementagainst an employee who was not capable of understanding its implications, andmaking a free and informed decision to settle the dispute.31[54] In the alternative, the employee submitted that the employer should be treatedas having knowledge of the employee's incapacity where the employer caused or30 Employment Relations Act, ss 157, 160 and 189.31 See Employment Court judgment, above n 3, at [65]–[66].contributed to the employee's mental health condition: an approach foreshadowed bythe Chief Judge.32 In those circumstances, it was submitted, the employer has apositive duty to make inquiries. They should be treated as knowing all matters whichwould have been disclosed by such inquiries.[55] Yet another option advanced on behalf of the employee in the course of oralargument was that in the employment context, a contract should be voidable if theemployee lacks capacity and the contract is substantively unfair.[56] The employee also argued that unconscionability and duress are independentgrounds for the Court to intervene, even where no issue of capacity arises. In this case,the employer's passive acceptance of the settlement agreement was unconscionable.And the employee was acting under duress.DiscussionThe balance struck by the orthodox approach to capacity[57] The law of contract seeks to strike a balance between respect for the autonomyof contracting parties and protection of the vulnerable, including those who arevulnerable as a result of mental illness.[58] If a party lacks capacity, and the other party knows this, there can be nojustification for enforcing a contract between them if the incapacitated party (or theirrepresentative) wishes to set it aside. Similarly, if the other party is on notice that anindividual may lack capacity, they should not be permitted to turn a blind eye to thosecircumstances and take the benefit of a contract that exploits that incapacity. Rather,if they refrain from making inquiries, they take the risk that the contract will be setaside because the other party lacked capacity to enter into it.[59] But on the orthodox approach, a contracting party dealing with an individualwho is not a minor can proceed on the basis that that individual has contractualcapacity unless they know the individual lacks capacity, or are aware of circumstancesthat would put a reasonable person on inquiry about the individual's capacity. They32 At [66].can enter into contracts with that individual without needing to actively inquire intoquestions of capacity, absent such notice, and do not face the risk of subsequentinvalidation of the contract on the basis of a lack of capacity. That approach isconsistent with the objective approach to contract formation that underpinsthe common law of contract. It promotes certainty. It also reduces barriers tocontracting for individuals, because other people who deal with them can assumecapacity and do not need to make inquiries or take other active steps to ascertain theircapacity.[60] If capacity could not be assumed, then in some (potentially quite broad)circumstances the risk of a contract being voidable for incapacity would incentivisebusinesses and other people entering into significant transactions with individuals toseek comfort on that issue: for example, by requiring a certificate in relation tocapacity from the individual's lawyer or a doctor. That would increase the cost andpractical difficulty of contracting for many individuals — not just those who do in factlack capacity. The cost and inconvenience of steps of this kind could prevent entryinto contracts that those individuals wish to enter into and would benefit from. Inother cases, the contract would be entered into despite the cost and inconvenience ofsuch steps, but that additional cost would be borne by the parties — includingthe individuals who were required to take steps to establish their capacity to enter intothe contract. The purpose of the second limb of the test in O'Connor v Hart is to avoidcreating barriers to contracting and costs of contracting of this kind.[61] Nor, it should be noted, is this a test that has been developed solely — or evenprimarily — in a commercial context. O'Connor v Hart itself was a case about anelderly farmer selling a family farm. All cases about mental capacity by definitionconcern dealings by individuals. Many of these are family transactions rather thantruly commercial transactions.No sufficient reason to depart from the orthodox approach[62] The employee argued that there is real unfairness to an employee in being heldto a contract they did not have the capacity to understand and enter into, regardless ofthe employer's knowledge. We recognise the force of that argument. But that is truein other contexts — it is not a factor peculiar to the employment context, and does notsuggest that the balance struck by the established test is any less applicable inthe employment context.[63] The "equity and good conscience" character of the employment jurisdictiondoes not require a different approach. Equitable doctrines such as duress, undueinfluence and unconscionability all depend on the stronger party having knowledgeof, and exploiting, the vulnerability or disadvantage of the other party. That is notsurprising. The stronger party's conscience is not affected if they neither know, norhave reason to know, of the vulnerability or disadvantage affecting the other party.It is not contrary to good conscience to enter into an agreement in the absence ofknowledge of some factor that makes it unconscionable to do so.[64] It might be argued that it is contrary to equity and good conscience forthe stronger party to hold the weaker party to an agreement if they subsequentlybecome aware of the vulnerability or disadvantage of the other party. But that is notthe approach taken by the courts of equity in any of these contexts, and we do notconsider that the employment context is so different that it requires a different result.[65] Indeed the wider statutory context points very much the other way. Section 68of the Act sets out the circumstances in which an individual employment agreementcan be set aside as unfair as a result of disability, undue influence, duress, or certainother factors. It provides:68 Unfair bargaining for individual employment agreements(1) Bargaining for an individual employment agreement is unfair if—(a) 1 or more of paragraphs (a) to (d) of subsection (2) apply toa party to the agreement (person A); and(b) the other party to the agreement (person B) or another personwho is acting on person B's behalf—(i) knows of the circumstances described inthe paragraph or paragraphs that apply to person A; or(ii) ought to know of the circumstances in the paragraphor paragraphs that apply to person A because personB or the other person is aware of facts or othercircumstances from which it can be reasonablyinferred that the paragraph or paragraphs apply toperson A.(2) The circumstances are that person A, at the time of bargainingfor or entering into the agreement,—(a) is unable to understand adequately the provisions orimplications of the agreement by reason ofdiminished capacity due (for example) to—(i) age; or(ii) sickness; or(iii) mental or educational disability; or(iv) a disability relating to communication; or(v) emotional distress; or(b) reasonably relies on the skill, care, or advice of person B ora person acting on person B's behalf; or(c) is induced to enter into the agreement by oppressive means,undue influence, or duress; or(d) where section 63A applied, did not have the information orthe opportunity to seek advice as required by that section.(3) In this section, individual employment agreement includes a termor condition of an individual employment agreement.(4) Except as provided in this section, a party to an individualemployment agreement must not challenge or question the agreementon the ground that it is unfair or unconscionable.[66] Parliament has codified the rules relating to mental incapacity andunconscionability in the context of bargaining for individual employment agreements.The code set out in s 68 requires both that there be circumstances affecting the abilityof the employee to understand the agreement or make a free and autonomous decisionto enter into the agreement,33 and that the other party knows or ought to know ofthe relevant circumstances.34 Section 68 confirms that a knowledge requirement akinto the second limb of the O'Connor v Hart test is consistent with the purpose of the Actand the values that underpin it.33 Employment Relations Act, ss 68(1)(a) and (2).34 Section 68(1)(b).The United Kingdom caselaw is not relevant[67] Counsel for the employee referred us to the decision of the United KingdomSupreme Court in Dunhill v Burgin.35 The Court affirmed the general principle thatcapacity is issue-specific and that capacity is to be judged in relation to the decisionor activity in question and not globally.36 The Court held that Ms Dunhill lackedthe capacity to commence and conduct proceedings arising out of a personal injuryclaim against Mr Burgin.37 Ms Dunhill ought to have had a litigation friend fromthe outset. Any settlement she entered into required approval by the Court underthe Civil Procedure Rules 1998 (UK).38 Because she did not have a litigation friendand the settlement she had entered into had not been approved by the Court,the settlement was of no effect.39[68] As the Court noted in Dunhill, the regime for approval of settlementagreements under the Civil Procedure Rules is a significant exception to the generalposition under English law that a contract entered into by a person who lacks capacityis voidable only if that lack of capacity is known, or ought to be known, to the otherparty.40 The law in New Zealand in relation to settlement agreements is different intwo important respects. First, there is no general requirement that a settlement enteredinto by a person who lacks capacity must be approved by the Court. Second, underthe High Court Rules 2016 a step in a proceeding taken by an incapacitated personwho does not have a litigation guardian is not void. Rather, r 4.34 provides:4.34 Court may set aside a step in a proceedingThe court may set aside a step in a proceeding if an incapacitated person didnot have a litigation guardian when that step was taken and the Court considersthat the incapacitated person was unfairly prejudiced.[69] Rule 4.34 was not engaged in this case, as a settlement agreement was enteredinto before any proceedings had been commenced in any court. But if it had applied,it would not have led to a different result in this case. As noted above,35 Dunhill v Burgin [2014] UKSC 18, [2014] 1 WLR 933.36 At [13].37 At [34].38 At [34].39 At [21] to [33].40 At [30].the Employment Court found that the settlement agreement was unremarkable andwas not unfair to the employee. There was no unfair prejudice of the kind that wouldresult in a step being set aside under r 4.34.The employee's alternative arguments[70] The employee advanced a number of alternative arguments, in the event thather primary argument that the second limb of the O'Connor v Hart test should notapply was unsuccessful.[71] Her first alternative argument was that the employer can be treated as havingknowledge of a lack of capacity where that lack of capacity was caused or contributedto by the conduct of the employer. This does not follow as a matter of logic. It isperfectly possible for the conduct of an employer to have caused mental healthproblems for an employee, but for the employer not to be aware of those mental healthproblems.[72] This alternative argument may be better understood as an argument thatknowledge on the part of the employer is not required — the second limb ofthe O'Connor v Hart test does not apply — where the employer has caused orcontributed to the employee's mental illness and resulting lack of capacity. That ishow the argument was framed by the Chief Judge in her discussion of alternativeapproaches to this issue.41[73] We doubt that an argument along these lines is within the scope of the leavegranted by this Court. But in any event, we consider that there is no reason to modifythe orthodox approach to issues of capacity in the manner contended for, forthe reasons set out above.[74] If the employer has breached their obligations to the employee in a manner thathas caused or contributed to a mental illness affecting capacity, then they will be liablefor the harm they have caused. If the employee pursues a claim for that harm againstthe employer, and alleges that they suffer from a mental illness as a result of41 Employment Court judgment, above n 3, at [66].the employer's breaches, then the employer will be on notice that there may be anissue of capacity; if they proceed to settle with the employee in the absence of alitigation guardian, then the agreement will be voidable at the option of the employee.No special rule is required to achieve this result.[75] But if the employee makes a claim without alleging a mental illness or anyother matters that put the employer on notice of a possible lack of capacity, and thereis nothing else to put the employer on notice, then there are good reasons not to requirethe employer to bear the risk of possible incapacity. An approach that did not requireknowledge or notice of incapacity where the incapacity was contributed to bythe employer's conduct would hinder entry into settlement agreements, especially inthe common scenario where an employee claims to have suffered stress as a result ofthe employer's actions. It would be likely to result in employers seeking confirmationof an employee's capacity to settle a dispute in many cases where the employee doeshave capacity. The additional cost and inconvenience involved would disadvantage asignificant number of employees and employers. We do not consider that it is justifiedin the employment context, any more than in other contractual contexts.[76] The second alternative argument advanced on behalf of the employee was thatin the employment context, a contract should be voidable if the employee lackscapacity and there is substantive unfairness. This argument faces a number ofdifficulties. The first (insuperable) difficulty is that the Employment Court found thatthere was no substantive unfairness in this case: the agreement was unremarkable.The second difficulty is that for the reasons set out above we consider that the generalrule concerning capacity applies in the employment context: a contract is voidablebecause an employee lacks capacity only where the employer knows or ought to haveknown of that lack of capacity.[77] The employee's final alternative argument, contending that the settlementagreement should be set aside on the grounds of unconscionability or duress, did notcome within the terms of the leave granted by this Court. But in any event thatargument could not succeed on the facts. Nothing amounting to duress was made outin this case. And as explained above, a bargain is unconscionable only if the strongerparty knows or ought to know of the disability or disadvantage affecting the weakerparty. Otherwise, their conscience is not affected and the agreement is not voidable inequity. The Employment Court found that the employer neither knew nor ought tohave known of the employee's impaired capacity. So there is no factual basis for achallenge on the grounds of unconscionability.Decision on the second issue[78] The second question in respect of which leave was granted was:If the answer to a. is no, does the test in the Privy Council decision ofO'Connor v Hart, subsequently applied in other courts of New Zealand, applyin the employment jurisdiction (and to certified s 149 agreements) being thata contract cannot be voidable for mental incapacity unless the othercontracting party has knowledge (actual or constructive) of the incapacity, orequitable fraud is established?[79] The answer is yes.Conclusion[80] Our answers to the two questions in respect of which leave to appeal wasgranted are set out at [48]–[49] and [78]–[79] above. We have upheld the decision ofthe Employment Court on both issues. The appeal is therefore dismissed.[81] The employee was successful on the first issue. The employer was successfulon the second issue. In those circumstances, we consider that costs should lie wherethey fall.[82] The employer submitted that if the appeal was dismissed, it should receivecosts. Counsel for the employer submitted that both questions had been proposed bythe employee when seeking leave to appeal, and the employer as respondent simplyconsented to the two issues being raised. However, we consider that in identifyingboth issues for consideration by this Court, the employee was simply recognisingthe inevitability that, if the second issue was raised by the employee, the employerwould wish to argue the first. If the employer had responded to the application forleave by saying that the s 149 issue was conceded, and they did not wish to pursue iton appeal, it would not have been necessary for this Court to address it. It occupiedat least half of the hearing time before us. We therefore remain of the view that costsshould lie where they fall.Result[83] The appeal is dismissed.[84] We answer the questions of law submitted for determination by the Courtas follows:(a) Does s 149(3) of the Employment Relations Act 2000 operate as astatutory bar to the setting aside of certified s 149 agreements?No.(b) Does the test in the Privy Council decision of O'Connor v Hart,subsequently applied in other courts of New Zealand, apply inthe employment jurisdiction (and to certified s 149 agreements) beingthat a contract cannot be voidable for mental incapacity unless the othercontracting party has knowledge (actual or constructive) ofthe incapacity, or equitable fraud is established?Yes.[85] There is no order as to costs.Solicitors:McCarthy Law Ltd, Blenheim for AppellantDyhrberg Drayton Employment Law, Wellington for Respondent