England and Wales Court of Appeal (Civil Division) Decisions

IN THE SUPREME COURT OF JUDICATURE
IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM ORDER OF MR STANLEY BURNTON QC
(Sitting as a Deputy High Court Judge)

		Royal Courts of Justice Strand London WC2
		16th November 2000

1. LORD JUSTICE CHADWICK: This is an appeal against the order made on 16th July 1999 by Mr Stanley Burnton QC, sitting as a Deputy Judge of the High Court in the Chancery Division, in proceedings brought by the appellant, City Alliance Ltd, against Oxford Forecasting Services Ltd and Advanced Transaction Systems Ltd. The appeal raises a short question of construction in relation to an agreement made between those three companies on 20th October 1998. The three companies are described in the agreement of 25th October 1998 respectively as "City Alliance", "Oxford" and "ATS". For convenience, I will adopt those descriptions in this judgment.
2. ATS was, at the date of the agreement, a wholly owned subsidiary of Oxford. The purpose of the agreement was to set out terms upon which City Alliance was to subscribe for and be issued with three shares in the capital of ATS. The consideration for those shares was £100,000 per share; that is to say, the total consideration payable by City Alliance was £300,000. Of that sum, £30,000 was payable, and was paid, on completion, which took place immediately after execution of the agreement. The balance was to be paid by nine consecutive monthly payments of £30,000; the first of such payments to be made thirty days after completion.
3. Clause 5 of the agreement contains warranties on behalf of Oxford and ATS that: (A) immediately prior to completion Oxford owned the entire issued share capital of ATS and there were no subsisting options in relation to the shares of ATS; (B) immediately after completion the three ordinary shares which would then have been issued to City Alliance in pursuance of the agreement would represent 1.5% of the issued equity share capital of ATS, and, (C) Oxford had assigned to ATS all intellectual property rights of whatever nature anywhere in the world in a software system, originally created by Oxford and known as Virtex, which was intended to "optimise execution for a multi-global network" but limited to use of that system in financial markets. On the basis that 3 shares of £1 each represented 1.5 per cent of share capital of ATS it is plain the capital was 200 shares of £1 each.
4. Clause 6 contained provisions which, on their face, were intended to protect the value of the investment which City Alliance was to make in ATS. For example, paragraph (A) prevented ATS from selling, transferring, leasing or otherwise disposing of any security interest in the intellecltual property save at an arm's length basis; and paragraph (C) prevented ATS from disposing of any part of its business, undertaking or assets. The relevant provision for present purposes is sub-clause 6 (B), which is in these terms:

"For so long as City Alliance is the owner of any shares in the capital of ATS, Oxford and ATS agree that (unless City Alliance agrees otherwise in writing):

.....

(B) no share or loan capital of ATS shall be created or issued nor shall any option or right be granted to any person whereby any share or loan capital of ATS may be or become due to be allotted or issued PROVIDED THAT ATS may at any time issue ordinary £1 shares to any person at a price per share of not less than £100,000 per share, payable in full on subscription."

5. City Alliance made the payments due on 20th November and 20th December 1998 and 20th January 1999. It did not make the payments due inFebruary, March and April 1999; a total of £90,000. By letter dated 24th April 1999 ATS purported to terminate the agreement of 20th October 1998 on the grounds that the failure by City Alliance to pay those three monthly instalments constituted repudiation of the agreement by City Alliance which ATS was entitled to, and did, accept.
6. On 21st May 1999 ATS served a statutory demand for £90,000 on City Alliance; £90,000 being the monies said to have accrued under the agreement of 20th October 1998 prior to termination. Following receipt of that statutory demand City Alliance issued proceedings in the Chancery Division claiming damages for breach of the agreement. At or about the same time City Alliance issued an originating application in the Companies Court seeking an injunction to restrain Oxford and ATS from presenting a winding-up petition consequent on the failure or refusal of City Alliance to pay under the statutory demand.
7. The originating application came before Mr Burnton QC on 9th July 1999. He explained the approach that he would adopt in the following passage of the judgment which he delivered on 16th July:

"[City Alliance] does not deny that it did not pay the instalments due from it as claimed in the statutory demand. It relies on the breaches it alleges of clause 6 of the Agreement as giving rise to a counterclaim that is entitled to set off against, and to extinguish, its liability to ATS. It was not in issue before me that [City Alliance] is entitled to succeed on this Application if it can show an arguable case to go forward, a reasonable prospect of establishing a counterclaim and set off which are sufficient to dispose of the claim of ATS. The service of a statutory demand, and proceedings to wind up a company, are wholly inappropriate means of dealing with genuine disputes, and I do not think it would be right to take a stringent view to establish a case. Any arguable issue should be dealt with in the proceedings appropriate for that purpose, namely the existing Chancery proceedings."

8. But that judge directed himself that, insofar as the dispute was as to the construction of the 20th October 1998 agreement, the court should embark on the task of construing that document in summary proceedings - including proceedings to restrain presentation of the petition - unless, as the judge said, there was a real possibility of the construction being affected by evidence of the factual matrix which was not available at the summary judgment stage.
9. City Alliance relied on two matters which, it alleged, constituted breaches of Clause 6 (B) of the October 1998 agreement. The first of those arose from the terms of an employment contract made between ATS and Mr Michael Cornford in March 1999. The second arose from a deed dated 6th April 1999 made between Oxford, ATS and LIFFE Administration and Management Ltd. The judge held that the terms of the LIFFE agreement did not constitute a breach of Clause 6 (B) of the agreement of 20th October 1998. There is no appeal against that matter and it is unnecessary to say more about it.
10. The judge then turned to consider the contract between ATS and Mr Cornford. The relevant provision was contained in Clause 3, under the heading "Salary". The clause is in these terms, so far as material:

"Mike Cornford's salary shall be defined in a separate share option agreement which the company shall enter into within 4 weeks from today. Under this agreement, ATS shall be obliged forthwith to grant Mike Cornford an option over such number of shares as represent 9% of the Company's issued shares at the time at which the option is granted, at a strike price of £3.6 million, which he may exercise at any time before 7th March 2002 provided that he is at the time of exercise in employment with ATS or has left employment with ATS no more than three months before exercise ..... "

11. If that option were exercised in full Mr Cornford would, for so long as the issued capital of ATS remained at 200 shares, become entitled to 18 shares for which he would be required to pay £3.6m; that is to say, an amount equal to £200,000 per share. It is clear, therefore, that an option granted in accordance with Clause 3 of Mr Cornford's employment contract would contravene the prohibition in Clause 6 (B) of the agreement of 20th October 1998 unless the grant of that option fell within the proviso to that sub-clause. It is plain, also, that unless the proviso to Clause 6 (B) can be extended beyond the actual issue of shares - so as to include the grant of an option or right to have shares issued in the future - an option granted in accordance with Clause 3 of Mr Cornford's employment contract does not fall within the proviso. It is that which poses the question of construction with which the judge was faced: "does the proviso to Clause 6 (B) of the agreement of 20th October 1998 permit ATS to grant an option to issue shares in the future on terms that, when issued, the shares will be issued at a price of not less than £100,000 per share payable in full on subscription?" The judge held that that question was to be answered in the affirmative. The proviso did permit the grant of such an option and, accordingly, the provisions in Clause 3 of Mr Cornford's employment contract gave rise to no breach of the prohibition in Clause 6 (B) of the October 1998 agreement. The judge said this:

"It is correct that there is a contrast in clause 6 (B) between the wording of the first part of the clause and the proviso. The 'issue' of shares, and 'option' and 'right' to acquire shares are expressly mentioned in the first part, whereas only 'issue' is mentioned in the proviso. The literal wording of clause 6 supports Mr Warwick's submission. However clause 6 (B) must if possible be given a commercially sensible construction. Mr Warwick [counsel for City Alliance] was unable to identify any commercial reason why the parties to the Agreement should have agreed to permit the issue of shares for a minimum price, but prohibited an agreement for the issue of shares at the same price. The reason cannot be anything to do with timing, since the proviso permits the issue of new shares at the permitted price 'at any time'."

12. In effect, therefore, the judge satisfied himself that what he described as the literal construction of the proviso was inconsistent with any sensible commercial objective or purpose. He thought that that was sufficient licence for him to read into the proviso words which, plainly, are not there. He did not, in his judgment, go on to identify what words would be necessary to achieve a result under which the proviso covered the grant of an option. But he must have thought it necessary to introduce after the words "may at any time issue" some words such as "or grant an option or right to have issued". That indicates the violence which has to be done to the words actually used in order to reach the result at which the judge arrived.
13. In my view, the judge fell into error in principle. It is not for party who relies upon the words actually used to establish that those words effect a sensible commercial purpose. It should be assumed, as a starting point, that the parties understood the purpose which was effected by the words they used; and that they used those words because, to them, that was a sensible commercial purpose. Before the Court can introduce words which the parties have not used, it is necessary to be satisfied (i) that the words actually used produce a result which is so commercially nonsensical that the parties could not have intended it, and (ii) that they did intend some other commercial purpose which can be identified with confidence. If, and only if, those two conditions are satisfied, is it open to the court to introduce words which the parties have not used in order to construe the agreement. It is then permissible to do so because, if those conditions are satisfied, the additional words give to the agreement or clause the meaning which the parties must have intended.
14. In the present case neither of those two conditions are satisfied.
15. It is impossible to hold that the words which the parties did use effect a result which is not commercially sensible. The feature of fixed price option is that it is unlikely to be exercised unless, at the time when it is exercised, the value of the shares which are to be acquired is more than the price which has to be paid for them. That is why share options provide an incentive to employees. There is little (if any) incentive to an employee who is entitled to purchase for £3.6m shares which at the time of purchase are worth less than £3.6m. The incentive is provided by the right to exercise the option at a time when the shares are worth more than the amount to be paid. So, if the company binds itself by way of an option to issue shares at a fixed price in the future, it is likely that, at the time when upon the exercise of the option those shares come to be issued at the fixed option price they will be issued at a price which is less than the price at which they would have been issued if the option had not been in place; that is to say, at a price which is less than the true value of the shares measured by reference to the then financial position of the company. Having that in mind, an investor in the position of City Alliance is likely to wish to restrict the ability of the company in which it is investing to bind itself to issue shares pursuant to a fixed price option exercisable at some date in the future. The particular option in Mr Cornford's employment contract is limited to the exercise before March 2002. But an option could have a life extending over 21 years. There is no reason at all why the parties should not have had those considerations in mind when they came to agree the terms of Clause 6 (B).
16. It is important, also, to bear in mind that the terms of the proviso do not permit the directors of ATS to act in breach of their duty as such. The fact that the proviso allows shares to be issued at a price of not less £100,000 per share does not mean that the directors can issue shares at that price if, having regard to the financial position of the company at the time of issue, £100,000 per share would be an undervalue for the share. What the proviso does is to prevent the directors of ATS from issuing shares at less than £100,000 a share notwithstanding that it would otherwise be open to them to do so consistently with their duties as directors. If it would not otherwise be open to them to issue shares at a price of £100,000 per share then there is nothing in the proviso which permits them to do so.
17. As it seems to me, the bargain which, on the construction of the words actually used, the parties may be take to have intended, is a sensible commercial bargain. They envisaged that there should be a general prohibition against the issue of shares or the grant of options; but that that prohibition should be subject to an exception or proviso in the case in which shares were actually being issued at a price of not less than £100,000 a share. In such a case ATS could issue further shares at a price which reflected the value of the company at that time. The parties did not think it appropriate to agree an exception in relation to share options; and there was, for the reasons I have sought to explain, a good reason why they should choose not to do. It is not for the Court to make for the parties a bargain which they did not make forthemselves. In this case they made a bargain which can be seen to be a sensible bargain. The Court is not entitled to impose on them some other bargain, which they did not make, on the grounds that that is thought to be a more sensible bargain. That goes well beyond the role of the court in construing documents.
18. For those reasons I am satisfied that the judge was wrong to reach
19. the conclusion which he did reach as to the true meaning and effect of Clause 6 (B).
20. The position, therefore, is that there was a breach of the agreement of 20th October 1998 when Mr Cornford entered into his employment contract. It is said, however, that that breach caused no damage to City Alliance; so that there is no cross-claim which can be set against the liability to pay the £90,000, which had accrued before the agreement was determined; or (in so far as material) to pay the £30,000 which had accrued before the date on which Mr Cornford's agreement was executed. That was not a point which the judge addressed in his judgment. It appears to have been accepted before him that, if there could be a cross-claim arising out of the breach of Clause 6 (B), then the proceedings before him would not be appropriate proceedings in which to attempt to quantify that cross-claim. That was a matter which needed to go to trial. Indeed, that is reflected in the passage from the judgment which I have read earlier.
21. In my view, it is plain that there is, conceptually at least, a cross-claim for damages.
22. Mr Cornford's option, if exercisable, would have had the effect of devaluing both the existing shares held by City Alliance and the right to acquire further shares to which, it is said, City Alliance is entitled under an option of its own. The extent of that devaluation will depend upon, amongst other things, the current value of ATS and the option price at which City Alliance are entitled to acquire additional shares. Those matters are not in evidence; but it is impossible, in my view, to hold that the cross-claim cannot exceed £90,000. That depends upon what the figures turn out to be. That is a question into which it is not appropriate to go on contested material on an application to restrain the presentation of a winding-up petition. Insofar as the judge did not reach the point, I think that it should be made clear that - if there were a breach of Clause 6 (B), as I think there was - then this a case in which an injunction to restrain presentation of the petition ought to be granted. The point shoudl be fought out in the Chancery proceedings.
23. For those reasons I allow this appeal.
24. LORD JUSTICE LATHAM: I agree.
25. THE VICE CHANCELLOR: I also agree.
Order: Appeal allowed