England and Wales Court of Appeal (Civil Division) Decisions

IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT OF JUSTICE
(QUEEN'S BENCH DIVISION (COMMERCIAL)
Hon Mrs Justice Gloster DBE

[2005] EWHC 78 (Comm)

		Royal Courts of Justice Strand. London. WC2A 2LL
		20/10/2005

Lord Justice Longmore:

1. This appeal concerns the sale of a nuclear engineering business by the defendant vendors ("AEA") to the claimant purchasers ("RWE"). The sale contract of 1st June 2001 was a lengthy and detailed document and amongst the many matters with which it dealt were existing contracts with third parties under which ABA had agreed to do work for owners of plants such as Trawsfynydd on the moors of Gwynedd in North Wales. Schedule 6 of the Agreement contained the warranties given by AEA to RWE. Schedule 13 set out the principles pursuant to which the necessary Completion Statement was to be compiled under the title "Completion Accounts Principles" and Schedule 19 dealt with the relevant existing contracts ("Customer Contracts").
2. As was usual in business sales of this kind AEA provided a Disclosure Letter to which was attached a Contract Monitoring Report ("Comon") in respect of each Customer Contract with a value of more than £100,000. According to paragraph 15.2 of Schedule 6 this Comon was to state accurately both the historical financial position of each such contract as at 31st March 2001 and a reasonable judgment of the future financial position of the contract. Each Comon provided to RWE set out a large amount of information including, in particular:-

(1) the original contract price;

(2) the price of agreed variations;

(3) sums likely to be recoverable in respect of future claims or future variations, sometimes called shortly "Recovery of Claims";

(4) the forecast fixed sums due, being the total of (I), (2)

and (3) above;

(5) the cost of the contract to date;

(6) the forecast cost to complete; and

(7) the anticipated final cost, being the total of (5) and (6) above.

3. This appeal relates to the provisions of Schedule 19 whereby AEA as vendors agreed to indemnify RWE as purchasers for what may, in general, be called shortfalls in expected recovery in relation to six specific Customer Contracts. In two cases; referred to ·as the D Bench Contract and the PFR LMD Contract, AEA agreed to indemnify RWE for failure to receive any of the Recovery of Claims figures as set out in the relevant Comon. In three further cases, referred to as the Southern Storage Area Contract, the MAC Contract and the FED contract, AEA agreed to indemnify R WE against "Losses" incurred under or pursuant to the contract. "Losses" are defined in Schedule 19 as follows:-

"in respect of, as appropriate, the FED Contract, the MAC Contract or the Southern Storage Area Contract, an amount equal to the difference between the amount recoverable on the contract and the cost of completing the contract not provided for in the Completion Statement".

In a sixth case, referred to as the KFK II Sodium Contract, AEA agreed to indemnify R WE against any properly incurred expenses in excess of those provided for in that contract. These indemnities are contained in clauses 1 to 6 of Schedule 19.

4. Clause 7 then sets out limitations on AEA's liability. Clause 7.1 provides that AEA is to pay only 90% of the amounts payable under clauses 1 to 6. Clause 7.2.1 entitles RWE to pursue a co-.extensive claim under the warranties clause of the Agreement but provides that payment of any such claim is to satisfy pro tanto any claim under the indemnity provisions. Clause 7.2.2 sets an aggregate limit of £6,660,000 to AEA's liability. Clause 7.3 is the clause in dispute between the parties and needs (with clause 7.4) to be set out in full:-

"7.3 in calculating any of the Losses, Recovery of Claims or (in the case of paragraph 6) relevant expenses under paragraphs 1 to 6 above the following adjustments shall be made:

7.3.1 in respect of the D Bench Contract the Purchaser shall be deemed to have recovered or reduced unagreed claims/variations under such contract in the sum of £300,000;

7.3.2 in respect of the PFR LMD Contract the Purchaser shall be deemed to have recovered or reduced unagreed claims/variations under such contract in the sum of £300,000;

7.3.3 in respect of the Southern Storage Area Contract the Purchaser shall be deemed to have recovered or reduced unagreed claims/variations under such contract in the sum of £500,000;

7.3.4 in respect of the MAC Contract the Purchaser shall be deemed to have recovered or reduced unagreed claims/variations under such contract in the sum of £500,000;

7.3.5 in respect of the FED contract the purchaser shall be deemed to have recovered or reduced.· unagreed claims/variations under such contract in the sum of £1,500,000;

73.6. in respect of the KFK II Sodium Contract the Purchaser shall be deemed to take responsibility for the breakdown repair costs up to the sum of £50,000;

7.4 in relation to each of the MAC Contract and the FED Contract, the £600,000 of plant investment contained

in work-in-progress will not be taken into account when calculating any Losses in respect of such Relevant Contracts."

5. Of the six contracts to which I have referred, disputes have arisen in relation only to four viz. (1) all three of the contracts in respect of which there is an indemnity against Losses viz. the Southern Storage Area contract, the MAC Contract and the FED Contract (clauses 3, 4 and 5 of Schedule 19) and (2) the PFR LMD Contract in respect of which the indemnity is expressed to be against the failure to receive the Recovery. of Claims figure in the Comon report (clause 2 of Schedule 19). In relation to these contracts a preliminary issue has been formulated for resolution by the court in the following terms:-

"On the true construction of Paragraphs 2, 3, 4, 5 and 7 of Schedule 19 to the Agreement, do the sums specified in paragraphs 7.3.2, 7.3.3, 7.3.4 and 7.3.5 respectively of that Schedule operate:

(a) as an offset, so as to reduce the amounts payable by the Defendant to the Claimant under the indemnities referred to in the said paragraphs 2, 3, 4 and 5 by the sums specified in the said paragraphs 7.3.2, 7.3.3, 7.3.4 and 7.3.5 respectively as alleged in paragraphs 33(c) and 63(c) of the Defence; or

(b) as a threshold, such that if any recoveries or reductions in respect of unagreed claims/variations under the contracts referred to in the said paragraphs 2, 3, 4 and 5 exceed the sums specified in the said· paragraphs 7.3.2, 7.3.3, 7.3.4 and 7.3.5 respectively then such sums are to be disregarded in calculating the amounts payable by the Defendant to the Claimant under the indemnities- referred to in the former paragraphs as alleged in paragraphs 15 and 30 of the Reply?"

6. Gloster J (who determined three other issues in relation to which no complaint is made) answered this question by assenting to (a) and rejecting (b). RWE who argued for (b) now appeal.
7. As formulated, the preliminary issue will be opaque to any uneducated reader. In his opening submissions, Mr Richard Wilmot-Smith QC for RWE explained the difference between the parties by producing the following worked example, based on what could have happened in relation to the FED contract for Trawsfynydd:-

(A) RWE's CONSTRUCTION

(1)	EXPENDITURE		£8,244,244	£8,244,244
(2)	INCOME		£5,898,912	£5,898,912
	(i)	Original Contract	£3,107,222
	(ii)	Agreed Variations	£1,248,077
	(iii) LFC&Vs	£1,543,613
(3)	LOSS			£2,345,312
	Deduct forecast loss		£ 845,312	£ 845,312
(4)	TOTAL LOSS		£1,500,000	£1,500,000
	Amount claimable 90%		£1,350,000	£1,350,000

(B) AEA's CONSTRUCTION

(1)	EXPENDITURE		£8,244,244
(2)	INCOME		£5,898,912
	(iv) Original Contract	£3,107,222
	(v) Agreed Variations	£1,248,077
	(vi) LFC&Vs	£1,543,613
(3)	LOSS		£2,345,312
	Deduct forecast loss		£ 845,312
(4)	TOTAL LOSS		£1,500,000
(5)	DEDUCT DEEMED RECOVERY		£ 1,500,000
	Amount claimable		£0

He further explained that, on the basis that R WE was to be deemed according to clause 7.3.5 to have recovered the sum of £1,500,000 in respect of likely future claims and variations (LFC&Vs in his example), it could be seen that in the example they had in fact recovered more than that deemed amount in the sum of £1,543,613 and the "threshold" was thus exceeded. If they had recovered less than £1.5 million for LFC&Vs, then the figure of £1.5 million would have to be included in the worked example instead of the amount actually recovered; that would provide a final figure for income greater than had been earned in fact and a resulting smaller figure for loss than the loss which had actually been incurred. Then it would be such smaller figure which would be recoverable. This, said Mr Wilmot-Smith, was how the clause was intended to operate. If, on the other hand, the deemed recovery was deducted at the end of the calculation in the worked example as an "offset", a very different figure would be reached (in his example a figure of nil) ..

8. Another way of explaining the different approaches is to say that RWE's case is that, if the LFC&V figure exceeds £1.5 million the deeming provision is satisfied and the actual figure can be used in the calculation of loss whereas AEA' s case is that the £ 1.5 million has in any event to be added to whatever figure is the correct figure for LFC&Vs and it is only the resulting loss figure (if any) which RWE can recover.
9. The judge preferred AEA' s construction primarily because clause 7.3 provided for a mandatory adjustment which "shall" be made in calculating "any" of the losses or recovery of claims or relevant expenses under clauses 1-6 of Schedule 19, not an adjustment which would, if RWE were correct, be made in some cases but not others (paras. 44(e) and (g) of her judgment).
10. Mr Wilmot-Smith submitted that the judge misunderstood the nature of clause 7.3 which was. a deeming provision as to what the LFC& V s were. If the true sum for LFC&Vs was greater than the sum it was deemed to be, then the actual sum was to be used instead of the deemed sum. To offset the deemed sum at the end of the calculation or to add it to the actual sum was not something provided for in the contract. The intention of the deeming provision in respect of LFC&Vs was to provide an incentive for RWE to exert itself to get in as much as possible of the predicted figure for future claims and variations. To treat the purchaser as having got in a figure of £ 1.5 million in excess of the actual figure would be excessively harsh.
11. Mr Keith Rowley QC for ABA supported the judge by emphasising the mandatory and universal nature of the clause. He further submitted by reference to the speech of Lord Mustill in Torvald v Ami Maritime (The Gregos) [1994] 1 WLR 1465, 1473G that the court should not be influenced by assertions that one construction or another yielded the more sensible result. If, however, the court did think the incentive behind the deeming provision was important, AEA's construction in fact provided a greater incentive for RWE to spend time and effort to recover as much money as possible since, if the losses were subject to an unavoidable deduction of the fixed sum specified, RWE would work all the harder to achieve maximum actual recoveries.
12. In giving permission to appeal, Waller LJ said that, while the judge appeared to be right at first sight, closer analysis indicated a reasonable prospect of success. My own mind has fluctuated during the argument but I have in the end concluded that I prefer R WE' s argument for 4 main (and overlapping) reasons.
13. First, it is important to appreciate that the deeming provisions of clause 7.3 apply to the "recovered and agreed claims/variations". It is therefore at the point of assessing this sum in the overall calculation that the deeming provision takes effect viz. at A(2)(iii) or B(2)(vi) of Mr Wilmot-Smith's worked example. (This contrasts with the wording of clause 7.4 which provides that £600,000 of plant investment is not to be taken into account when calculating "any Losses". This makes it explicit that that figure is to be taken into account at the time of the calculation of "Losses".) It is not, in my view, consistent with the Agreement that the deemed figure in respect of recovered unagreed claims should be dealt with at the end of the calculation, as AEA's submission would appear to require.
14. Secondly, although this first point is not conclusive of the argument because AEA's submission could apply at point B(2)(vi) of the calculation as much as at the end of the calculation, it does show that the effect of AEA's submission is that the deemed figure is to be added to the figure for recovered unagreed claims. That, however, is not what the deeming provision says is to happen. One would ordinarily expect that a provision whereby, in respect of a particular element in a calculation, a party is deemed to have received a given amount, would operate by substituting that amount for the actual receipts for the purposes of the calculation. Neither side argued for the substitution of the fixed sum in all cases, which would make no commercial sense. On RWE's contention it is to be substituted in one case (which does make commercial sense) whereas on AEA's argument it is not to be substituted at all, but rather added to the actual figure. It is more natural to hold that the deemed figure is to be the basic LFC&V figure if the recovery is less than the deemed figure than to hold that the deemed figure should be added to whatever the actual recovery turns out to be.
15. Thirdly, the argument which appealed to the judge viz. that it is mandatory to make the contemplated adjustments in calculating "any" of the Losses, Recovery of Claims or relevant expenses cannot be carried too far. The provision in clause 7.3.6, in respect of the KFK n Sodium Contract (that RWE is to be deemed to take responsibility for breakdown repair costs up to the sum of £50,000) can only sensibly apply if there is a breakdown and if there is a repair, the cost of which RWE seek to bring into account. If no breakdown has occurred or no repair is effected, it cannot be supposed that AEA are nevertheless entitled to an offset of £50,000.
16. Fourthly, it follows that the words "as appropriate" must be understood to be incorporated into clause 7.3.6. It seems to me to do less violence to the contractual wording to say that the working of clause 7.3 sub-clauses 1-5 should be similarly understood than to imply some such words as "in addition to the actually recovered sum" in those sub-clauses.
17. I should add that I have not been swayed by the submissions about the degree of incentive given to RWE by the alternative constructions. The, considerations are finely balanced and it seems to me more sensible merely to construe the actual words used against the background that the Agreement was a sale agreement between experienced and well-advised businesses.
18. For the reasons given I prefer RWE's submissions, would therefore allow this appeal and would answer the preliminary issue by saying that the sums specified in clauses 7.3.2-5 operate as a "threshold", in the sense used in the preliminary issue, so that, if the actual recovery exceeds the threshold figure, the calculation of "Loss" or "Recovery of Claims" is to use the actually recovered figure.

Lord Justice Lloyd:

19. I agree.

Lord Justice Sedley:

20. I also agree.