England and Wales Court of Appeal (Civil Division) Decisions

IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE LEEDS COMBINED COURT,
QUEEN'S BENCH DIVISION
HIS HONOUR JUDGE GOSNELL
3YS12212

		Royal Courts of Justice Strand, London, WC2A 2LL
		02/02/2017

Lord Justice Lewison:

1. The main issue on this appeal is whether an additional fee referred to in clause 5.1 (a) of a consultancy agreement between TJH & Sons Consultancy Ltd ("TJH") and CPP Group plc (CPP") is payable as of right or whether CPP has a discretionary power not to pay it. HHJ Gosnell held that CPP had a discretion to decline to pay.
2. CPP is in the financial services business in the course of which it supplies a number of services both to business and to consumers. In about April 2006 Mr Haig was appointed as CPP's UK sales director where he was also based. As sales director he received substantial annual remuneration part of which consisted of bonuses awarded under the discretionary bonus scheme operated by CPP. In early 2011 Mr Haig was told that he was to be promoted to the role of Regional Director with responsibility for Turkey, India and Germany. After his promotion was announced, Mr Haig raised the possibility of leaving his employed position and working for CPP via an independent company as a consultant. There were tax advantages in this course of action both for him and for CPP; and in due course that is what happened.
3. TJH is a company incorporated in the Turkish Republic of Northern Cyprus, where Mr Haig was building a house. It is wholly owned and controlled by Mr Haig. It became the company which entered into the consultancy agreement with CPP. TJH claimed additional fees under the agreement for the years 2012 and 2013; but CPP declined to pay on the ground that the group as a whole was in financial difficulties, claiming to have a discretion to withhold payment. The judge held that CPP was entitled to withhold payment.
4. Although the written consultancy agreement bears the date 2012 it appears to have been made in about March 2011. By clause 2 of the agreement TJH was engaged as consultant and undertook to make Mr Haig available to provide the services defined in the agreement. This obligation was supplemented by detailed provisions in clause 3. By clause 4.1 CPP undertook to pay TJH a fee of £700 per day inclusive of VAT reviewable each year. Clause 5 was headed:

"ADDITIONAL CONSULTING FEES"

5. It provided:

"5.1 Additional consultancy fees will be charged as follows:

(a) An additional annual fee may be payable in March subject to the level of service provided and the impact of this on regional performance. Additional fees may be awarded up to a maximum potential of £99,000 in 2011 and £132,000 in future years. The calculation of the additional fee will follow similar principles to the Regional Director's Annual Bonus Plan operated by CPP.

(b) The following consulting fees will be payable to incentivise continuity of the consultancy services provided by the Consultancy Company…."

6. The clause went on to specify fees to be paid in 2013 and 2014 calculated by reference to gains which would arise over a specified number of share options under certain long term incentive plans operated by CPP.
7. Clause 5 (1) (a) referred to the Regional Director's Annual Bonus Plan operated by CPP. The bonus plan with which we have been supplied was not in fact limited to regional directors. It applied to any employee selected by the remuneration committee "in its absolute discretion" to participate in the plan. "Bonus" was defined in clause 1.1 as "a discretionary cash sum (if any) payable to a Participant under this Plan". Clause 3 provided that the maximum potential bonus in respect of a performance period (i.e. a financial year) expressed as a percentage of annual base salary should be "determined by the Committee, in its absolute discretion" subject to certain maxima. Clause 4 enabled the remuneration committee to set performance targets. These are not defined except by reference to the committee's power to set them. Clause 4.1 required the committee to communicate performance targets to the participants as soon as reasonably practicable after they had been set. Clause 4.2 provided:

"For the avoidance of doubt, the Committee may set more than one Performance Target and Participants may be subject to different Performance Targets."

8. Clause 5 dealt with payment of bonuses. Clause 5.1 provided:

"The maximum amount of Bonus payable to a Participant for a Performance Period shall depend on the extent (if at all) to which the Performance Targets are, in the opinion of the Committee, satisfied over the Performance Period."

9. Clause 5.2 required the committee to notify the participant of the "amount that is potentially payable" but went on to provide that between the date of notification and the date of payment "the Committee may, in its absolute discretion, reduce the amount payable on such basis as it determines." Clause 5.8 provided that:

"For the avoidance of doubt and notwithstanding any Rule or term to the contrary, a participant shall have no right, interest or entitlement to be paid a bonus until it is paid."

10. The general approach to the interpretation of contracts is that laid down by the Supreme Court in Arnold v Britton [2015] UKSC 36, [2015] AC 1619. Lord Neuberger said that the court is concerned to identify the intention of the parties by reference to what a reasonable person having all the background knowledge which would have been available to the parties would have understood them to be using the language in the contract to mean. He continued at [15]:

"And it does so by focusing on the meaning of the relevant words, …in their documentary, factual and commercial context. That meaning has to be assessed in the light of (i) the natural and ordinary meaning of the clause, (ii) any other relevant provisions of the [contract], (iii) the overall purpose of the clause and the [contract], (iv) the facts and circumstances known or assumed by the parties at the time that the document was executed, and (v) commercial common sense, but (vi) disregarding subjective evidence of any party's intentions."

11. He emphasised a number of points. These included:

i) The reliance placed in some cases on commercial common sense and surrounding circumstances should not be invoked to undervalue the importance of the language of the provision which is to be construed.

ii) The court should not embark on an exercise of searching for, let alone constructing, drafting infelicities in order to facilitate a departure from the natural meaning.

iii) Commercial common sense is not to be invoked retrospectively. The mere fact that a contractual arrangement, if interpreted according to its natural language, has worked out badly, or even disastrously, for one of the parties is not a reason for departing from the natural language.

12. In considering the background knowledge which was available to the parties, the court should not rely on the parties' pre-contractual negotiations except for very limited purposes: Chartbrook Ltd v Persimmon Homes Ltd [2009] 1 AC 1101. Those purposes include establishing a fact which may be relevant as background: Chartbrook at [42].
13. The consultancy agreement is clearly not a self-contained document because of the reference in clause 5 (1) (a) to the principles of calculation applicable to the Regional Director's Annual Bonus Plan operated by CPP. It is clear, therefore, that there must be some recourse to extraneous material in order to flesh out the bare bones of clause 5 (1) (a). The question is: what and to what extent? In Tradigrain SA v King Diamond Marine Ltd [2000] 2 All ER (Comm) 542 this court considered the effect of a contract incorporating by reference terms contained in a different contract. Rix LJ said at [78]:

"The first rule relating to the incorporation of one document's terms into another document is to construe the incorporating clause in order to decide on the width of the incorporation. … A second rule, however, is to read the incorporated wording into the host document in extenso to see if, in that setting, some parts of the incorporated wording nevertheless have to be rejected as inconsistent or insensible when read in their new context."

14. It was common ground that this was the approach to adopt.
15. The argument that Mr Ralston advanced for TJH is that the application of the "first rule" leads to the conclusion that the Regional Director's Annual Bonus Plan does no more than inform the principles by which the calculation of the additional fee will be made. A "calculation" is a mathematical concept consisting of a computation. A "calculation" cannot be a discretionary exercise. Once the calculation has been carried out in accordance with the principles in the Regional Director's Annual Bonus Plan, that is the end of the function of that Plan. It is not therefore legitimate to look beyond the method of calculation so as to confer upon CCP a discretion which is nowhere mentioned in the consultancy agreement. In essence I accept this argument.
16. Clause 5.1 begins by saying that additional fees "will be" charged. At first blush that is the language of entitlement. Clause 5.1 (a) goes on to say that an additional fee "may become payable". That language suggests that the payment of the additional fee is contingent. But contingent on what? The answer, at least in this sentence, is that it is "subject to", that is to say contingent upon, the level of service provided and the impact of this on regional performance. No other contingency (such as group performance or the exercise by CPP of a discretion) is specified. This coincides with the language of entitlement at the beginning of the clause. It is also noticeable that the payment is described as an "additional fee" and not a "bonus", so the defined term "Bonus" in the Annual Bonus Plan does not apply. The second sentence of clause 5.1 (a) prescribes the maximum additional fees not only for 2011 but also for "future years." Thus CPP's liability to pay additional fees is capped for the duration of the agreement. The third sentence states that "the calculation" of the additional fee will follow the same principles to the Regional Directors' Annual Bonus Plan. It was common ground that a "calculation" is a mathematical exercise. Principles of calculation do not, in my judgment, envisage an exercise of discretion once the calculation has taken place although there may be elements of judgment in the process of making the calculation. Mr Spalton submitted on behalf of CPP that if, as a matter of discretion, CPP decided to insert "0" as the multiplier in the calculation that would impact on the calculation such that the product of any calculation would itself be "0". I do not accept this argument. Any calculation must be carried out in good faith and the deliberate manipulation of a calculation so that its inevitable result was zero cannot, in my judgment, be what a reasonable person would understand this sentence to mean. Thus far, therefore, I do not see any room for the exercise of any discretion not to pay an additional fee once it has been calculated by reference to the two criteria specified in the first sentence. However, since the third sentence of clause 5.1 (a) refers to the principles applicable to the Regional Directors' Annual Bonus Plan it is necessary to consider where those principles might be found.
17. Clause 5.1 of the Bonus Plan document is as close as it comes to any principles of calculation. But it is in such general terms, that it is of little help in deciding what principles of calculation are to be applied to decide whether the two specified criteria in clause 5.1 (a) of the consultancy agreement have been met. Where is one to look to find out what those principles are (or, perhaps more accurately, what they were at the date of the contract)? There seem to be two possible candidates. The first is the contents of an e-mail which Ms Duducu sent to Mr Haig on 3 February 2011. That described the Bonus Scheme as it was in 2010. It began by describing a "Group Performance Factor" which was measured by reported operating profit calculated under IFRS, excluding exceptional items, and subject to a quality of earnings adjustment as determined by the Group Remuneration Committee. It then went on to say that regional performance would be assessed subjectively following a review of the regional percentage growth, delivery of regional objectives and a judgment of financials against a quality of earnings assessment. This section concluded:

"70% of your bonus potential is based on this factor (of which 80% will reflect the performance of your region unit and the remaining 20% will reflect Group performance."

18. It then went on to refer to an "Individual Performance Factor" and gave details of how that was calculated. This section concluded:

"As noted above, however, this still remains subject to a discretionary minimum group performance level."

19. This appears to have been the only description of the method of calculation of bonus that was sent to Mr Haig or TJH before the contract was signed. The judge also referred to a document to which Ms Johnson (CPP's Group Financial Controller) referred in her witness statement. That document consists of a paper presented to CPP's group remuneration committee on 28 February 2012; that is to say after the contract was made. The principles of calculation described in that paper do not, however, seem to me to be materially different, although it seems to me that the pre-contractual document is the preferable candidate.
20. Although both these documents referred to group performance, clause 5 (1) (a) of the consultancy agreement referred only to "level of service provided and the impact of this on regional performance." There was no mention of group performance. The judge said at [33]:

"The phrase "subject to the level of service provided and the impact of this on regional performance" is relied on by [TJH] to show that the terms of the RD Scheme were changed in relation to this contract to exclude the relevance of group performance to the calculation of the bonus. It is difficult to conceive why that particular phrase was included in the contract at all unless it was intended in some way to amend the terms of the RD Scheme. If it was intended to reflect the strict terms of the RD Scheme it would have said either "subject to performance targets" or "subject to the level of service provided and the impact of this on regional and group performance". That fact that it did not, in my view, means that the intention of the agreement was to restrict consideration of targets to individual and regional performance only with no consideration of group targets."

21. I agree.
22. It follows, in my judgment, that references to group performance in those documents are to be excluded from the principles of calculation applicable under the consultancy agreement. The only discretionary element described by Ms Duducu applied to the group performance level: it was not the articulation of a general discretion to withhold bonus. I do not, therefore consider that this material is enough to displace the natural meaning of clause 5.1 (a) of the consultancy agreement that CPP has no general discretion to withhold an additional fee once it has been calculated according to these principles.
23. The judge, of course, reached a contrary conclusion. In doing so I consider that he made four related errors. First, he placed heavy weight on what witnesses for CPP (most of whom had not been involved in the negotiations) told him CPP intended to achieve. That was corroborated, in the judge's view, by selective e-mail traffic passing between the parties. But the judge's reference to the e-mail traffic failed to distinguish between looking at statements of intention in the one hand, and objective facts known to both parties. In his oral address Mr Spalton did not rely on any of that material in his account of the relevant background, and rightly so. From his review of the e-mail traffic and the oral evidence, the judge approached the interpretation of the consultancy agreement on the basis that it was intended, so far as possible, to replicate the position of an employee. In other words he allowed himself to be over-influenced by surrounding circumstances at the expense of the contractual language. I observe, parenthetically, that at one stage in the negotiations it was proposed that the contract should say that TJH should "participate in the Group Regional Directors Incentive Scheme under its existing terms and conditions" but this was rejected in favour of the final contractual wording. His inference from background about what the parties intended led to his second error. He overlooked a large number of clauses in the consultancy agreement which were inconsistent with that intention. It is not necessary to rehearse them all but among them are clause 2.2 (entitlement to terminate without cause on six months' notice); clause 4.3 (wide powers of set-off or deduction from fees); clause 11.2 (requirement to carry professional indemnity insurance); clause 12.1 (d) (power of summary termination if in CPP's opinion either TJH or Mr Haig was incompetent); clause 12.1 (g) (power of summary termination if Mr Haig was incapable of providing the services for 20 days in any consecutive period of 52 weeks) and clause 14.1 (status of both TJH and Mr Haig to be an independent contractor). This in turn led to his third error. In considering which parts (if any) of the Annual Bonus Plan should be treated as having been incorporated by reference into the consultancy agreement, the judge said that the obvious way to interpret clause 5.1 (a) was that the Bonus Plan should apply "save where those terms cannot apply due to [TJH] not being an employee of [CPP]." In other words the judge determined the incompatibility of the terms of the bonus plan by reference to TJH's status (or more accurately non-status) rather than by reference to the terms of the consultancy agreement itself. Lastly, having correctly said at [33] that at least the first sentence of clause 5.1 (a) was inconsistent with his interpretation he ought to have revisited his interpretation of the clause as a whole.
24. In my judgment, therefore, the judge's interpretation of clause 5.1 (a) cannot stand. I would hold that once the calculation of the additional fee has been carried out applying the principles of the Regional Directors' Bonus Scheme CPP has no discretion to withhold payment. It follows that the question whether CPP wrongly exercised its discretion does not arise.
25. The judge went on to consider briefly what the correct additional fee would have been in the event that his interpretation was wrong. Although Mr Ralston criticised the brevity of his reasoning, his criticism was unfounded. It is no part of a judge's function to give elaborate reasons on points which have been argued but which in his view do not arise for decision, provided that he explains what his conclusion would have been, and why, if they had arisen for decision. In this case the judge held that the "quality of earnings adjustment" was applicable to the calculation of the additional fee. He accepted the evidence of Ms Johnson of CPP about what that expression meant in practice and how it would have been applied to TJH's targets. The material that Ms Duducu supplied to Mr Haig before the contract was made said in terms that in relation to regional performance there would be a "judgment of financials against a quality of earnings assessment". This, in my judgment, was one of the applicable principles of calculation and as the judge noted it was repeated in the remuneration committee paper of 2012. In principle, therefore, CPP was entitled to make that assessment. Ms Johnson explained that, having made that assessment, the regional performance target had been missed. Mr Haig did not challenge her explanation at trial; and indeed said in evidence that he had not even read her detailed explanation. Although Mr Ralston told us that Mr Haig's view (no doubt sincerely held) was that TJH had met its regional target and showed us some material that might have supported that view, the time for advancing that contention was at trial and not on appeal. I do not consider that the judge was wrong in his identification of the applicable principles of calculation or his application of those principles.
26. The judge said that if he were wrong about CPP having a discretion to withhold payment, he would have awarded TJH £39,600 for 2012 and £33,000 for 2013: a total of £72,600. I would allow the appeal to the extent of awarding that amount to TJH with whatever ancillary consequences follow. TJH's challenge to the judge's decision on the counterclaim was abandoned so his award to CPP on the counterclaim stands.

Lord Justice Elias:

27. I agree.