England and Wales Court of Appeal (Civil Division) Decisions

IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM LEEDS DISTRICT REGISTRY
(HIS HONOUR JUDGE PHILIP MARSHALL QC)

		Royal Courts of Justice Strand, London, WC2A 2LL
		19 June 2014

1. LORD JUSTICE FLOYD: This is an appeal from the judgment and order of Mr Philip Marshall QC, sitting as a deputy High Court judge, on a preliminary issue in a dispute relating to a contractual expert determination of an amount to be paid for the sale of a share in a dental practice. The judge declared, contrary to the appellant's contentions, that the determination was not valid and enforceable. The appellant appeals. Mr Andrew Latimer represented the appellant, Mr Jonathan Bellamy represented the respondent.
2. The dispute arose in the following way. The claimant and appellant, Ms Sophia Shafi, is a businesswoman who invests in and administers dental practices. The defendant and respondent, Dr Alexandra Rutherford, is a practising dental surgeon. In May 2007 the parties formed a company, the Shipley Dental Team Limited ("the company") in order to establish a dental practice. The parties each held 50% of the shares in the company and jointly owned the premises from which the practice carried on business. In order to establish the practice, a number of items of equipment were acquired under the terms of leases from Close Asset Finance, trading as Braemar Finance ("the Braemar leases").
3. In 2009 the parties decided to part company. On 17 December 2009 the parties entered into an agreement ("the agreement"). By the agreement the appellant agreed to sell her 50% shareholding in the company and her 50% interest in the business premises to the respondent, leaving the respondent to continue the practice at the premises on her own account. The agreement required the respondent to pay £25,000 on completion.
4. Thereafter the agreement contained detailed terms designed to enable the parties to work out the precise amount of the consideration and for resolution of any disputes on the completion account. A dispute arose concerning the proper treatment of the Braemar leases in the completion accounts. In due course this led to the appointment of Mr Richard Pughe, an independent chartered accountant, as an expert to resolve the dispute.
5. In the company's accounts for the year ending 2008, the Braemar leases were apparently treated as operating leases and thus as giving rise to only a small amount to be taken into account as a liability. The expert concluded that the Braemar leases were not operating leases but finance leases, and therefore that they should be treated on that basis. However, he also concluded that he was prevented by the terms of the agreement from treating the Braemar leases in that way, and was bound to treat them as operating leases, contrary to the fact. He did not therefore have to determine a subsequent question which is what sums under the leases when treated as finance leases ought to be brought into account at the completion date.
6. I need to set out some of the terms of the agreement. By clause 4.1, the share consideration was £136,500 less 50% of all Completion Liabilities as calculated in accordance with Schedule 4 and detailed in the Completion Accounts, and further adjusted by reference to certain other matters which are not relevant.
7. "Completion accounts" were defined in the agreement as:

"The unaudited balance sheet of the Company, as at the Completion Date, and the unaudited profit and loss account of the Company for the period from the Accounts Date [which is defined elsewhere as 30 June 2008] to the Completion Date, prepared in accordance with Clause 6."

8. "Completion liabilities" were defined as:

"all liabilities of the Company as at the Completion Date net of all relevant receipts from the PCT, as calculated in accordance with Schedule 4 as detailed in the Completion Accounts, as agreed or deemed (as the case may be) pursuant to clause 6."

9. That brings me to clause 6, which provided:

"As soon as practicable following Completion ... the Buyer shall procure the preparation of the draft Completion Accounts by the Accountants on the basis of the requirements, accounting policies and accounting methods set out in Part II and Part III of Schedule 4."

10. Clause 6.5.1 provided that the parties would attempt to resolve all matters in dispute, but in the event that they failed to do so by 31 March 2010 they could refer any matter in dispute to an independent expert accountant. Clause 6.5.2 provided:

"In making such determination, such accountant shall act as an expert and not as an arbitrator and the decision shall (in the absence of manifest error) be final and binding on the parties."

11. Schedule 4, Parts II and III of the agreement contained provisions governing the preparation of the completion accounts. The provisions of Part II, so far as material, read:

"1.2 The draft completion accounts shall:

1.3 be prepared in accordance with the specific accounting policies and principles set out in Part III of this schedule so that, in the case of any conflict, such policies and principles shall override the provisions of paragraphs 1.4 and 1.5;

1.4 subject to paragraph 1.3, be prepared in accordance with the accounting policies, principles, practices and procedures adopted by the Company in the preparation of the Accounts, which include the policies set out in paragraphs 1, 2, 3 and 5 of Part III of Schedule 4, so that, in the case of any conflict, such policies, principles, practices and procedures shall override the provisions of paragraph 1.5;

1.5 where none of the accounting policies, principles, practices or procedures referred to in paragraphs 1.3 and 1.4 deal with the matter, be prepared in accordance with generally accepted accounting principles in the UK as applicable to small companies as at the Completion Date."

12. The proper construction of paragraph 1.4 of Part II of Schedule 4 is at the heart of this appeal. In paragraph 1.4, "the Accounts" is a defined term, which means, according to Clause 1.1, "the financial statements of the Company, prepared in accordance with the Act and the FRSSE as applicable to small entities for the accounting reference period ended on the Accounts Date." The accounts date is further defined as 30 June 2008. "The Act" is the Companies Act 2006 and FRSSE means Financial Reporting Standard for Smaller Entities. We have seen the accounts prepared by the company's accountant, Morris & Co, to 30 June 2008. They contain an express statement that they have been prepared under FRSSE. Under the heading "Accounting Convention", they state that the accounts have been prepared under the historical cost convention and in accordance with FRSSE effective at January 2007. They are in the short form permitted by Part VII of the Companies Act for small companies. One does not learn from them anything express about the treatment of the Braemar leases, which are not mentioned in the accounts.
13. Part III of Schedule 2 went on to provide some specific matters in accounting. In particular, paragraph 2.1 provided:

"In the calculation of the Completion Liabilities, liabilities shall include any and all sums paid at or payable by reference to the period up to and including the Completion Date including but not limited to [certain specific matters]."

14. Pursuant to the agreement, exchange and completion took place on the same day, whereupon the appellant transferred her 50% shareholding and 50% beneficial interest to the respondent and the respondent paid £25,000 on account. The respondent has continued to trade from the premises.
15. Morris & Co produced two sets of draft completion accounts for the period ended 16 December 2009: one in May and one in July 2010. The draft accounts treated the Braemar leases as operating leases not finance leases, in the same way as had been done in the company's 2008 accounts. The parties did not agree either set of accounts; it does not matter why. This led to the appointment of Mr Pughe.
16. The joint letter of 2 March 2011 appointing Mr Pughe as expert included the following:

"Our respective clients are parties to the Agreement. They cannot agree on the balance of the Consideration to be paid for the sale and purchase of Ms Shafi's shares in the Company. The disagreement revolves around those items which are assets and liabilities of the Company and whether the prepared accounts comply with the accounting terms and policies of the Agreement, and as such, whether they are to be included in the Completion Accounts.

Terms of Appointment.

Pursuant to Clause 6.5.1 of the Agreement, it has now become necessary to refer the matter to an Independent Accountant to resolve this dispute, subject to strict reference to the Agreement to the parties' wish to jointly instruct you in this matter on the following terms:

1. Upon you accepting this appointment, the parties shall make written submissions to you within seven days of such appointment becoming effective, on the issues of:

1.1 The Completion Liabilities and assets of the Company as provided for in the Agreement."

There were two other matters, but they are not relevant.

17. The letter also instructed Mr Pughe as follows:

"Your decision on the matters you are asked to determine shall be final and binding on the parties."

The parties attached the May and July 2010 draft completion accounts to their joint letter of instruction, as well as the Braemar leases and the company's accounts for the periods 2007 to 2009.

18. The parties made written submissions to the expert. The appellant submitted that the Braemar leases were for equipment for the company's business and rental payments had always been discharged by the company as the equipment was used by the company. They were thus properly omitted from the balance sheet because they were operating and not finance leases.
19. A meeting was held between the expert and the parties' representatives on 10 May 2011, following which the expert reported to the parties in part as follows:

"Completion liabilities

We all agreed that the overriding accounting policies under the Agreement are in Part III of Schedule 4.

The Completion Liabilities are dealt with in clause 2.1 which states

'liabilities shall include [and he sets it out].'.

We agreed that if I were to determine that the leases are operating leases, then they would not properly fall to be deducted from any calculation of consideration under the Agreement.

If I were to determine that the leases are Finance leases, the issue is whether the future payments due are 'payable by the reference to the period up to and including the Completion Date'.

Please include in your submissions clarification of this clause."

20. On 21 June 2011 the expert wrote again to both parties. In his letter, he explained that he considered that the Braemar leases were finance not operating leases. Thus their treatment in the company's June 2008 accounts, as well as in the draft completion accounts, was wrong and did not comply with FRSSE. He said that his interpretation of the agreement was that he could not amend the June 2008 accounts, yet it was impossible for a determination to be made under the terms of the agreement when the accounts which are, as he said, the starting point for the agreement, are not FRSSE-compliant. He asked for the June 2008 accounts to be amended to treat the Braemar leases as finance leases, or for the parties to agree that he could amend the accounts himself to treat the leases as finance leases. The expert's conclusion that he needed to amend the June 2008 accounts was based on his interpretation of the agreement, namely that he was bound to treat the leases in the way treated there unless and until the company's June 2008 accounts were amended.
21. The parties did not agree to either alternative suggested by the expert. The appellant's position in her letter of 1 July 2011 was that the Braemar leases had been properly treated as operating leases and the expert had to follow that treatment.
22. On 4 July 2011 the expert issued his determination. His findings were:

i) He had discussed the matter of the Braemar leases with the company's accountants who now accepted they were finance and not operating leases. They had never previously seen full copies of the leases;

ii) His determination was accordingly that the Braemar leases were finance leases and the 2008 accounts had not been properly prepared under FRSSE;

iii) There was no mechanism under the agreement for him to amend the 2008 accounts, although they had not improperly prepared, and according to him formed the basis of the agreement;

iv) Accordingly he could not take account of any lease liability.

23. The expert proceeded to determine the share consideration under these constraints.
24. The claimant considered that, applying the expert determination, a sum of nearly £70,000 was payable to her. The respondent did not accept that the expert's determination was enforceable. The claimant consequently issued proceedings against the defendant seeking a declaration that the defendant was bound by the determination. On 19 April 2013 His Honour Judge Raeside ordered a preliminary issue to be tried, namely "whether the determination of Richard Pughe is valid and enforceable so as to bind the parties."
25. It was this issue which came before the deputy judge. The parties did not file any witness statements, but simply made written submissions based on the documents.
26. The main issue between the parties therefore concerns the proper construction of paragraph 1.4 of Part II of Schedule 4. The appellant says that the expert was right to interpret it as requiring him to treat the Braemar leases in the same way as they had been treated in the 2008 accounts. The respondent says that the expert wrongly interpreted his mandate or instructions: paragraph 1.4 did not require him to carry forward an incorrect treatment of the Braemar leases.
27. The deputy judge concluded that:

i) (paragraph 12 of the judgment) the question of how the Braemar leases were to be categorised and the impact of that upon the completion liabilities was a matter that came within the scope of the expert determination and in particular within paragraph 1.1 of the letter of instruction;

ii) (paragraph 12 of the judgment) the completion accounts should have taken account of the proper treatment of the Braemar leases applying FRSSE, given that they were to be prepared in accordance with the accounting policies, principles, practices and procedures adopted in the preparation of the accounts, such accounts having been expressly stated to have been prepared on the basis of FRSSE;

iii) (paragraph 13 of the judgment) when clause 1.4 refers to "the accounting policies, principles, practices and procedures adopted in the preparation of the Accounts," it was referring to the policies et cetera used by the profession generally on which those accounts are stated to be drawn up, not to the way in which the company has actually applied those policies;

iv) (judgment paragraphs 14 to 15) the argument that the parties should be taken to have negotiated the figure of £136,500, taken as the starting point for the consideration on the basis that there had been correct treatment of the Braemar leases, and that it was therefore incorrect and unfair to treat them differently when calculating liabilities, should be rejected. It was equally possible that the parties may have arrived at a figure on a somewhat imprecise basis in the agreement, and then embarked on a more precise adjustment process to arrive at what is intended to be the correct figure. In that context, the significance of the starting figure lacked force;

v) (judgment paragraph 15) a much stronger commercial argument was that the parties cannot seriously have expected the expert to proceed on the basis that, although the previous set of accounts were expressly stated to be prepared according to a particular policy, and that policy was erroneously applied, one then ignores the correct implementation of the policy;

vi) (judgment paragraph 17) the expert had committed an error in considering he was prevented from embarking on the task of applying the correct policy. This was an error in interpreting his jurisdiction, or, putting it a different way, was a material departure from the scope of his instructions. The error justified the intervention of the court.

28. The judge was, if necessary, prepared to have gone further and hold that the expert committed a manifest error.
29. In the light of his conclusions, the judge did not have to decide the question whether the report was "final and binding", given the reservation in paragraph 1.5 of the report, but he doubted whether it was final or binding.
30. The judge accordingly decided the preliminary issue by declaring that the expert determination was not valid and enforceable.
31. On this appeal, the appellant says that the expert did not commit the errors which the judge found. The respondent supports the judge on those issues and, in the alternative, raised the lack of finality by her respondent's notice.
32. In his written submissions, Mr Latimer repeats the arguments which the judge rejected, namely:

i) that the figure of £136,500 in clause 4.1 represents the bargain struck between the parties on the basis of the annual accounts of the company in their possession, which were prepared on the basis that the Braemar leases were operating leases

ii) that paragraph 1.4 of Part II of Schedule 4 means the policies adopted in fact, not those which might have been adopted, and that the judge had erred in adopting the construction which he did.

33. Mr Latimer expanded on the construction of paragraph of 1.4 in the following way. He relied heavily on the fact that the clause required the application of practices as well as policies, principles and procedures. What would be the point, he asked, of including the word "practices" if it was not the parties' intention to add something to those other words? He also relied heavily on the use of the word "adopted" contending that it must mean adopted in fact. He also submitted that the judge elevated paragraph 1.5, which relates to general accounting practice, above the earlier and more specific paragraph 1.4 when he should have done the reverse.
34. There are a number of specific answers to these points. Firstly, the word "practice" is just as apt to refer to a rule as it is to something actually done "in practice". Accountants commonly make statements of accounting practice, by which they mean statements of the rules used in conducting the accountancy exercise. Those who remember the old Rules of the Supreme Court will know that it was referred to as the Supreme Court Practice and later the Senior Court Practice. It is a set of rules.
35. Secondly, the place of the word "practice" in the paragraph, as it is after "policies" and "principles" and before "procedures", is consistent with practices and procedures being used to fill in gaps not resolved by policies and principles. I reject the suggestion that the more specific word "practices" must govern in the case of conflict with policy. One only has to think of an error consisting in adding a zero to a sum in the accounts repeated year-on-year to see why that cannot be so.
36. Thirdly, I would not attach the weight which Mr Latimer seeks to attach to the word "adopt", which seems to me to be, putting it at the best from his point of view, neutral. The question is whether it means "purported to be adopted" or "stated to be adopted" on the one hand or "adopted in fact" on the other.
37. I am also not persuaded by Mr Latimer's point about paragraph 1.5. It is based on paragraph 13 of the judgment where the judge said this:

"It seems to me when referring to accounting policies, principles practices and procedures in paragraph 1.4 in Part II of Schedule 4, the agreement is referring to matters of policy or practice or procedure within the accounting profession generally, which the company has stated that it is expressly adopting for the purposes of its financial statement."

38. Mr Latimer has, it seems to me, seized rather unfairly on the judge's use of the term "accounting profession generally" when read in context, what he is referring to is the accounting policy, practice or procedure which the company has stated that it is adopting in its financial statements. Viewed in that way, the judge is not giving priority to general methods of accounting over paragraph 1.4; he is simply doing no more than applying 1.4 itself.
39. I think without intending the least disrespect to Mr Latimer's well sustained submissions, the question can be asked and answered at a rather higher level. What, against the relevant factual background, were the parties using the language of paragraph 1.4 to mean? Did they mean the liabilities of the company should be computed by reference to correct accounting policy, supplemented if necessary by reference to practices adopted, or did they mean that they should be computed according to such policies except where contradicted by the actual treatment of those liabilities in the 2008 accounts, whether that treatment was right or wrong?
40. In my judgment, the judge was right to accept the first of those alternatives for essentially the reasons he gave. The completion accounts were to provide the final adjustment between the parties of the consideration for the sale of the shares. For my part, I can see no reason why in those circumstances they would have wished to carry forward erroneous accounting treatment of liabilities. Rather, they would have been seeking to reflect, at least so far as the liabilities are concerned, the reality of the situation. It is true that the agreement had started off from a roughly negotiated figure of £136,500, from which the liabilities were to be deducted, and that it may have been the case that reliance by the parties was placed to some degree on the company's accounts in arriving at that figure. Whether they did in fact, we do not know. But, like the judge, I do not find that consideration as compelling as the considerations which favour the respondent's construction of the agreement.
41. There was no dispute that if the expert was wrong to conclude that his computations were constrained in the which he concluded they were, then this was a case in which it was appropriate for the court to intervene. It is therefore not necessary to decide between the alternatives of misinterpreting jurisdiction and manifest error.
42. In the result, I would for my part dismiss the appeal. I would leave the judge's order directing a fresh determination on the correct principles in place.
43. LORD JUSTICE UNDERHILL: I agree.
44. LADY JUSTICE GLOSTER: I also agree.