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Cite as: [2008] 2 WLR 1289, [2008] QB 706, [2007] EWCA Civ 1301, [2008] 1 BCLC 613, [2008] Bus LR 1279, [2008] 1 All ER 941, [2007] 2 CLC 947, [2008] 1 All ER (Comm) 548

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		Neutral Citation Number: [2007] EWCA Civ 1301
		Case No: B2/2006/1614

IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM DEWSBURY COUNTY COURT
Mr Recorder Prosser
5LS07383

Royal Courts of Justice
Strand, London, WC2A 2LL

06/12/2007

B e f o r e :

LORD JUSTICE WARD
LADY JUSTICE SMITH
and
LORD JUSTICE WILSON
____________________

Between:

	Anthony Pitts and Ors	Appellants
	- and -
	Andrew Jones	Respondent

____________________

Mr P J Cherry (instructed by Chadwick Lawrence) for the Appellants
Mr Darren Finlay (instructed by Lupton Fawcett) for the Respondent
Hearing date: 25 October 2007
____________________

HTML VERSION OF JUDGMENT
____________________

Lady Justice Smith :

Introduction

This is an appeal from the order of Mr Recorder Prosser made in the Dewsbury County Court on 7 July 2006 when he dismissed the appellants' claims against the respondent, Andrew Jones, for damages for breach of contract. Permission to appeal was given by Sir Henry Brooke. The facts of the case were to some extent in dispute before the Recorder but there is no appeal against any finding of fact and the appeal relates only to two issues of law.

The Facts

The appellants were employees of and minority shareholders in a company called HM Shopfitting Ltd (hereafter referred to as 'the Company') of which the respondent was the managing director and majority shareholder. The respondent held 700 shares. Of the appellants, Mr Anthony Pitts and Mr John Kenny held 50 shares each and Mr Chris Morgan held 25.

In November 2002, the respondent, who wished to sell his shares in the Company, reached a provisional agreement with a Mr Simon Allso that Mr Allso would buy his shares for £500,000. The agreement had to be provisional because, pursuant to the Articles of Association of the Company, the appellants had a right of pre-emption.

On 9 December 2002, the respondent told the appellants of his intention to sell his shares in the Company and reminded them of their right of pre-emption. He told them how much they would have to raise if they were to exercise this right; they would have to pay him £714.29 per share. He also told them that he had negotiated a deal with the purchaser whereby their shares would be bought at the same price. On hearing that, the appellants agreed to sign waivers of their rights of pre-emption. Messrs Kenny and Morgan signed theirs that day; Mr Pitts signed his on 2 January 2003. At the time, the appellants believed that all the proposed share transactions would be for cash.

After the meeting of 9 December, it appears that the respondent had further meetings with Mr Allso and his advisers and the details of the sale were worked out. The purchase was to be made in the name of a company called W. G. Birch Ltd ('Birch') and the purchase price of his shares was to be paid by instalments, spread over the period January to April 2003. The reason for this appears to have been that Mr Allso did not intend to use his own funds to pay for the shares; he wanted Birch to borrow the purchase price from the Company. Such an arrangement would be contrary to section 151 of the Companies Act 1985 unless the appropriate resolutions (the whitewash procedure) were carried at an extraordinary general meeting (EGM) of the Company. It appears that the major portion of the Company's assets took the form of book debts and the instalments were to be paid when it was expected that these debts would be paid. The respondent had also arranged security for payment of the purchase price of his shares. The Company was to give a guarantee to the respondent in respect of Birch's obligations to pay for the respondent's shares and was also to grant a debenture over the Company's assets in favour of the respondent. The purchase of the appellants' shares was to take place later; the options by which they could require Birch to purchase their shares could not be exercised until June 2003. Completion of the sale of the respondent's shares was scheduled to take place on 7 January 2003.

On 7 January, the appellants were summoned unexpectedly and at short notice to a meeting at the Company's offices. They were needed because it was intended that there should be an EGM that day and the requisite notice had not been given. If the deal were to proceed, the appellants would have to agree to the convening of an EGM at short notice. Section 369 of the Companies Act requires that the holders of at least 95% of the shares consent to holding the meeting without due notice. If either Mr Pitts or Mr Kenny had refused to cooperate, the meeting could not have been held. Also, the option agreements for the purchase of the appellants' shares were ready for signature.

Attending at the offices that day, in addition to the appellants, were the respondent, together with Mr Paul Forster, his solicitor, and representatives of the purchaser. The appellants were, of course, not accompanied by a solicitor or other professional adviser.

Initially, Mr Forster spoke to the three appellants together in the absence of any other person. He told them that the respondent's shares were to be purchased by instalments and also that the options for the purchase of their own shares could not be exercised until June 2003. He warned them that they would have no security and that, if Birch became insolvent before their shares had been bought and paid for, the options would be worthless. When the appellants heard this, they were worried and were unwilling to sign the option agreements. It does not appear that at that stage anything had been said about them consenting to the abridgment of time for the EGM. Mr Forster went to fetch the respondent, who then came in. There followed a discussion, the content of which was disputed at trial. The Recorder found that, when the appellants had expressed their concern about their own position, the respondent undertook that, if Birch did not pay them for their shares, he would do so.

The Recorder also found that Mr Morgan asked for this undertaking to be put in writing. However, Mr Forster advised against this, apparently on the ground that there would be adverse tax implications for the respondent. Eventually, all the appellants said that they trusted the respondent's word and the undertaking was not put in writing. The Recorder said that he was satisfied that neither the respondent nor any of the appellants was aware of the provisions of Section 4 of the Statute of Frauds Act 1677.

Soon after the respondent had given this undertaking, each of the appellants signed an option agreement for the purchase of his shares by Birch and also signified his agreement to the abridgment of the notice period for holding the EGM. The EGM took place later that day. The Company approved the proposal that it should lend money to Birch and the sale of the respondent's shares went through.

The respondent received part payment to the extent of £386,000. The remainder was not paid because of a bad debt to the Company, by reference to which the respondent agreed to at least part of that reduction. Two of the appellants, Mr Kenny and Mr Morgan sought to exercise their options; Mr Pitts did not. However, in the event nothing turns on that. By late 2003, Birch was insolvent and went into liquidation in December 2003. The appellants received nothing for their shares. They looked to the respondent pursuant to his undertaking. He denied that he had given any undertaking but offered to share the money he had received from Birch with the appellants on a pro rata basis. The appellants refused and sued for the full amount of £714.29 per share which they claimed the respondent had promised to pay if Birch did not do so.

The Recorder's Judgment

Apart from the factual issues, which are no longer in contention, the Recorder had to decide two issues of law, which are the subject matter of this appeal. He held first that the respondent's undertaking to pay the appellants £714.29 per share if Birch failed to pay was not a contractual promise; it was unsupported by consideration and was of no legal effect. That disposed of the appellants' claim. However, the Recorder held that, even if he were wrong about the question of consideration, the appellants' claim would still fail because, if there was a contract between the respondent and the appellants, it was a contract of guarantee and unenforceable under the Statute of Frauds. It was not evidenced in writing signed by or on behalf of the guarantor.

The Appeal

In this Court, Mr P.J.Cherry, on behalf of the appellants seeks to overturn the Recorder's decision on both points. Success on one will not help; the appellants must win on both points if they are to recover the sums claimed.

Was the Respondent's Promise supported by Consideration?

Mr Cherry submitted that the Recorder was wrong to hold that the respondent's promise was unsupported by consideration. At the trial, the appellants had argued that they had given consideration for the promise. Mr Cherry accepted that the appellants were not in a position altogether to prevent the respondent from selling his shares to Birch. Indeed, he accepted that the appellants were not in a strong bargaining position. However, the respondent wanted the transaction to go through that day and, at the very least, the appellants' agreement was required if the EGM were to be held that day. Without the EGM, the transaction would be unlawful. If the EGM were not held that day, with the appellants' consent, it could not be held until 2 weeks later, when due notice had been given. By that time, the purchaser might have thought better of the deal; one of the Company's debts was due by then and, if it were not paid, the purchaser might have backed out. But, submitted Mr Cherry, the appellants held a rather more powerful card than refusing to agree to the abridgment of time. They could have withdrawn the waivers of their rights of pre-emption. If the waivers were withdrawn, the sale of the respondent's shares might well have been in real jeopardy. It might not have been possible to proceed for a substantial period of time and the deal might well have gone off. Mr Cherry submitted that it was to 'buy' the appellants' cooperation that day that the respondent gave his undertaking.

In holding that the undertaking had not been supported by consideration, the Recorder relied heavily on the evidence of the appellants, that they had never given any thought to refusing to sign the documents as requested on 7 January. That being so, said the Recorder, they had not given their cooperation in return for the undertaking. There was no consideration.

Mr Cherry submitted that the Recorder was wrong. The fact that the appellants had not given any active thought to withholding their cooperation was irrelevant. The respondent had made his promise in order to secure their cooperation and the cooperation had been given as a result. That was enough.

Mr Darren Finlay for the respondent submitted that the Recorder had been right. He accepted that the Court would never look at the adequacy of consideration but he submitted that here there was no consideration at all. The appellants could not give consideration subconsciously; they had to make positive decisions that they would act in a particular way (agreeing to the abridgment of time or deciding not to withdraw their pre-emption waivers) as the result of the promise the respondent had offered. The Recorder had held that they never gave any thought to the possibility of refusing to sign the documents on 7 January. By implication, he had also found that they had never thought of withdrawing the waivers of their pre-emption rights – even assuming that they could do so. Accordingly, the respondent's undertaking had been a bare promise, unsupported by consideration.

For my part, I am persuaded by Mr Cherry's arguments on this issue. It seems to me that that the Recorder was wrong to place such emphasis on the appellants' conscious thought processes. I accept that, as a rule, a party to a contract will be consciously aware of what consideration he is giving for the promise he is accepting. But here, it seems to me, the course of events was such that the Recorder ought to have held that the appellants gave consideration even though they did not consciously work out exactly what it was that they had given. The position was that the options to purchase the appellant's shares had been arranged by the respondent as an inducement to encourage the appellants not to exercise their pre-emption rights. They signed their waivers in the belief that they would be paid cash for their shares. When Mr Forster spelled out the true nature of the deal they were being offered, the appellants were unhappy about it. At that stage, they did not articulate their stance that they would not cooperate over the signing of documents that day unless their position was improved. But that appears to have been their position, as understood by Mr Forster, who immediately went to fetch the respondent. No one knows what the appellants would have done if the respondent had not then come in and given his undertaking. They never had either the need or the time to consider what they would do in that situation. They might have said that they were not prepared to sign anything until they had consulted a solicitor. On the other hand, they might have decided that there was nothing they could do about their position and they would sign all the documents even though they were unhappy. One or other of them might have taken a different stance from the others. But they never had to decide what to do because the respondent came in and offered the undertaking. The appellants were united in accepting it and, after discussion about whether or not it should be put in writing, they were all content with the arrangements and immediately signed the option agreements and consent to the abridgment of time for convening the EGM. It seems to me that there was so clear a chronological link between the respondent's offer of the undertaking and the appellants' willingness to sign the documents that the natural inference to draw was that the two were directly connected. I would hold that the appellants' cooperation was given in return for the respondent's undertaking. I would also hold that that was good consideration notwithstanding the fact that the appellants' did not consciously realise that by signing the documents they were subjecting themselves to a detriment and were giving consideration for the respondent's undertaking. For those reasons I would hold that the respondent's undertaking was supported by consideration and was therefore a contractual agreement.

Was the Respondent's Undertaking Enforceable?

The Recorder held that, even if the respondent's undertaking were supported by consideration and was therefore a contractual agreement, it was unenforceable because it was a contract of guarantee. Under section 4 of the Statute of Frauds 1677, a contract of guarantee is not enforceable unless it is in writing signed by or on behalf of the guarantor. This contract of guarantee was not in writing.

The argument advanced by Mr Cherry before the Recorder and rejected by him was that this contract was not in fact a contract of guarantee but was an indemnity. Mr Cherry renewed this argument before this court, with vigour and ingenuity.

Although it was common ground that a contract of guarantee is a type of indemnity, it is important to distinguish between the two because Section 4 of the Statute of Frauds applies only to contracts of guarantee. It was also common ground that there are many types of indemnity and the term merely connotes the right of one party to look to another satisfy his losses and may arise under a contract (for example under a contract of insurance) or by operation of law. A guarantee, on the other hand, is a specific type of indemnity whereby the guarantor promises to answer for the debt or default of another person. A typical contract of guarantee arises where A promises or has already promised to pay B a sum of money and C then promises or 'guarantees' that, if A fails to pay B that sum of money, C himself will pay B.

Mr Cherry conceded that the pleading of the appellants' claim against the respondent used words suggestive of a contract of guarantee, although had not applied that label to the transaction. At paragraph 7 of the Particulars of Claim, it was pleaded that, at the meeting on 7 January 2003, the respondent Mr Jones had said that 'if the purchasing company, HM Birch Ltd, did not pay the amount due under the option agreement, he would pay the claimants himself'. Mr Cherry also conceded that the Recorder's finding of fact reflected that pleading. However, he pointed out that the task for the court in deciding whether the words used were a guarantee or an indemnity was to look at the substantial meaning of the words rather than their form and to examine the substance in the relevant factual context.

Mr Cherry submitted that the Recorder had failed to take account of an authority cited to him, namely Sutton and Co v Grey [1894] 1 QB 285 which clarified and explained the distinction between an indemnity and a guarantee. That was a case in which the plaintiff firm of stockbrokers had agreed with the defendant that he would introduce business to them which they would conduct on the stock exchange. If any profit were made it would be shared equally; if losses resulted, the defendant would be liable to the plaintiff for half. The agreement was oral and the court held that the agreement was not a guarantee caught by section 4. The defendant had an interest in the transaction. Mr Cherry placed particular reliance on a passage at page 288 where, after citing from Couturier v Hastie 8 Ex.40, Lord Esher MR summarised the test for distinguishing between a contract of guarantee and one of indemnity as follows:

"There the test given is, whether the defendant is interested in the transaction, either by being the person who is to negotiate it or in some other way, or whether he is totally unconnected with it. If he is totally unconnected with it, except by means of his promise to pay the loss, the contract is a guarantee; if he is not totally unconnected with the transaction, but is to derive some benefit from it, the contract is one of indemnity, not a guarantee, and section 4 does not apply."

Mr Cherry submitted that, if that test is applied to the facts of the present case, it is seen that the respondent was clearly interested in the transaction. He submitted that 'the transaction' was the whole package whereby the respondent sold his shares to Birch (with the concurrence of the appellants who waived their pre-emption rights) and the appellants took option agreements in respect of their own shares, in respect of which the respondent promised to pay the purchase price if Birch failed to pay. The respondent was plainly interested in that transaction. He negotiated the option agreement for the purchase by Birch of the appellants' shares. He was central to the transaction and was not introduced into it merely to promise to make good the appellants' loss if Birch failed to pay.

Mr Finlay submitted that Sutton and Co v Grey was not of general application and should be confined to its own facts. In the alternative, he argued that, if the test outlined in Sutton is applied to the facts of this case, the conclusion must be that the respondent had no interest in the share option agreements which his undertaking went to support and that the undertaking was therefore a guarantee.

The Court spent some time looking at the facts of Sutton and of Couturier v Hastie. We also considered the case of Harburg India Rubber Comb Company v Martin [1902] 1 KB 778. In that case, the Court of Appeal considered whether a promise given orally by the defendant was a guarantee (unenforceable on account of the Statute of Frauds) or a contract of indemnity, as contended by the plaintiff. The facts briefly stated were that the defendant was a member of a company (described in the report as a syndicate) which owed money to the plaintiff. The plaintiff obtained judgment against the syndicate and tried (unsuccessfully) to execute a writ of fi fa. The defendant then gave an oral promise that, if the plaintiff would desist in execution, he would issue bills of exchange to satisfy the syndicate's liability.

At page 783, Vaughan Williams LJ (with whom the other Lords Justices agreed) said that the question for the Court was whether on the facts of the case the bargain was 'a promise to answer for the debt of another' within section 4 of the Statute of Frauds or, on the other hand a contract of indemnity. The court held that it was a contract of guarantee.

Vaughan Williams LJ then considered the authorities and in due course formulated a general proposition as to the distinction between a contract of guarantee and one of indemnity. At page 784, he said:

"…I wish to mention one other class (of case), which …..I think does not come within the section (that is section 4) at all. I mean the cases which have been spoken of as "indemnity cases". Of course in one sense all guarantees, whether they come within s.4 or not, are contracts of indemnity. But the difference between those indemnities which come within the section and those which do not is very shortly thus expressed in the notes to Forth v Stanton (Williams' Notes to Saunders, ed.1871, vol.i.p.234): "These cases establish that the statute applies only to promises made to the person to whom another is already or is to become answerable".

That to my mind is an accurate definition of a guarantee of indemnity which comes within s. 4 of the statute, as distinguished from an original liability which is not within the section, and which has reference to the debt of another, but creates a new liability which is undertaken by the promisor, and has been called in the course of argument a contract of indemnity."

Vaughan Williams LJ then referred with approval to Guild & Co v Conrad [1894] 2 QB 885 where at page 896 Davey LJ had said:

"In my opinion, there is a plain distinction between a promise to pay the creditor if the principal debtor makes default in payment, and a promise to keep a person who has entered, or is about to enter, into a contract of liability indemnified against that liability, independently of the question whether a third person makes default or not."

Finally, Vaughan Williams LJ returned to consider in greater detail the cases in which the court had held that an undertaking which sounded like a guarantee was not caught by the statute but was in truth an indemnity. One such case was Sutton. At page 786 he said this:

"…it seems to me that in each of them the conclusion arrived at really was that the contract in question did not fall within the section because of the object of the contract. In each of those cases there was in truth a main contract - a larger contract - and the obligation to pay the debt of another was merely an incident of the larger contract. As I understand those cases, it is not a question of motive – it is a question of object. You must find what it was that the parties were in fact dealing about. What was the subject-matter of the contract?"

The Lord Justice then gave several examples of the type of contract he had in mind where the object of the contract was some 'larger matter' and continued:

"That (the larger matter) being the object of the contract, the mere fact that as an incident to it – not as the immediate object but indirectly - the debt of another to a third person will be paid, does not bring the case within the section."

As I understand it, Vaughan Williams LJ was here suggesting another, slightly different, rationale for the result which the court had reached in cases such as Sutton. Instead of asking whether or not the promisor had had any interest in the transaction, the court should ask what was the object of the contract or transaction and if the promisor's obligation to pay arose as an incident to the central object of the contract or transaction, that obligation would be an indemnity, whereas if it was the central obligation of the contract or transaction, it would be a guarantee. This distinction appears to have been related to the Court's concern about the use by other judges (including Lord Esher MR) of the term 'interest' when seeking to distinguish between a contract of indemnity and one of guarantee. In short, it appears that the court in Harburg was saying that Lord Esher's formulation should not be taken literally. Not every interest in the transaction would serve to take the promise out of the statute; there had to be more than a motive for offering the promise; there had to be a real interest in the subject matter of the contract. If the promisor had no real interest in the subject matter of the contract but only a motive for offering his promise, the promise would be a contract of guarantee. On the facts of Harburg, the defendant promisor had 'an interest' in the contract or transaction between the syndicate and the plaintiff in that he wanted the plaintiff to forbear to execute judgment against the syndicate. That was his motive for offering his promise. However, his promise was not an incident to the main contract or transaction and he did not have the kind of legal interest in the subject matter of the main contract which would make his promise an indemnity.

After that consideration of the authorities, I turn to apply these principles to the facts of the present case.

First, looking at the matter in the round, it appears to me that the respondent did in fact promise to satisfy the liability of Birch if Birch failed to pay for the appellants' shares after they had exercised their options. That looks like a guarantee. There would be no liability on the respondent unless Birch failed to pay under its agreements with the appellants. The respondent had no potential liability and no potential benefit under those share option agreements other than the liability I have just described. The promise does not look like an indemnity.

However, it has been submitted, in effect, that this was a case such as those discussed in Harburg in which there was a larger subject matter in which the respondent's undertaking was an incident of the main object of the contract. What was the subject matter of the transaction or contract in which the respondent's promise was made? Mr Finlay submits that it was just the appellants' share purchase options. Mr Cherry submits that the transaction embraced both the appellants' share options and the sale of the respondent's shares to Birch.

Although I can see that the transactions which took place on 7 January were linked with each other, they were not, in my view, one transaction. The main transaction which took place on that day was the sale of the respondent's shares to Birch with the attendant resolutions of the Company which enabled the Company to lend Birch the purchase price. I will call that transaction X. The respondent's undertaking to the appellants was not part of that transaction. A little earlier that day, the appellants had signed their share option agreements with Birch (transactions Y). The respondent undertook that, if they exercised their options and Birch did not pay for the shares, he would do so. Although the respondent had negotiated the share options, he had no interest in them in the sense that he could not possibly derive any benefit from them. The respondent's interests and all his potential benefits arose solely from transaction X.

The respondent concerned himself with transactions Y only as a means of persuading the appellants to cooperate in the mechanics of transaction X. His motive in offering his undertaking was to persuade the appellants to cooperate. In that way and to that extent only, transaction X was linked to transactions Y. I have held that that linkage comprised the consideration for the respondent's undertaking. However, that linkage does not mean that transactions X and Y were all one transaction. In my view, they were not; they were separate transactions.

I conclude therefore that there was no larger contract of which the respondent's undertaking was a part. The respondent's undertaking was given solely to support the appellants' share options and the respondent had no other role or interest in those transactions than that of promising to pay the appellants if Birch failed to do so. I conclude therefore that the respondent's promise was a guarantee within section 4 of the Statute of Frauds and, as such, was unenforceable.

I reach that conclusion with some reluctance as it appears to me that there is much general merit in the appellants' case. They were unrepresented on 7 January, having been quite unaware prior to that day that any important events were to take place. They extracted an undertaking from the respondent and asked for it to be put in writing. For reasons which were not explained to this Court, Mr Forster advised against that course. On the face of it, the respondent's stance was most unattractive. It was for that reason that Mr Cherry told us, in fairness to the respondent, that the respondent had offered to share his proceeds with the appellants on a pro rata basis. It is a thousand pities that that sensible and fair offer was not accepted.

For the reasons I have given. I would dismiss this appeal.

Lord Justice Wilson : I agree.

Lord Justice Ward : I also agree.