England and Wales Court of Appeal (Civil Division) Decisions

IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)

		Royal Courts of Justice Strand, London, WC2A 2LL Monday 30th July 2001

LORD JUSTICE JUDGE:

1. On 14 September 2000 Lord Brennan QC, sitting as a Deputy Judge of the Queen's Bench Division, entered summary judgment for £1,631,000 (inclusive of interest) in favour of the claimants, Fortman Holdings Limited (Fortman) against the defendants, Modem Holdings Limited (Modem). Both parties appeal. The claimants contend that this judgment was too low, the defendants that it was excessive and should be reduced to a sum in the region of £600,000, plus interest.
2. This dispute arose out of the sale by Fortman to Modem of the entire share capital of Tele Links Holdings Limited. The sale agreement itself was dated 10 February 1999. The price was £30 million. £20 million was payable immediately and was paid. It plays no further part in the litigation. Although Modem were entitled to immediate enjoyment of the benefits of the contract, payment of the final £10 million was deferred, and due to be paid in four subsequent instalments. The sale agreement, and the payment of these instalments, was supported by a certified and enforceable issue of unsecured loan notes by Modem on 15 February 1999 in the principal sum of £10 million.
3. Clause 2 of the Loan Note Certificate provided:

"The Company (that is Modem) shall repay to the registered holder of the Note ….. and redeem this Note by way of banker's draft in the amounts and on the Redemption Dates set out below……."

The relevant redemption dates and amounts to be paid and redeemed were then specified. On 30 April 2000, £1 million was payable, on 30 April 2001, £2 million was payable, on 30 April 2002, a further £3 million was payable, and on 30 April 2003, the final instalment of £4 million was due.

4. Clause 8 provides that "Notwithstanding any other provision of this Note the Company shall be entitled to set-off against an amount due for payment or repayment hereunder any amount due to the Company under any provision of the Agreement …… so that to the extent of any such set-off an amount shall be treated as paid or repaid hereunder". This clause was inextricably linked with the original sale agreement, to which I shall return later in the judgment.
5. Clause 4 of the Loan Note Certificate is critical. It provides:

"Notwithstanding any other provisions of this Note the Principal Sum shall become immediately repayable in any of the following events:

……

4.5 The Company being in material or persistent breach of any obligation under these Notes and failing to remedy the same within fourteen days of it becoming aware of such breach; or

4.6 The Company stopping payment of its debts or being unable to pay its debts within the meaning of English Insolvency Acts….."

6. This provision generally was directed to provide a degree of protection for Fortman against the development of financial problems in Modem likely to diminish Fortman's prospects of receiving the payments under the instalment agreement. Although condition 4.6 was referred to in the claimant's skeleton argument, Mr Peter Smith QC did not pursue it in his oral submissions, rightly because this contention had no realistic prospect of success. There was no evidence to support it. The essential argument deployed by Mr Smith in his oral submissions was that £10 million (the principal sum) had become immediately repayable when the first instalment of £1 million (due to be repaid on 30 April) was not paid. This was a material and persistent breach of Modem's obligations. The Company was aware of the breach from 2 May 2000 onwards. The breach was not remedied within fourteen days.
7. The relevant facts can be taken briefly. The agreement was completed on 10 February 1999. £20 million was paid. The first instalment was therefore due some fifteen months later. Throughout this period Fortman heard nothing to suggest complaints or problems. When its solicitor, Phil Turner, pointed out that 30 April 2000 fell on a Sunday, and that 1 May was a Bank Holiday, it was mutually agreed between him, and Mr Porter, of the defendant's solicitors, that payment under the agreement could be made on 2 May.
8. On 28 April 2000 Mr Turner wrote to confirm the amount of interest due under the Loan Note up to 30 April 2000. He said expressly "we will treat payment on Tuesday 2 May 2000 as payment in accordance with the Loan Note. Please let me know if you need our client account details – I can arrange for those to be faxed over to you direct". He went on to deal with the mechanism for redemption, and in particular whether the requirement for "presentation" might sensibly be modified.
9. By fax of the same date Mr Porter responded:

"I have forwarded the interest calculation to my clients and thankyou for allowing payment to be made next week. Please send me your client account details."

He went on to agree the modified arrangements for delivery of the Loan Note certificate.

10. 2 May came and went without payment. The next communication was a letter dated 4 May from Mr Porter. The entire letter requires quotation, not because of what it says, but because of what is omitted. There is no suggestion of any claim against Fortman by Modem, nor any set-off, nor any contention that the instalment due was not payable, nor any reference to clause 8 and the remedy provided for Modem by that provision. It reads:

"Page 163"

I refer to my discussions with your colleague Phil Turner last week.

Our client has received funds in the UK to meet the loan note redemption but is holding the funds pending the clarification of certain issues to ensure that there is no claim in relation to the building contract with Waterfields.

In particular, our client is currently trying to settle the final account with Waterfields and during April it has emerged that the final contract sum demanded is substantially more than our client expected compared to the figures given by your client at the time of the acquisition. Waterfields have suggested that the increased sums are due to instructions given by your client prior to acquisition: this suggestion may of course have no foundation and our clients are trying to ascertain the position which may need your client's co-operation.

I am sure you will understand that the Waterfields position needs verifying (which we and our clients are trying to do as a matter of some urgency) and until this has been done our client will hold the funds with interest accruing from the agreed payment date of 2 may 2000.

I will let you have further information once I have it.

11. By 16 May, that is at the end of the period of grace allowed by condition 4.5, nothing more had been heard from Modem or its solicitors. Without further notice, on 22 May, on the basis of non-payment of the instalment due on 2 May, proceedings were taken to secure the full £10 million.
12. The judge below found that there was a default in payment of £1 million due on 2 May. There was no payment on that date, or afterwards. He examined the allegations by Modem that Fortman were themselves in breach of warranty under the sale agreement in relation to three specific areas and accordingly entitled to the protection provided by clause 8 of the Loan Note Agreement and clause 3.2 of the sale agreement. The areas of dispute need no recitation in this judgment.
13. These clauses, so it was argued, enabled Modem to set-off all bona fide claims arising under the warranties made by the vendors against the unpaid £10 million. Clause 3.2 provided:

"The Purchaser shall have the right …. to set off against monies payable under the Loan Notes as provided therein all bona fide claims under the Warranties or any other claim under this agreement and to the extent of any such set off the respective amount shall be treated first as a reduction in the amount secured by the Loan Notes, affected by redemption, cancellation or variation of the same and thereafter as a reduction in the consideration for the Sale Shares ……"

Clause 5 precluded any limitations of liability against the consequences of fraud, dishonesty or deliberate concealment by Fortman, but subject to the express terms of clause 5.1, clause 5.2 applied schedule 6. Schedule 6 limited the liability of Fortman. Dealing with the matter generally, limits were imposed on the amount of any possible claims, both in relation to individual claims, and in aggregate. Clause 1.2(c)(i) imposed a time limitation. No claim was to be brought, and all liability was to cease, unless notice in writing, specifying the nature of the breach, was given "not later than the second anniversary of Completion", and any such claim, unless otherwise settled or withdrawn or satisfied, was deemed to have been withdrawn unless within six months of written notice, proceedings were started. A further time limitation was produced by clause 1.2(c)(ii) in relation to taxation liabilities. These details are unimportant. Clause 1.2(i) and (l) prescribed the arrangements which would apply to claims against Fortman or the Group Company which might create a liability in Fortman to Modem under the sale agreement. In particular clause 1.2(l) exempted Fortman from liability "to make any payment pursuant to the Undertakings unless and until the relevant Group Company has or would but for the availability of some other relief become liable to make payment under the claim in question which date shall be deemed to be the last date on which the relevant Group Company is …… able to make such payment …."

14. Ignoring, as clause 12.8 requires, the words "Warrantors' Protection" at the heading of Schedule 6, it is clear from the terms of condition 5 and Schedule 6, taken together, that the effect is to provide a degree of protection for Fortman against claims which might otherwise be thought to reduce its entitlement to payment of the instalments as when and they fell due. The judge below concluded:

"In my view whilst clause 3.2 enables the purchaser to claim set off in respect of all bona fide claims, that general entitlement is subject to the particular provisions of Schedule 6 in particular, subject to the contractual requirements that there be no set-off of a claim until the claim or claims made have crystallised in the sense set out in clause 1.2(l). So …. The contract provided by 2 May 2000 the defendants must make first payment of £1 million with interest. Schedule 6, under clause 1.2(l) makes it plain that any rights claimed to be exercised under 3.2 in relation to the set-off could not be pursued as of that date unless as of that date the defendants had become liable through the Group Company to make payment….. There is no evidence to indicate that as of 2nd May they had become so liable in respect of any of the three matters alleged to represent a breach of warranty. Indeed, prior to 2nd May 2000 no notice whatever of any breach of warranty was alleged by the defendants against the claimants, certainly not in the context of a crystallised liability… It has been alleged that well over £1 million can be claimed by way of set-off. It is for the defendants to pursue what they think to be their rights in that regard. Therefore, it may be appropriate, should they be so advised, to make a claim for set-off of any sum so due, to be set-off against the amount of payment due on 30th April 2001. I therefore conclude that the defendants' position as to set-off …. ought not to be prejudiced by the decision I have made about liability for the sum due from 2nd May last."

15. The judge's conclusion is criticised in the cross appeal. Mr Christopher Moger QC suggested that clause 3.2 of the sale agreement provided his clients with a clear defence against liability for non-payment of the instalment due on 2 May 2000. In effect the set-off envisaged in clause 8 of the Loan Note Agreement did not depend on a breach of contract by Fortman of which notice had been given by Modem and which had crystallised. It was enough if a set-off had accrued or was available, even if it did not crystallise into an "amount due to the Company". The difficulty with this argument is identified, correctly in my view, by the judge below. Clause 8 of the Loan Note Agreement read with clause 3.2 and Schedule 6 of the sale agreement provides a series of pre conditions to any reduction of payments due under the instalments. The distinction sought to be drawn by Mr Moger between a set-off and a claim, and the potentially different consequences of each in the context of Fortman's entitlement to payment of the instalments in full, when due, is not borne out by the language used in the express terms which bear on this issue. For clause 8 to bite an amount arising under the sale agreement must be due to Modem on the date fixed for payment of the instalment, and for the entire liability under the instalment to be extinguished, the sum due to Modem should have exceeded the instalment due. As at 2 May 2000, nothing was due to Modem under the agreement, and no claim or set-off was asserted then, or indeed by 22 May. Accordingly the full £1 million instalment was payable on that date without deduction. Whether, as indeed is now contended by Modem, there would be an entitlement to any reduction as against the instalment due on 30 April 2001 is a separate question.
16. I should add that I find nothing daunting about this conclusion. The starting point is a deferred liability to pay the balance of an agreed purchase price. It is hardly surprising that any permissible reduction in these sums under the contract should be subject to stringent preconditions. In my judgment the cross appeal must be dismissed.
17. Accordingly we are left with the judge's conclusion that Modem were liable to Fortman for the sum of £1 million due on 2 May 2000, together with interest, for which summary judgment was entered. Nevertheless he rejected the claim for payment of the full principal sum.
18. He held that the failure to pay on 2 May 2000 was not a "material" breach of obligation. In particular it related to 1/10^th only of the total sum still due, £1 million out of £10 million. Moreover the reason for non payment was Modem's belief that they enjoyed a bona fide right of set-off. He also rejected the suggestion that Modem had been in "persistent" breach of obligation. What this phrase was intended to cover was the situation in which Modem deliberately and without reasonable excuse ignored requests for payment. That would not be an accurate description of their behaviour. Finally he held that conditions 4.5 and 4.6 (and for this purpose I shall ignore 4.6) were apt to cover deliberate action by Modem to frustrate its contractual obligations to pay under the Loan Notes.
19. The complicating feature of clause 4 of the Loan Note Certificate is the absence of any provision that in default of payment of any individual instalment the principal sum shall automatically become payable in full. On the other hand there is no general option to postpone payment of any instalment. Some limited room for manoeuvre is permitted, and the major issue for decision is its extent. What is clear is that if Modem were unaware of the breach alleged, even if it was material or persistent, the principal sum did not immediately become repayable. And although non-payment is a plain breach of the express obligation in clause 2 to repay the agreed amounts on due dates, the contract itself does not directly assert whether of itself that constitutes a "material" or "persistent" breach of obligation.
20. Mr Moger submitted that in the sense of materiality to the risk envisaged in clause 4, which was throughout concerned with the risk of non-payment, this non-payment was immaterial. He accepted that an unexplained failure to pay might be material, but suggested that a sufficient explanation had been provided in the letter dated 4 May, which also provided a sufficient undertaking that funds were available. Accordingly the risk of non-payment was minimal. In any event the non-payment represented 10% of the total due to Fortman, and on that ground, too, was immaterial.
21. In my judgment this argument did not focus sufficiently on the commercial context. This was an unsecured instalment agreement to repay an agreed debt. The payment of each instalment represented a separate obligation, and the non-payment on 2 May 2000 represented total non-compliance with that obligation. While acknowledging the serious consequence of the breach – from Modem's view – that an immediate liability to pay 10% of the balance still unpaid would be triggered into a liability to pay the whole of it, the significance of the breach to Fortman was undeniable. It was non-payment of the whole of an agreed instalment, at a time when Modem enjoyed an unrestricted right to the benefits of the sale agreement, without any contemporaneous purported justification which fell within the terms in the contract which permitted postponement or reduction of payment. In my judgment, for the purposes of clause 4.5 of this agreement, the breach was material.
22. Mr Smith further submitted that the breach was "persistent". For this purpose he sought to derive support from the fact that non-payment continued after 22 May when proceedings were started. It is unnecessary to recite the narrative of events subsequent to that date. In my judgment the date for deciding whether the breach relied on by Fortman was "persistent" was not later than the date when proceedings were issued. If the cause of action to recover the principal sum on the basis of "persistent" breach had not accrued on the date when proceedings began, relief would not be obtainable in this litigation on the basis that Fortman could establish a cause of action on this basis which accrued afterwards. In the context of clause 4.5, read as a whole, the reference to a "persistent" breach, rather than a "continuing" one, as well as the provision enabling a "persistent" breach to be remedied, suggest that the single failure to pay the instalment when it was due should not, in the absence of requests for payment, of which there were none, be treated as "persistent" for the purposes of clause 4.5. It is unnecessary to express a final view. Fortman have succeeded in establishing a "material" breach.
23. There was some interesting analysis by both counsel of the effect of the language in the second half of clause 4.5. It plainly introduces a subjective element. Modem's liability to pay the entire principal sum was not established by a material breach of the contractual obligation. It was an additional requirement that Modem should be aware of the breach, which may be remedied within 14 days of Modem becoming aware of it.
24. Mr Moger submitted that Modem obviously believed that there was a defence to or justification for non-payment on 2 May 2000. If so the letter dated 4 May was singularly unspecific, but in summary proceedings it would perhaps be inappropriate to form an adverse conclusion. From this foundation Mr Moger suggested that clause 4 did not bite if and while it was believed by Modem that the terms of the contract entitled them to withhold payment on the basis of set-off and Fortman's breach of warranty.
25. Mr Smith highlighted the omissions from the letter dated 4 May, and submitted that if adopted Mr Moger's approach would have the somewhat novel effect that Modem's erroneous analysis of its own contractual liabilities and entitlement nevertheless enabled it to escape the consequences of its own breach of contract. He argued that even if the honesty of Modem's belief could not be impugned in summary proceedings, the belief did not avail it. The question was whether it was aware of the breach of obligation, that is the obligation to pay the instalment when it was due.
26. The conclusion that the decision not to pay the instalment due on 2 May was deliberate rather than inadvertent is inevitable. By that date there had been an appropriate reminder on Fortman's behalf. Funds were available. There was no error in transmission, or accidental drawing up of inadequate paperwork to complete the appropriate transfer of funds. In that sense Modem were plainly "aware" of the breach. For the reasons given, whatever Modem's view may have been, it was a material breach. The effect of Mr Moger's submission, carried to its logical conclusion, was that Modem should escape liability under clause 4.5 because it did not believe that its own deliberate decision to withhold payment amounted or would amount to a material breach of obligation. In the commercial context of this case it would be an unusual contractual provision that enabled one party to an agreement to escape liability because of a subjective belief that conduct which in fact constituted a breach of contract, was not believed by the party in breach to do so. As Mr Smith pointed out, on that basis Modem could continue to withhold payment even if the issue whether it was entitled to do so was decided adversely in court. It might continue honestly to believe that the court was wrong. Clause 4.5 makes no such provision. It does not suggest or imply that Modem was permitted to postpone or reduce payment an instalment when due on the basis of an erroneous belief that there was or might be a reasonable justification for doing so, when for the purposes of this contract, there was none.
27. In my judgment this appeal by Fortman should be allowed. Fortman is entitled to repayment of the principal sum.

PILL LJ:

28. I agree that the appeal should be allowed and the cross-appeal dismissed.
29. I agree with the judge's findings on the clauses the subject of the cross-appeal but accept for present purposes that the judge considered Modem to be in good faith in the arguments they put forward on those clauses. Because we are disagreeing with the judge on the appeal, I add some words of my own.
30. The appeal turns on the construction and application to the facts of Clause 4.5 of the conditions to the loan note certificate dated 15 February 1999. The certificate provides that Fortman is the registered holder of the "principal sum" of the notes "which are issued with the benefit and subject to the conditions annexed". Clause 4 provides that notwithstanding any other provision of the note the principal sum shall become immediately repayable "in any of the following events". The event set out in Clause 4.5 is:

"The Company [Modem] being in material or persistent breach of any obligations under these Notes and failing to remedy the same within 14 days of it becoming aware of such breach."

31. By virtue of the note, Modem was obliged to pay the sum of £1 million on 30 April 2000, a date varied by agreement to 2 May. That the sum was due on 2 May is acknowledged (subject to possible defences which on the judge's findings on the cross-appeal do not exist) in Modem's solicitor's letter of 4 May 2000.
32. I agree with Judge LJ's analysis of the commercial context of the agreement and that the failure to pay on 2 May was a "material" breach of obligation. The judge's construction of the clause was that it refers to "deliberate action by the purchaser [Modem] designed to frustrate its obligation to the claimants to pay under the loan notes". Mr Moger QC seeks to uphold that finding, submitting that the words "becoming aware of such breach" mean that there is no breach of the obligation to pay while Modem genuinely, albeit wrongly, believes that the obligation has not arisen.
33. I am unable to accept that submission. The presence of the words "becoming aware" does not confer on Modem a contractual right not to pay while there exists a genuine belief in the availability of a defence arising from the terms of the sale and performance agreement. It does no more than protect the company against a lack of awareness that the sum due has not been paid. Modem was plainly aware on 4 May that the sum of £1 million had not been paid on 2 May. If Modem failed to pay within fourteen days of having such knowledge the principal sum became repayable immediately.
34. The wording of Clause 4.5, and its departure from that of a conventional acceleration clause, is in some respects curious. Construed objectively and in the commercial context, however, the wording relied on by Modem was in my judgment intended only to protect the company against trivial breaches (unless persistent) or breaches of which, by failures in the post or in banking procedures, for example, they were unaware. I am far from persuaded that the wording confers on Modem protection against a breach of contract provided only that there is a genuine belief there is no breach.
35. For those reasons, and the reasons given by Judge LJ, I would allow the appeal,

RIMER J:

I agree with both judgments.

ORDER: Appeal allowed; costs below subject to detailed assessment, respondent to pay appellant's costs of appeal and cross-appeal; interim detailed assessment of £27,000. (Order does not form part of approved Judgment)