England and Wales Court of Appeal (Civil Division) Decisions

IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM QUEEN’S BENCH DIVISION
MANCHESTER DISTRICT REGISTRY
MERCANTILE LIST
His Honour Judge Kershaw QC

		Royal Courts of Justice Strand, London, WC2A 2LL
		8 November 2002

Lord Justice Rix :

1. This appeal concerns a claim for breach of a profit before tax ("PBT") warranty. The warranty was given by the appellant, Mr Kevin Devine, under a share sale agreement (the "SSA") relating to BIT Holdings Limited ("BIT") made between him as vendor and the respondent, Torex Group plc ("Torex"), as purchaser. The accounting year for which BIT’s profits were warranted was the year ending 31 December 1996, which I will refer to as the 1996 year. The SSA was made on 26 November 1996 and was completed on 8 January 1997. On 13 January 1997 Housing Units Limited ("Housing"), a customer of one of BIT’s subsidiary companies (BIT Group Limited, but it will suffice if I refer to it also as "BIT"), cancelled its contract with BIT and claimed damages for repudiation. That claim came "out of the blue", as was common ground. In due course, BIT’s new owner, Torex, encouraged it to make provisions totalling £150,000 in respect of Housing’s claim for the purposes of its 1996 accounts. Those provisions reduced BIT’s profit before tax for 1996 by the like amount causing, as Torex alleged, an equal shortfall for the purposes of Mr Devine’s PBT warranty. BIT’s 1996 accounts were signed off on 24 October 1997.
2. At about the same time Mr Devine and Torex entered upon this litigation: Mr Devine sued for deferred consideration under the SSA in the sum of £750,000, and Torex set off and counterclaimed various sums in debt and/or damages pursuant to a number of the SSA warranties, among them the PBT warranty. There were numerous individual items which entered into Torex’s counterclaim, and those items were variously made the subject of claims under the heading of several warranties: what concerns this court, however, is the item arising out of Housing’s claim against BIT, BIT’s provision against that claim for the purposes of its 1996 accounts in the sum of £150,000, and Torex’s case against Mr Devine to found on one or other of those matters an element (among others) in its overall claim under the PBT warranty. Thus in its amended defence and counterclaim dated January 1998 Torex referred to BIT’s 1996 overall loss, as shown in its 1996 accounts, in the sum of £1,229,227, but went on to plead that the outstanding claim from Housing "may exceed the provision in the 1996 accounts".
3. There was parallel litigation between BIT and Housing in which BIT claimed £22,654 in debt for services supplied under its contract, and Housing counterclaimed damages, particularised under its 10 October 1997 pleading in the total of some £257,000. On 14 August 1998 BIT allowed its claim to be struck out and judgment to be given against it on Housing’s counterclaim in default of compliance with an unless order for further discovery. There remained an enquiry into damages. On 30 September 1998 BIT paid £100,000, and on 28 April 1999 a further £75,000, into court. Ultimately, on 2 December 1999 judgment was given against BIT, following a substantial trial on quantum in the Technology and Construction Court, in the sum of £395,902.20, plus interest and costs. That judgment (the "TCC judgment") was handed down during the trial between Mr Devine and Torex, at a time after the close of evidence and before the filing of closing written submissions.
4. The essential issue on this appeal is whether BIT’s 1996 accounts provision in the sum of £150,000 and/or BIT’s ultimate liability to Housing under the TCC judgment count against BIT’s profits for 1996 for the purpose of the PBT warranty; or whether, as Mr Devine submits, he has a complete defence under the "Vendor Protection" provisions contained in Schedule 7 of the SSA. To explain that issue it is necessary first to cite from the provisions of the SSA.

The SSA

5. The PBT warranty is contained in clause 8.1.11:

"8.1 Subject to the matters set out in the Disclosure Letter which it is agreed limit the Warranties the Vendor warrants to the Purchaser that:

…

8.1.11 The Company will achieve in the financial year ending the 31^st December 1996 Profits before Tax ("PBT") of at least £120,000-00. For the purpose of this sub-clause PBT shall mean profit assessed in the same manner as in the Principal Accounts entitled "Profit on Ordinary Activities before Taxation" to which there shall be added such profit attributable to Members of the Company. Notwithstanding any other provision in this agreement if the Purchaser establishes after Completion that the PBT was on Completion less than the said figure the Vendor shall on demand reimburse the Purchaser the deficit on a pound for pound basis"

6. The reference to the "Principal Accounts" in clause 8.1.11 was in effect to BIT’s 1995 statutory accounts, defined in clause 1.1 of the SSA as "the audited balance sheet as at the Last Accounts Date and audited profit and loss account for the year ended on the Last Accounts Date…and the audited consolidated profit and loss account for that year and the directors’ report and notes".
7. Schedule 3 of the SSA (headed "Warranties") contained further provisions relating to the Principal Accounts. Clause 1.1.2 of Schedule 3 provided inter alia warranties as follows:

"1.1.2 The Principal Accounts:

(a) give a true and fair view of…profits for the financial period ended on that date;

(b) Comply with the requirements of the Companies Acts and other relevant statutes;

(c) Comply with all FRSs [Financial Reporting Standards] applicable to a United Kingdom Company;…

(g) make proper provision or reserve for all known liabilities and capital commitments of each Group Company outstanding at the Last Accounts Date including known contingent known unquantified or known disputed liabilities…"

8. Schedule 7 was headed "Vendor’s Protection Provisions" and provided as follows:

"(1) The liability of the Vendor…in relation to the Warranties shall cease on a date being 18 months after Completion…save as regards any alleged specific breach of which notice in writing (containing details of the event or circumstance giving rise to the breach the basis upon which the Purchaser is making a claim against the Vendors and the total amount of the liability results) has been given to the Vendor prior to such dates…

(5) The Purchaser shall not have any Warranty Claim if and to the extent that the subject matter of the claim is fully and fairly disclosed in the Disclosure Letter

(6) The Vendor shall not be liable for any claim under any Warranty:-

(a) unless he has received written notice from the Purchaser giving reasonable details of the claim including details of the amount involved on or before the expiration of the agreed eighteen months from the date of Completion…and proceedings in respect of any such claim are issued and served on the Vendor no later than twelve months from the date of such notice;

(b) to the extent that:-

(i) an express and specific allowance provision or reserve in respect of any liability the subject of such claim was made or taken into account or payment or discharge of which was taken into account in preparing the Principal Accounts;…

(ii) any liability included in the Principal Accounts has been discharged or satisfied below the amount attributed to it or included in respect of it in such accounts;

(x) the liabilities under it are contingent future or unascertainable in which case the Vendor shall not be liable to recompense the Purchaser until such time as the Purchaser shall actually have suffered loss or incurred the liability in question provided that this provision shall not operate to avoid a claim in respect of any such liability made before the expiry of the relevant period specified in paragraph 1 if full details of such claim have been delivered before the expiry of such period and in the case of such a claim based upon a contingent liability the 18 month period referred to in paragraph 1 will start on the date upon which such liability becomes an actual liability…

(9) Conduct of Claims

…

(b) The Purchaser shall procure that the conduct negotiation settlement or litigation of the claim by or against such third party is so far as is reasonably practicable carried out in accordance with the wishes of the Vendor and at his cost subject to his giving timely instructions to the Purchaser and providing reasonable security for any costs and expenses which might be incurred by the Purchaser…"

The issues below

9. By reference to these provisions of the SSA the following issues were debated in the trial court. Was the liability to Housing properly referable to 1996 at all, or was it merely a contingent, future or unascertainable liability within the meaning of Schedule 7’s clause (6)(b)(x) for which there could be no liability until Torex had actually suffered a loss? What was meant by the PBT warranty’s reference to a 1996 profit assessed "in the same manner" as in the 1995 accounts? In that connection, how had disputed liabilities been dealt with in the 1995 accounts? Was it proper to utilise a degree of hindsight down to the date when the 1996 accounts were drawn up, for the purpose of deciding whether a provision could properly be made against the 1996 profit and loss account in respect of Housing’s claim? Had the £150,000 provision been properly made? Had Housing’s claim in any event been disclosed to Torex in the SSA’s disclosure letter, and if it had, did that mean that it could give rise to no warranty claim in any event, because of the opening words of clause 8.1 and Schedule 7’s clause (5)? And what of the effect of the "claim control" exclusion contained in Schedule 7’s clause 9(b) – had Mr Devine been properly consulted on Housing’s litigation?

Expert evidence

10. The parties presented expert accountancy evidence in connection with at least some of these issues. Mr Devine called Mr Fendall and Torex called Mr Dexter. The judge said:

"Of the two, Mr Fendall was infinitely the more impressive. The fact that Mr Dexter’s firm was [Torex’s] auditor made him less than an ideal choice as an expert witness, but was not in itself the cause of my lack of confidence in his evidence, rather, I found him to be partisan."

11. Mr Fendall’s evidence was to the following effect. In drawing up any accounts, an element of hindsight, during the period in which those accounts are prepared, is permitted for the purpose at any rate of deciding what, if any, provisions are to be made for bad debts and/or claims. In the case of management accounts, a period of 14 days after the month end had previously been adopted by BIT. This made sense in the context of a completion date of 8 January 1997. In the case of the 1995 audited accounts, however, a period down to October 1996 had occurred until they were signed off. That was comparable to the signing off of the 1996 accounts on 24 October 1997. It was for the court to state what the relevant period was.
12. As for the concept of "the same manner" assessment within clause 8.1.11, there had been no precedent of BIT making provisions against claims during any hindsight period, or indeed at all. Such a policy, however, if it was properly to be described as such, would be "potentially inconsistent with UK Generally Accepted Accounting Practice (GAAP)" if a hindsight period extended to cover the period in which a claim was made, depending on whether the claim could be reliably quantified. Thus GAAP would require a provision to be made where there is –

"(i) a present obligation as a result of a past event;

(ii) it is probable that a transfer of economic benefits will be required to settle the obligation; and,

(iii) a reliable estimate can be made of the amount of the obligation."

13. Mr Fendall continued:

"Whilst this accounting treatment was codified in Financial Reporting standard 12 – Provisions, Contingent Liabilities and Contingent assets (FRS12), which was issued after the accounts were issued, it was considered to be best practice at the date the 1996 accounts were signed off."

If, however, it was not possible to estimate the likely outcome of a claim, then it was merely necessary to note the matter as a "contingent liability". Essentially the same approach was to be taken to the question of provision for bad debts. The question there was whether a relevant book debt was to be regarded as irrecoverable. BIT’s policy in the past had been simply to ask that question as of the year end in question. That again would be "potentially inconsistent" with GAAP if a hindsight period was to be applied. In this connection the £150,000 provision reflected in the 1996 accounts’ overall striking of profit and loss represented a writing off of Housing’s book debt of £17,370 and a provision against liability on Housing’s claim in the sum of £132,630.

The judgments below

14. The trial below, which was conducted by HH Judge Kershaw QC in the mercantile court of the Manchester district registry, was on liability only so far as the Housing claim was concerned. There are two judgments. The first, which was given on 28 July 2000, merely said this about the Housing claim and the provision of £150,000:

"While disclosure was given, the liability was clearly a 1996 liability and if proper provision had been made it would have reduced the profit. The real difficulty lies in the amount. On the balance of probabilities I think that [Torex’s] case that [Mr Devine] would not have achieved a better result to the litigation is sound.

"If provision had been made in the 1996 accounts in the late summer of 1997 it would, as events have turned out, have been inadequate and it would have been necessary to reopen the accounts after judgment was given in the TCC."

15. The judge also held that for the purposes of the "same manner" point he preferred the submissions for Mr Devine to the effect that what mattered was how the 1995 accounts had been drawn up, not whether they had been correctly prepared. He said:

"In my judgment the words in 8.1.11 mean that profit was to be determined for the year in question in the same way, in every respect, as in the preceding year irrespective of whether there was anything improper or unlawful in the way in which the accounts for the preceding year had been prepared."

16. It is not clear, however, that anything turned on this view as a matter of fact, because the judge plainly considered that BIT had been free to make the provision which it did in respect of a claim which had only been notified by Housing on 13 January 1997, ie after the 1996 year end.
17. The parties sought clarification of this first judgment, and that led to a further hearing and a second judgment, which was made available to the parties in July 2001. So far as concerned the Housing claim and its effect on Torex’s PBT warranty claim the judge said this:

"I have held this was a 1996 liability. By that I mean that when the accounts for the year to 31 December 1996 were prepared there was a known liability, though its amount was not known…This was not a case of whether a liability should be attributed to the accounting period in which acts or omissions giving rise to it occurred; nor can it be said that the liability was contingent or possible. In other words, ‘same manner’ accounts would have treated Housing Units as a liability, though the liability could not have been stated exactly and in the event might well have been under-estimated. In that event it would presumably have been necessary either later to re-open the 1996 accounts (if and in so far as allowable, particularly in relation to tax) or to provide in some other way for the excess of the actual amount of the liability over the figure used in the 1996 accounts. At the trial on amount the court can and will decide on what is relevant to the profits warranty by reason of the Housing Units claim, including whether the accounts can be re-opened in the light of the decision of the TCC on the amount of the Housing Units claim; if so, whether any such re-opening of the accounts in the light of the decision on amount in the TCC affects the claim against Mr Devine (a) because the claim against him is for breach of a contractual warranty and (b) in the light of Schedule 7(1) and (6)(a) of the contract; and whether any other factors are relevant, such as that Torex allowed judgment to be entered against it in default whereas if Mr Devine had been in control of the litigation the outcome might have been different – the Allied Maples point."

18. Counsel before this court have not found it easy to extract a clear statement of the issues which these judgments were addressing, nor of the reasoning for their conclusions. Thus in the first judgment it is said that "disclosure was given", which might lead one to think that the vendor’s protection for matters set out in the disclosure letter would operate, but elsewhere the judge had said that he agreed with Torex’s submission that "it is difficult to see how disclosure in the Disclosure Letter could ever affect the profit warranty". As for a hindsight period, he does not state expressly what, if any, such period is relevant to the drawing up of the 1996 accounts, although elsewhere in his first judgment he had found that in practice it is impossible to finalise a profit and loss account immediately at the end of a relevant trading period, and in his second judgment he explains his finding that the Housing liability was a "1996 liability" as meaning that it was a "known liability" at the time the 1996 accounts were prepared. Then again, in the light of his finding of the need for a hindsight period one might have expected the judge to have gone on to find that the £150,000 provision made in the 1996 accounts for Housing’s claim had been properly made and had reduced the profit and loss account by a similar amount, even if not conclusively so: but he did not so find, but on the contrary speaks subjunctively and hypothetically in terms of "if proper provision had been made it would have reduced the profits" etc. Yet again, he speaks in the second judgment of the liability to Housing as a "known liability" which might appear to be a reference to Schedule 3’s clause 1.1.2(g), but that clause is not otherwise cited in his extracts from the SSA. He says that the liability was not "contingent", but accepts that its amount "was not known" and "could not have been stated exactly", and does not find whether it could be described as "unascertainable" for the purposes of Schedule 7’s clause (6)(b)(x) or as not reliably quantifiable for the purposes of the GAAP about which Mr Fendall gave evidence. In both judgments he appears to assume that there would be a need or might be a case for reopening the 1996 accounts in the light of the TCC judgment: in his first judgment, he puts that need hypothetically ("If provision had been made in the 1996 accounts…it would have been necessary"), but in his second judgment he leaves the whole question of the possible reopening of accounts to the quantum hearing. On this appeal, it has been submitted on behalf of Mr Devine that that is a point of principle to be decided here. Finally, in his first judgment the judge finds that on the balance of probabilities Mr Devine would not have achieved a better result in the Housing litigation if he had had control of it, but in his second judgment he leaves that question for the quantum stage.
19. It may be that all or some of these puzzling aspects can be ascribed to the particular way in which matters were argued before the judge. It is not profitable to disinter those embers, and we have not been invited to do so. In the circumstances it has been necessary to approach the issues raised on this appeal more or less de novo.

The first issue: what is the relevant date for the purposes of finding the 1996 year PBT?

20. Someone unfamiliar with accounting principles might assume that if a profit or loss has to be struck for a period ending on a certain date, then it is that date which marks the terminus date for investigation. In a very real and critical sense that of course remains true. However, it is clear on Mr Fendall’s evidence that accounting principles operative at the time of the SSA (and said to be now codified in FRS 12) make special allowance during a hindsight period down to the drawing up of accounts for the recognition and quantification of provisions in respect of such things as bad debts and liabilities. Unlike the judge, I am not convinced that such a principle of hindsight is necessary: for I cannot see why the question of bad debts and liabilities cannot be looked at as of the cut-off date of the last day of the accounting period: and I note for myself that FRS 12 at para 36 states that "The amount recognised as a provision should be the best estimate of the expenditure required to settle the present obligation at the balance sheet date". Nevertheless, I quite understand that if, by the time of the drawing up of accounts, it becomes known that book debts are in fact irrecoverable or that liabilities are in the pipe-line, or if better and more up to date information becomes available about such matters, then it may well be considered desirable that the accounts should be adjusted to accord with contemporary knowledge. For the purposes of this appeal, I accept that good accounting practice requires, and required at the relevant time, such up to date knowledge to be written into the accounts in the form of provisions.
21. In this connection, at the outset of this appeal Mr Elleray QC on behalf of Mr Devine was likewise prepared to assume for the purpose of his submissions that the relevant date for the consideration of such provisions was 24 October 1997, when the 1996 accounts were signed off. This court was, nevertheless, interested to have his submission as to the effect in clause 8.1.11 of the words "on Completion" in the phrase "if the Purchaser establishes after Completion that the PBT was on Completion less than the said figure" (emphasis added). In his first judgment the judge had briefly said "(In this connection I record my agreement with Mr Charlton [QC, counsel for Torex] that the words "on Completion" in the last sentence of clause 8.1.11 do not make sense and should be blue pencilled.)" Mr Elleray fairly accepted that this point did not figure in his notice of appeal, but Mr Charlton did not on that ground object to its being raised.
22. Mr Elleray therefore submitted that the insertion of the words "on Completion" in that passage was to reflect the parties’ agreement that, for the purposes of the PBT warranty in clause 8.1.11, the date down to which hindsight could be operated for the purposes of assessing the PBT for the 1996 year was the Completion date. That, on the facts, was 8 January 1997.
23. Mr Charlton riposted by reminding the court that the date of the SSA itself was 26 November 1996, and that in such circumstances it must have been within the contemplation of the parties that Completion could take place before the end of the year: in which case he submitted that the reference in clause 8.1.11 to "on Completion" would indeed make no sense. Therefore the judge was right to strike the words out of the clause. In this connection Mr Charlton referred to clauses 5.1 and 7.1 of the SSA which set out the conditions which had to be fulfilled before the SSA went unconditional and provided that Completion should take place on the same day as that occurred.
24. It might equally be said that the SSA contemplated that Completion would not take place until after the year end, for clause 5.1.4 stated that either party could rescind the contract if any of the conditions precedent had not been fulfilled by 8 January 1997.
25. In these circumstances the court was faced, in theory, with four competing candidates for the date up to which liabilities should be recognised as affecting the PBT for 1996. The earliest such date was 31 December 1996. The first alternative was the Completion date, if later. The second alternative was 24 October 1997, the date of signing off the 1996 accounts. And the final alternative was the last date for establishing the true quantum of any relevant liability, in the case of the Housing claim a date which went down at least to 2 December 1999.
26. Mr Elleray’s submission was in effect for any of the first three such dates, and, given Completion within 1997, he submitted primarily for 8 January 1997 and in the alternative for 24 October 1997. Mr Charlton on the other hand submitted primarily for the last alternative, and only if he was wrong about that was he prepared to rest on the date of signing off the accounts. Thus his primary submission was that the assessment of PBT for the 1996 year for the purpose of clause 8.1.11 was an entirely conventional matter, not rooted in the statutory accounts for 1996, and subject to repeated reassessments until the last of liabilities which could be traced back to 1996 had been disposed of. Thus any particular accounts for 1996 could be again and again re-opened until the true figure could be established. If therefore any provision in the accounts produced in 1996 turned out to be an under-estimate of BIT’s ultimate liability, it was only that ultimate liability which counted for the purposes of the 1996 PBT.
27. It would seem to me to follow from Mr Charlton’s submission, if it is correct, that if an initial provision turned out to be an over-estimate, then again it would only be the final answer, possibly nil, which could ultimately go into the PBT equation.
28. In my judgment, however, Mr Charlton’s primary submission is not correct. It ignores the express reference to "on Completion", but I will for the present assume that those words are indeed to be deleted. In that case, the choice is between a date of 24 October 1987 and no date other than comes with the establishment of the quantum of liability (or the fact of non-liability). The case for the former is that it reflects an assessment of PBT "in the same manner" as that adopted for the 1995 accounts, on the assumption that "manner" includes the timing of the hindsight period. That appears to have been the judge’s view, subject to his being willing to contemplate the possibility of, and to allow Torex the opportunity of arguing at the trial of quantum for, a right to re-open the assessment at a later date. The case for Mr Charlton’s submission, however, is in my view to be rejected for the following reasons.
29. (1) Clause 8.1.11 contemplates that the 1996 PBT will be assessed in the same manner as the 1995 PBT. The 1995 PBT was assessed in statutory accounts. Although the tax consequences of such accounts may, as I am given to understand the position, depend on a reworking of the year’s PBT for tax purposes, there is no evidence before the court and there is nothing to support the submission that statutory accounts may be re-opened just because, in the natural development of events, a provision based on an estimate of a company’s liability may turn out to be different from that liability as finally agreed, established or adjudicated. On the contrary, FRS 12 states in its para 62, which is headed "Changes in Provisions", as follows:

"Provisions should be reviewed at each balance sheet date and adjusted to reflect the current best estimate. If it is no longer probable that a transfer of economic benefits will be required to settle the obligation, the provision should be reversed."

That suggests that changes in provisions can affect profit (down or up) in successive years, rather than that a change in provision is carried back to the profit and loss account of the year in which that provision first appeared. That also appears to be the logic lying behind Schedule 7’s clause (6)(b)(i) and (ii).

30. (2) A claim under the PBT warranty, as under any of the SSA warranties, has to be made by written notice within 18 months of Completion and proceedings in support of that claim have to be commenced within a further 12 months of that notice: see Schedule 7’s clauses (1) and (6)(a). (This is subject only to any possible extension of that limitation period under the proviso to Schedule 7’s clause (6)(b)(x)). Moreover, the notice must state "the total amount of liability" resulting (clause (1)) or "reasonable details of the claim including details of the amount involved" (clause (6)(a)). Although Mr Charlton’s submission could live with these limitation provisions (subject of course to the limitation itself), the period of 18 months strongly suggests that the reassessment of PBT to find the true ultimate liability is not what is contemplated. The 18 month period would allow for a claim based on provisions within the 1996 accounts, for in the case of private companies such as BIT such statutory accounts must be drawn up within 10 months of the end of the accounting period: but Mr Charlton’s submission is that what counts is not the provision contained in any set of accounts, but the ultimate true liability (or absence of liability). On that basis, pending ultimate settlement of the liability, the notice stating the "total amount of liability" or "details of the amount involved" could only be a provisional amount: but that would be inconsistent with the purpose of the notice required. It is only if a valid provision made in or for the purpose of the 1996 accounts fixes once and for all its effect on the 1996 PBT that such a notice can be sure of stating the "total amount of liability" etc. But that last possibility would reflect both parties’ alternative submission, rather than Mr Charlton’s primary submission.
31. (3) Quite apart from the point derived from the notice and limitation provisions of Schedule 7, Mr Charlton’s primary submission also seems to me to be uncommercial and unreasonable. It would mean that the account between the vendor and the purchaser struck by the terms of the SSA could not be closed until the last settlement of all liabilities which could be related to the 1996 year. If there was lengthy litigation relating to any such liability, that settlement could take a decade to be reached – possibly only after a visit to the House of Lords! Such an open-ended approach to the PBT warranty appears most odd, especially as, alone of the SSA’s warranties, it lies outside the otherwise general cap upon warranty liability of £500,000 (see Schedule 7’s clause (3)). Of course, if clause 8.1.11 compelled me to the construction favoured by Mr Charlton, its uncommercial or unreasonable nature would be beside the point. But, quite apart from any significance in the words "on Completion", I find nothing in the clause to compel or even urge the adoption of that construction.
32. (4) There are other clauses in the SSA which suggest that its parties are content to regulate their relationship by reference to provisions rather than ultimate settlements of book debts or liabilities. Thus Schedule 3’s clause 1.4.2 warrants:

"The amounts due from debtors as at the date of this agreement (less the amount of any relevant provision or reserve determined on the same basis as that applied in the Principal Accounts and disclosed in the Disclosure Letter) are bona fide…"

and Schedule 7’s clause (6)(b)(i) provides that Mr Devine is not to be liable for any claim under any Warranty to the extent that –

"an express and specific allowance provision or reserve in respect of any liability the subject of such claim was made or taken into account or payment or discharge of which was taken into account in preparing the Principal Accounts".

33. (5) In an attempt to deflect the force of such points Mr Charlton came round, in his oral submissions, to make a positive argument which he had not previously advanced but was as it happened exactly contrary to his previous submissions: namely that liabilities of the kind represented by the Housing claim were in truth "contingent" liabilities, so that under the proviso to Schedule 7’s clause (6)(b)(x) time only began to run for the purpose of the contract’s limitation periods from the "date upon which such liability becomes an actual liability" and not from Completion. Previously, he had denied that the Housing liability was a contingent liability and had argued that Mr Elleray’s reliance on clause (6)(b)(x) was a red herring, in that even if the liability was contingent, the only effect of the clause was to postpone limitation until after 2 December 1999. In my judgment, however, whatever effect clause (6)(b)(x) might have for the purpose of any of the other numerous warranties in the SSA^[1], it cannot directly affect the operation of the PBT warranty which depends on an assessment of the 1996 PBT "in the same manner as in the Principal Accounts". The 1995 PBT was not subject to constant re-evaluation or merely contingent status until such time as BIT had "actually…suffered loss or incurred the liability in question", whatever effect such re-evaluation might have on the PBT of succeeding years.
34. (6) In any event, to the extent that the provision made in the 1996 accounts was properly made, the Housing liability ceased in my judgment to be "contingent" for the purposes of the PBT warranty, even if it could previously have been so described. "Contingent" is the sort of word whose precise meaning will depend on its context. In ordinary language a liability is contingent if its existence depends on some other event. In legal terms a liability in damages for repudiation of a contract in the ordinary way either exists or it does not: the fact that it may take agreement or the resolution of a court to determine the merits of a disputed liability does not make that liability properly contingent on such agreement or judgment. However, in an accounting context, where it becomes especially important to be able to express matters in numerical terms, a potential liability upon which it is not possible to place a reliable value may well have to be described as contingent: because its numerical expression has to await resolution. The context and provisions of the SSA indicate a heavy dependency on technical accounting terms and practices and no more so than where PBT is concerned. FRS 12 discusses this very point concerning contingent liabilities at paras 12 and 13:

"In a general sense all provisions are contingent because they are uncertain in timing or amount. However, in the FRS the term ‘contingent’ is used for liabilities and assets that are not recognised because their existence will be confirmed only by the occurrence of one or more uncertain future events not wholly within the entity’s control. In addition, the term ‘contingent liability’ is used for liabilities that do not meet the recognition criteria.

The FRS distinguishes between:

(a) provisions – which are recognised as liabilities (assuming that a reliable estimate can be made) because they are present obligations where it is probable that a transfer of economic benefits will be required to settle the obligations; and

(b) contingent liabilities – which are not recognised as liabilities because they are either:

(i) possible obligations, as it has yet to be confirmed whether the entity has an obligation that could lead to a transfer of economic benefits; or

(ii) present obligations that do not meet the recognition criteria in the FRS because either it is not probable that a transfer of economic benefits will be required to settle the obligation, or a sufficiently reliable estimate of the amount of the obligation cannot be made."

35. In terms therefore of FRS 12, the concepts of provisions and contingent liabilities are mutually inconsistent: a contingent liability may be something which should be noted in accounts, but it does not affect the profit and loss account. If, however, a potential liability, whether disputed or not, can be made the subject of a reliable estimate of a probable payment needed to satisfy a present obligation, it can and should be made the subject matter of a provision – and this will affect the profit and loss account. Once such a liability, which might well up to that moment be thought of as contingent, has been properly made the subject of a provision, it ceases to be thought of as a merely contingent liability.
36. In the present case, a provision has been made to take account of Housing’s claim. If that provision has been validly made (and Torex’s claim in these proceedings has been put forward on the basis that it has been validly made^[2]), then, at any rate in terms of FRS 12, the liability in question has moved from mere contingency to the status of a provision.
37. Mr Charlton submits, nevertheless, that the SSA does not reflect these accounting principles and points to Schedule 3’s clause 1.1.2(g) as indicating a contrary use of the word "contingent". That sub-clause is a warranty that the 1995 accounts made "proper provision or reserve for all known liabilities…including known contingent known unquantified or known disputed liabilities". Thus Mr Charlton submits that the concepts of a provision and of a contingent liability are not mutually exclusive. I remind myself that FRS 12 was not in effect at the time of the SSA and that although the evidence at trial was that its principles were already recognised as good accounting practice at the relevant time, there is no specific expert evidence to assist the court on the detail of these matters. I note also that the sub-clause speaks of "proper" provision and also "reserve". My understanding is that whereas provisions affect the profit and loss account, reserves affect the balance sheet. I do not know what principles govern the making of reserves. Nevertheless, I do not consider that this sub-clause is shown to be inconsistent with what I have said above. If proper provisioning requires a provision to be made for a "known contingent liability", then that liability ceases to be contingent for the purposes of the profit and loss account, although the provision may of course be subject to change in future years’ accounts. The sub-clause is silent on whether a proper provision should be made for a known liability which is not only unquantified but also unquantifiable or unascertainable. I assume that it should not.
38. I would therefore conclude that Mr Charlton’s primary submission is uncommercial and unrealistic, inconsistent with such understanding as the court has of relevant accounting principles, and above all inconsistent with the contractual agreement that the assessment of the 1996 PBT is to be done in the same manner as the assessment of the 1995 PBT. Whereas I agree with Mr Charlton that that does not mean that the 1996 statutory accounts are conclusive of such an assessment, for it is always open to ask the question whether the 1996 PBT has been assessed properly and in the same manner as the 1995 PBT, it does, in my judgment, prevent the assessment of the 1996 PBT being conducted in a manner that is entirely open-ended until the last relevant potential liability has been resolved.

"On Completion"

39. Having rejected Mr Charlton’s primary submission, the next matter to resolve is whether the relevant date for assessing the 1996 PBT is 8 January 1997, the date of Completion, or 24 October 1997, the date of the drawing up of the 1996 accounts.
40. In my judgment the words "on Completion" should not be excised from clause 8.1.11 unless their presence there cannot be given any sensible meaning. The argument that their presence is nonsensical rests on the possibility at the time of contracting that the Completion would take place before the end of 1996. I grant that possibility, but it was equally possible that Completion would take place in 1997, as was expressly contemplated in clause 5.1.4 The expression "on Completion" would work in both sets of circumstances if it is understood as meaning "on Completion or 31 December whichever is the later". For clearly the 1996 PBT cannot be assessed until the end of the year.
41. Although there is that element of necessary manipulation involved in retaining the words "on Completion", the alternative is to exclude them entirely when their presence in the clause has all the appearance of being a deliberate one. It is noticeable that they balance the almost immediately preceding words "after Completion". In reviewing the respective arguments for one or other construction, I would have in mind the following considerations.
42. First, the direction to assess the PBT "on Completion" is the clause’s only such express direction as to the relevant date for assessment, other than of course is inherent in the period ending 31 December 1996 itself. The alternative candidate for the date for assessment is only derived as a matter of inference from the general language of assessment "in the same manner". I acknowledge that that phrase may be construed to cover the period of hindsight to be applied in the assessment, but it is equally satisfactory, in the light of the express reference to "on Completion", to regard "manner" as covering mode as distinct from timing.
43. Secondly, there is good commercial logic in tying the assessment date to the Completion date. On Completion, Mr Devine lost control of BIT to Torex. Claims could well then arise out of ongoing contracts, which might well be the subject matter of a hindsight provision later in the year, in circumstances far removed from those over which he had any control. Moreover, on the somewhat subjective question of proper provisioning, a vendor would be reluctant to put himself too much in the hands of his purchaser. These considerations remain even though the purchaser is required to assess "in the same manner" and in accordance with proper accounting practice. The fact that, alone of the SSA’s warranties, the PBT warranty is not capped within the overall limit of £500,000, merely emphasises the commercial importance of appropriate protection for a vendor.
44. Thirdly, there are many other warranties which protect the purchaser from unwanted liabilities which a vendor should have disclosed or for which he should bear responsibility: see, for instance Schedule 3 at clause 4.5 ("Liabilities"), clause 5.8 ("Litigation Disputes and Winding Up"), clause 5.16 ("Subsisting Contracts") and clause 5.17 ("Defaults by Group Company"). The same may be said for irrecoverable book debts, which can also be made the subject of provisions during any hindsight period (see clause 1.4, "Book Debts"). Those warranty obligations all fall within the general cap of £500,000.
45. In my judgment, these considerations weigh in favour of retaining the words "on Completion" and giving them a meaning which reflects their context in a situation where Completion might occur in a narrow period either side of the year end.

The consequences of adopting the Completion date.

46. The consequences of adopting the Completion date of 8 January 1997 as the date for assessment are not I think in dispute. Housing’s claim to cancel its contract with BIT and to be entitled to damages for repudiation only came forward on 13 January 1997. It came "out of the blue". Although Housing had complained in the autumn of 1996 of delays in installing the business systems which were the subject matter of its contract with BIT, the complaint appears to have been resolved for the present, following a meeting of principals, on certain terms set out in a letter written by Mr Devine to Housing on 18 October 1996. Those difficulties, as then perceived, were disclosed in the Disclosure Letter which accompanied the SSA, and it is not complained, as I understand it, that proper disclosure was not made of the position up to the time of contract. It is to this disclosure that the judge was really referring when he said in his first judgment "While disclosure was given". However, Mr Charlton accepts that the cancellation and claim in repudiation which were asserted on 13 January came out of the blue and were not anticipated. It follows that a liability arising out of Housing’s claim cannot be made the subject matter of a provision for the purposes of the assessment of the 1996 PBT as at the date of Completion.
47. If I am wrong about preferring the date of Completion as the relevant assessment date, then the matter has to be looked at as of 24 October 1997. In that case, Torex’s own assessment is £150,000, made up as to £17,370 in respect of irrecoverable debts and the balance in respect of liability to Housing. In such a case I am not sure whether Mr Elleray disputes the reasonableness of that assessment: I think he does, and that might have been a matter to go to a quantum hearing if the relevant date for assessment had been 24 October 1997. Even so, the matter of the reasonableness of that provision was argued, for Mr Elleray pointed to the fact that Mr Devine’s own advice to Torex was to settle the matter at a maximum of £70,000, taking account of both the bad debt and compensation to Housing. Mr Elleray also pointed out that as late as 30 September 1998, following judgment by default against BIT, the sum of only £100,000 was paid into court. However, the facts remain that legal advice to both Mr Devine and to Torex prior to the drawing up of the 1996 accounts was that BIT was probably in breach of contract and that the real question was that of quantum also allied to an issue arising out of an exclusion clause for consequential loss; that at a meeting on 16 April 1997 Housing put its claim at £155,000 and that in a letter dated 12 May 1997 its solicitors "guesstimated" a claim of £355,000; and that in its counterclaim of 10 October 1997 Housing pleaded a claim of some £257,000 and rising. In such circumstances a provision of £150,000 does not look unreasonable, especially as it is now known that BIT gave up on the question of liability and ultimately suffered a judgment in the sum of just under £396,000. However, it is unnecessary to decide the point, especially as it may strictly not be before the court.
48. In any event, I can say that, even if the relevant date was 24 October 1997 rather than the date of Completion, Torex’s maximum claim would be limited by its provision of £150,000. That, it seems to me, is a question of liability dependent upon the construction of the SSA, and in no way a question of quantum.
49. In the circumstances, all other issues become moot and I will deal with them only briefly.

"Contingent future or unascertainable"

50. Mr Elleray relied on Schedule 7’s clause (6)(b)(x) to submit that if, by the time for assessment, the Housing liability fell within the wording of "contingent future or unascertainable", then clause (6)(b)(x) operates as a complete defence. It is unnecessary to decide this point. As of the Completion date, Housing’s claim did not exist and it hardly matters how the potential liability is described. As of the date of the 1996 accounts, a provision had been made, and I have given my reasons above for thinking that in those circumstances the liability is no longer to be considered contingent. It is not a future liability, and, unless the provision was improperly made, it is not an unascertainable liability, which I am inclined to think means the same as an unquantifiable liability.
51. In any event, I have given my view above for thinking that clause (6)(b)(x) does not apply at all to the PBT warranty. If at the date of assessment a provision has been properly made, the liability is no longer to be considered contingent; and if no provision has been made, then no debit is to be made at all to the assessment of the 1996 PBT.

Disclosure

52. Finally, there is Mr Elleray’s submission, in reliance on the opening words of clause 8.1 and on Schedule 7’s clause (5), that disclosure is a complete answer to Torex’s claim based on the Housing liability. In my judgment, however, that submission is beside the mark. The difficulties of autumn 1996 may have been both resolved and disclosed (see para 46 above), but Housing’s repudiation claim was not, indeed it could not have been disclosed at the time of contract because it had not then been made, and when it came, it came out of the blue. It is therefore unnecessary to consider the interesting question as to whether disclosure could ever be a defence to a claim on the PBT warranty.

The respondent’s notice

53. In the circumstances it is unnecessary to consider Torex’s respondent’s notice, and Mr Charlton himself said hardly anything about it. In it, Torex complains about the judge’s reasoning that the 1996 PBT must be assessed in the same manner as the 1995 PBT, even if the 1995 accounts were drawn up improperly:

"what matters (for, I stress, the purpose of the profits warranty) is the manner in which profit figure in the 1995 accounts was reached, irrespective of whether there was anything improper or unlawful in that manner."

54. As it is, it is difficult to find either in the judgments below or in the submissions before this court what, if any, factual point there is for resolution relating to the (possibly improper or unlawful) accounting for the 1995 PBT. All that I think I need say is that, if it mattered, I should not necessarily be taken to agree that anything improper or unlawful in the working out of the 1995 accounts would be irrelevant. After all, the SSA contains a number of warranties under clause 1.1 of Schedule 3 relating to the proper accounting of the Principal Accounts, of which clause 1.1.1(g) is as pertinent as any ("make proper provision or reserve for all known liabilities" etc). For the purposes of my reasoning in this judgment I have assumed that in assessing the 1996 PBT in the same manner as in 1995 for the purposes of clause 8.1.11 the obligation was to do so, subject to the express direction to do so "on Completion", in accordance with proper accounting standards.

Conclusion

55. In sum, this appeal succeeds in as much as Mr Devine has no liability to Torex under the PBT warranty to the extent of BIT’s liability to Housing, however that liability is regarded, whether as finally adjudicated or as the subject matter of the provision in the 1996 accounts. I would propose that the court hears counsel further as to the detail of this court’s consequential orders, unless that can be agreed, which I hope it can be.

Sir Martin Nourse:

56. I agree.

Lord Justice Mantell:

57. I also agree.

Note 1   For instance: Schedule 3’s clause 4.5.1 (“So far as the Vendor is aware there are no liabilities of any Group Company which are outstanding other than those liabilities disclosed in the Principal Accounts or incurred in the ordinary and proper course of trading since the Last Accounts Date”), or clause 5.8.1 (“No Group Company is engaged in any litigation or arbitration proceedings as plaintiff or defendant other than routine debt collecting; there are no proceedings pending or threatened either by or against any Group Company”), or clause 5.16.2 (“No Group Company is a party to any contractual transaction arrangement or liability which...is known to be likely to result in a loss to it on completion of performance”).    [Back]

Note 2   See Torex’s solicitors’ letter of 4 November 1997, which enclosed a full breakdown of the provisions which went into the calculation of BIT’s 1996 loss and commented: “Please note that as provisions have now been made in the Accounts the matters are no longer contingent future or unascertainable as they are subject of claims under the PBT or NAV Warranty Claims.”    [Back]