England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION

		Royal Courts of Justice Strand, London WC2A 2LL
		10 February 2006

Mr Michael Furness QC:

1. This is an appeal from an order of Deputy Master Jefferis made on 2 November 2004. The issue before the Deputy Master was the basis on which an account should be taken of sums owed by the first and second respondents to the appellant, Mr Beaver. The first and second respondents, Mr Cohen and Mr Cooper, are disqualified accountants who used to work as self employed consultants to Mr Beaver. The third respondent Davis Bonley ('the firm') is a firm of chartered accountants for whom Mr Cohen and Mr Cooper now work. Permission to appeal was given by Warren J on 19 May 2005, but restricted to a limited range of issues.

The factual background

2. Mr Cohen and Mr Cooper used to be chartered accountants. In the late 1980s they were prosecuted, and convicted of accounting offences. As a result, they were, and remain, disqualified from professional practice. Notwithstanding their convictions it appears that they both retained a loyal following of clients, who valued their services. The problem for Mr Cohen and Mr Cooper was that in order to continue to make a living working for their clients they needed to be engaged as employees or consultants by a firm of chartered accountants, or an individual chartered accountant.
3. For two years from December 1989 Mr Cohen and Mr Cooper practised in partnership with Mr Beaver. When that partnership had to be dissolved Mr Beaver went into partnership with another accountant, a Mr Artman. Mr Cohen and Mr Cooper thereafter provided professional services to that partnership as self-employed contractors. Mr Artman left that partnership on 30 June 1992, and thereafter Mr Cohen and Mr Cooper provided their services to Mr Beaver practising as a sole practitioner.
4. When the partnership between Mr Beaver, Mr Cohen and Mr Cooper was dissolved Mr Beaver (before taking Mr Artman into partnership with him) acquired the assets of the former partnership. The consideration for Mr Cohen and Mr Cooper's share of those assets remained outstanding as a loan from them to Mr Beaver. There is no doubt that this was a genuine sale, and a genuine loan. Nor is there any doubt that after the partnership was dissolved Mr Beaver (save for the relatively brief period when Mr Artman was his partner) was treated as the sole owner of the practice by all parties. He alone was liable for the overheads, and he alone was responsible for the professional conduct of the practice.
5. The basis on which Mr Beaver paid Mr Cohen and Mr Cooper for goodwill and work in progress are of some importance, because both the parties and the Deputy Master have sought to draw inferences from the approach taken then in forming their views on the basis of valuation for the account now being taken. In summary the position in 1991 was this. For goodwill, Mr Beaver paid a sum computed on the basis of payment for each client of the practice as at the date of dissolution of the partnership. No adjustment was made to that sum as a result of clients subsequently dying or becoming insolvent before generating any work for Mr Beaver. On work in progress Mr Beaver paid the cost to the partnership of the work in progress at dissolution. This was done by taking the gross figure for outstanding fees at that date, and reducing them by an amount which represented the time partners had spent in earning them. Then a further deduction was made of 30 per cent for the risk of fees being unrecoverable and then 60 per cent of the net sum was deducted as representing the profit element in the fees. In consequence Mr Beaver paid the partnership a sum representing the cost (in terms of overheads, staff costs and so forth) incurred in earning the outstanding fees.
6. It is, I think, important to bear in mind two further aspects of the agreement reached in 1991. The first is that Mr Beaver agreed to pay Mr Cohen and Mr Cooper a fixed level of remuneration for the future. The second point is that no agreement was reached as to the terms on which Mr Cohen and Mr Cooper might in due course go their separate ways. In particular no agreement was reached as to what should happen if they took some or all of the practice's clients with them,
7. In 1996 relations between Mr Cohen and Mr Cooper on the one hand, and Mr Beaver on the other became strained. By the end of August 1997 Mr Cohen and Mr Cooper had stopped providing services to Mr Beaver and were working for the firm. Mr Beaver sought payment for the work in progress which Mr Cohen and Mr Cooper took with them to the firm, and also for the goodwill associated with the clients who followed Mr Cohen and Mr Cooper to the firm. There is no doubt that this work in progress and goodwill did belong to Mr Beaver at the point at which Mr Cohen and Mr Copper stopped working for him, because Mr Beaver was the sole proprietor of the practice.
8. This dispute over payment resulted in the present proceedings. Mr Beaver claimed an account. Mr Cohen and Mr Cooper defended the claim, arguing that as there was no concluded agreement for the payment of compensation to Mr Beaver no compensation was in fact payable. The action came on for trial before Mr Bernard Livesey QC, sitting as a deputy judge of this court. During the course of the hearing Mr Cohen and Mr Cooper submitted to an order for an account of the sums owed to Mr Beaver in consequence of their moving to work for the firm. This account included an account of the payment due for goodwill and work in progress. However, because the trial was not concluded and no findings of fact had been made as to the terms of the arrangements between the parties, the order for the account did not specify the basis on which the assets and liabilities subject to the account were to be valued.
9. Accordingly, the hearing before the Deputy Master was devoted to issues as to the principles on which the account should be taken. At that hearing no expert evidence was adduced as to the appropriate basis for valuing goodwill or work in progress. The Deputy Master, therefore, with the agreement of the parties, set about determining a reasonable basis of valuation having regard to current circumstances and the past history of the matter. The Deputy Master gave judgment on 2 November 2004. So far as relevant to the issues raised on this appeal the Deputy Master's order of the same date reads as follows:

1. In the account ordered to be taken by Mr Bernard Livesey QC (sitting as a deputy High Court judge) on 20 June 2003 the following items shall be valued in accordance with the principles hereafter set out.

Goodwill

(a) The goodwill acquired by [Mr Cohen and Mr Cooper] from [Mr Beaver] in 1997 shall be valued on the basis of recurring annual fees paid by former clients of [Mr Beaver] who transferred to the Defendants (or any of them) save where the client:

(i) died; or

(ii) was made bankrupt or wound up after August 1997.

(b) Where a former client of [Mr Beaver] transferred to the defendants (or any of them) before an annual fee had arisen, an estimate shall be made of what the recurring annual fee attributable to that client would be.

(c) In assessing the recurring annual fee attributable to a client no account shall be taken of recurring, one-off work.

Work in progress

(a) The work in progress acquired by Mr Cohen and Mr Cooper in 1997 shall be valued at cost by deducting from the gross book value:

(i) the value of Mr Beaver's and Mr Cohen and Mr Cooper's time; thereafter

(ii) 30 per cent in respect of excess or unchargeable time and bad debts; thereafter

(iii) 60 per cent in respect of profit

(b) No account shall be taken of the value of work in progress relating to former clients of [Mr Beaver] who transferred to the [respondents] (or any of them) and who:

(i) died; or

(ii) were made bankrupt or wound up after August 1997.

10. Following this order Mr Beaver sought permission to appeal from Mann J. This was refused on 28 February 2005, but Mr Beaver was given permission to renew his application if he clarified the basis of his appeal. This he did, before Warren J, on 19 May 2005. Warren J gave permission in limited terms. So far as relevant his order reads as follows:

1. [Mr Beaver] do have permission to appeal the order of Deputy Master Jefferis made on 2 November 2004 ... limited to the following issues:

(1) As to the valuation of goodwill:

(a) whether account is to be taken of post transfer events; and

(b) what is meant by former clients of [Mr Beaver] who transferred to the [respondents] (or any of them).

(2) As to valuation of work in progress:

(a) whether gross book value should be subject to deduction of:

(i) the value of [Mr Beaver's] and [Mr Cohen and Mr Cooper's] time; and

(ii) 60 per cent in respect of profits.

(b) whether account is to be taken of post transfer events; and

(c) what is meant by former clients of [Mr Beaver] who transferred to the [respondents] (or any of them).

2. Mr Cohen and Mr Cooper do have leave to cross-appeal on the issues at (1)(b) and (2)(c) above.

Goodwill

11. I turn now to the parties' submissions on the issues raised on this appeal, beginning with goodwill. It became clear in the course of submissions that the two issues on which Warren J gave leave in respect of goodwill are really aspects of the same issue. That issue concerns the test for deciding which clients have transferred their business to the respondents or any of them to such a degree that Mr Cohen and Mr Cooper ought to pay something in respect of the goodwill attaching to their business. There is no appeal from the Deputy Master's decision as to the amount to be paid in respect of each transferring client. The only issue is how to determine the identity of the transferring clients.
12. Mr Green, appearing for Mr Beaver, took as his starting point the proposition that the list of transferring clients should be fixed as at 29 August 1997. That he said was the effective of the transfer, and any risk as to those clients dying or being wound up after that date was a risk which had to be borne by the respondents. He fortified this submission by reference to the fact that in 1991, when Mr Beaver acquired the goodwill of the partnership, no adjustments were made for post transfer insolvencies or deaths. However, Mr Green did accept that in the circumstances of 1997 some reference had to be made to post transfer events because otherwise it would be impossible to determine who had actually transferred to the respondents. He accepted that only those clients who placed business in the way of the respondents over and above any work in progress would qualify as transferring clients. But this of course means that clients who died or who were wound up before placing that business would fall to be excluded from the category of transferred clients. But by taking this view Mr Green is not so far apart from Mr Campbell, who represents Mr Cohen and Mr Cooper. Mr Campbell is also of the view that only those who actually transfer their business to the respondents should be the subject of goodwill payments.
13. It seems to me that if one adopts a test which concentrates on the point at which a client of Mr Beaver places business with the respondents there is no need to incorporate an exclusion for deaths or windings up after August 1997. In my view the most appropriate criterion is whether the client has incurs a liability to pay fees to any of the respondents after 29 August 1997. Any client which does so must be regarded as having taken its business to the respondents, and Mr Cohen and Mr Cooper must pay a sum in respect of the goodwill of that client.
14. Although this point was not canvassed before me, I think that in refashioning the Deputy Master's order in this way I ought to impose a cut-off date, after which the fact that a former client of Mr Beaver instructs one or more of the respondents ought to be disregarded. Otherwise Mr Cohen and Mr Cooper could end up paying for goodwill in respect of a former client of Mr Beaver who transferred to the respondents only recently. I would propose a cut-off date of 29August 1998, although if either party disagrees with this date I will hear submissions after giving judgment.

Work in progress

15. The Deputy Master's order in essence lays down the same basis for valuing work in progress as was adopted in 1991. The respondents are permitted to acquire the work in progress of transferring clients (subject to a deduction for the risk of fees proving irrecoverable) after deducting amounts representing the time spent earning the fees by Mr Beaver, Mr Cohen and Mr Cooper and after deducting 60 per cent of the remainder for the profit element in the outstanding fees. It is important to note that the terms of the permission to appeal are limited to challenging these last two deductions. The starting point of taking the gross fees outstanding at 29 August 1997 and deducting 30 per cent in for the risk of fees being irrecoverable is not subject to appeal. The only issue before me is whether deductions for the relevant individuals' time and for profits should be made.
16. The Deputy Master refers in his order to work in progress 'acquired' by Mr Cohen and Mr Cohen. He used the same terminology as he used in respect of goodwill (as respects those dying or companies being wound up after 29 August 1997) when identifying the clients whose work in progress should be excluded from the computation paid for by the Mr Cohen and Mr Cooper. It is clear that by making a deduction of 30 per cent for bad debts (a decision which is not subject to appeal) the Deputy Master was assuming that Mr Cohen and Mr Cooper must pay in respect of work in progress for clients who transfer by reference to a date before it is known whether they will in fact survive long enough to enable the work in progress to be completed and before it is known if they will in fact pay for the work in progress.
17. It seems to me that work in progress must be acquired by the respondents in respect of those clients for whom they complete the work to the point of being able to invoice for it. To this extent one needs to look at events subsequent to 29 August 1997. As with goodwill, I think that if one adopts this approach there is no need to make express reference to the exclusion of deaths or windings up after 29 August 1997.
18. Mr Green's preferred approach to the valuation of work in progress, on behalf of Mr Beaver, was to look at what has actually happened. He would see how much income the respondents have received form work in progress and apportion the income pro rata on a time basis for the periods before and after 29 August 1997 in respect of which the fees were earned. However, it seems to me to be impossible to adopt this approach in the light of the terms of the permission to appeal. Any approach which starts with a deduction for potentially irrecoverable fees cannot be squared with an approach which looks at what was received in reality. Notwithstanding Mr Green's submissions to the contrary I consider that the terms of the permission to appeal have closed off the possibility of arguing for a pro rata apportionment. I should add that because permission to appeal was granted after an oral hearing it is not open to Mr Green now to seek to extend the ambit of that permission at this hearing (CPR PD 52 paragraph 4.21).
19. The next question is whether it is right simply to deduct 30 per cent from the gross work in progress for clients who transfer to the respondents and then make Mr Cohen and Mr Cooper pay the remaining 70 per cent. The problem I have with this approach is that I can see no justification for adopting it. It is incumbent upon Mr Beaver to show why Mr Cohen and Mr Cooper should pay on such a basis. There is, for example, no evidence that this represents the market value of the work in progress. The 30 per cent deduction is accepted by both sides as a reasonable estimate for bad debts and unbillable time in relation to work in progress, but it by no means follows that a purchaser in the open market would make the same deduction, and, if he would make a larger deduction, I have no means of knowing what that larger deduction would be, I have real doubts as to what value a third party purchaser in the market would in fact have been prepared to pay Mr Beaver for work in progress for clients whose real loyalty, it appears, was not to Mr Beaver's practice but to Mr Cohen and Mr Cooper. While I accept Mr Green's submission that Mr Cohen and Mr Cooper would probably be precluded from soliciting clients from Mr Beaver's practice, the evidence is that a significant number of the clients for whom Mr Cohen and Mr Cooper worked owed their loyalty to them personally, and not to Mr Beaver's practice as such. As I say, there is no evidence as to how the market might respond to a sale of work in progress in these circumstances.
20. The court is in reality left, in the absence of any other evidence, with the approach to the valuation of work in progress adopted by the parties in 1991. I agree with the Deputy Master that the basis on which the parties valued assets when their business association was set up in 1991 ought to form the basis, or at least the starting point, for the same exercise when their association falls to be unscrambled in 1997. This is also the approach advocated by Mr Campbell. As Mr Campbell points out, the court is dealing with a situation in which it has to determine a fair basis for the dissolution of a business arrangement. In the absence of evidence for any other approach there is obvious force in starting from the valuation basis on which that arrangement was set up.
21. There is, however, a difficult issue as to how to transpose the approach taken in 1991 to 1997. In 1991 Mr Beaver, Mr Cohen and Mr Cooper were all principals in the partnership whose goodwill was acquired by Mr Beaver. When ascertaining the cost to the partnership of the work in progress at that date, the time of each of them spent in earning the work in progress was deducted from the value of the work in progress. In 1997 the only principal was Mr Beaver. Clearly the value of his time should be deducted from the gross value of the work in progress in order to arrive at the cost to him of earning that gross figure, as should the 60 per cent figure representing the profit element. But why should the time spent by Mr Cohen and Mr Cooper also be deducted, as the Deputy Master's order provides for? By 1997 the cost of Mr Cohen and Mr Cooper was being paid for by Mr Beaver out of the profits of the business, so why is the cost of their time not treated like any other overhead, and not deducted?
22. Mr Campbell's response to this point is to argue that the essential working relationship remained the same both before and after 1991. Mr Beaver, it is said, provided a structure within which Mr Cohen and Mr Cooper could make a living providing accountancy services to their clients. In return Mr Beaver received the profits of the practice less the monthly sums paid to Mr Cohen and Mr Cooper. Mr Campbell argued that if the court did not replicate the approach to the valuation of work in progress adopted in 1991 Mr Beaver would receive an unrmerited windfall, because he would be receiving a more generous basis of compensation at the end of the arrangement between the parties than he had to pay at the outset.
23. I have sympathy with the windfall argument up to a point. There would to my mind be a windfall if the 60 per cent deduction for the profit element in the work in progress were not deducted. Otherwise Mr Beaver would be acquiring the asset on a cost basis and passing it on for sum which also included the potential profit element. Equally, in order to preserve a cost basis for the valuation in 1997 Mr Beaver must deduct something for the value of his own time. But also to require him to deduct the value of Mr Cohen and Mr Cooper's time seems to me to be wrong in principle, and fails to take account of the real change in the legal relationship under the arrangements in place after 1991. Mr Cohen and Mr Cooper had the benefit of an arrangement under which they were paid for their work without any risk of exposure to liability for the debts of the business. I think it would be wrong now to place a cost on the work in progress which assumes that they have been principals all along. To this extent, therefore, I differ from the Deputy Master.
24. My conclusion on work' in progress is therefore that post transfer events should be taken into account to the extent of seeing for which clients the respondents completed work in progress to the point of being able to invoice for it. As to the quantification of work in progress, the Deputy Master's order (a) should stand save for the deletion of the names of Mr Cohen and Mr Cooper from sub-paragraph (i).
25. The appeal is therefore allowed in part. I will hear counsel on the precise form of order which should be made in consequence of this judgment.