England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION

		28th October 2009

1. This is an application for summary judgment by the Claimants on their claim for a declaration as to the meaning of a price calculation clause in a Shareholders Agreement.
2. The Defendant contends that the explicit language of the disputed clause produces a commercially absurd result and that the court should give it a meaning that reasonable people in the position of the parties at the time of the contract objectively would have intended even though that involves some violence to the language. So the case concerns the application of the very recent guidance by the House of Lords in Chartbrook v Persimmon Homes [2009] UK HL38.

Background

3. The Claimants were shareholders in Solent News Distributors Limited ("Solent News") a company which distributed newspapers and magazines in the South of England. The Defendant ("Surridge Dawson") competed with Solent News until in May and July 1995 the parties entered into a Merger Agreement and the Shareholders Agreement ("the Agreement"). The effect of these agreements was as follows. The Claimants sold their shares in Solent News to SD Trade Company, a special purpose vehicle, in exchange for shares in that company and £1.5 million loan notes. Surridge Dawson transferred its Winchester and Southampton businesses to SD Trade. Solent News then transferred its business into its new parent (now renamed Solent SD Limited). The new company would be owned 50% by each party. As a term of the Merger Agreement the parties entered into the Agreement and the merged business was thereafter managed by Surridge Dawson.
4. It was against that background that the parties entered into the put option in clause 9.3 of the Agreement for the Claimants to dispose of their shares to the Defendant three months after giving notice to that effect. The First Claimant gave notice under the put option on 3 February 2009 and the remaining Claimants did so on 16 February. Calculation of the price to be paid on exercise of the option has given rise to this dispute. I next set out the disputed clause which must of course be seen against the background and in the context of the other provisions of the Agreement.

The disputed clause

"9.3 Buy Out-

9.3.1 Three months written notice ("the Notice") must be given by the Solent Shareholder specifying the number of shares to be sold.

9.3.2 Subject to the adjustment mentioned in clause 9.3.3 below the price per share will be the greater of:

(i) £21.25 x R P I Sale

R P I '95

where "RPI '95" is the General Index of Retail Prices in July 1995 and "R P I Sale" is the General Index of Retail Prices on the date of the giving of the Notice

and

(ii) £           __ "Profits" x 6___

Total number of Issued Shares in the Company

where "Profits" is:

(a) Nil if the Notice is given before 30th June 1996

(b) The pre-tax pre-management charges profit for the year ended 30th June 1996 as certified by the Company's Auditors if the Notice is given between 1st July 1996 and 30th June 1997

(c) and otherwise is the average of the pre-tax pre-management charges profits as certified by the Company's Auditors for the two most recent completed years of the Accounts of the Company at the time of the giving of the Notice

9.3.3 (i) The provisions of this clause shall only apply if at the date which is three months after the giving of the Notice the Company has lost Publishers Contracts and/or is aware (following the receipt of written notice) that it is about to lose Publishers Contracts ("the Lost Agencies") to the extent that the turnover of the Company has been and/or will be reduced by 10% or more of the total of the turnover set out in the Schedule hereto

(ii) In such event the price per share set out in clause 9.3.2 (ii) shall be reduced by the same proportion as the turnover of the Lost Agencies bears to the total turnover set out in the Schedule hereto."

5. The schedule to the Agreement is headed "Estimated turnover for the year ended 31/12/94" and it sets out turnover referable to contracts with publishers for the merged business amounting to £29,319,535. The Publishers Contracts referred to are those set out in the schedule and which are defined in the interpretation clause as "Contracts entered into by the publishers of newspapers, magazines and periodicals for wholesale distribution of the publishers' products by Solent News Distributors Limited and the Southampton and Winchester branches of Surridge Dawson on 25 November 1994 which contracts including their turnover are set out in the schedule hereto". As a result the reduction mechanism applies if by the date three months after the option is exercised there is a loss of turnover from the actual or prospective loss of those contracts so that the turnover generated by them as identified in the schedule falls by at least 10%. The Company has recently received notice of losses of agency contracts potentially triggering the application of the reduction mechanism.
6. The price per share under the R P I basis in 9.3.2(i) will be higher than the profits basis whichever parties' approach is preferred. The question is whether the reduction mechanism in 9.3.3 applies, despite what it says, to 9.3.2(i) as well as or instead of 9.3.2(ii). If that mechanism applies the price will be £2,673,940 instead of £5,142,195
7. The evidence before the court consists of the agreed bundles of documents and statements from Mr Barker and Mr Hill of the Claimants' solicitors and from Mr Redding of the Defendant and Mr Thomas from the Defendant's solicitors. It is common ground that much of the material in the statements is inadmissible to the questions of construction before the court. However some of it is helpful factual matrix material. There is no claim for rectification. I proceed on the basis that the Agreement contains no mistake or error of a kind that would justify rectification.
8. Although this is an application for summary judgment the parties are agreed that I should decide the central point of construction and not simply evaluate it to a "real prospect of success" standard.

The Law

9. Before turning to the competing submissions of the parties I summarise briefly the relevant legal position which is not in dispute and involves application of the cases on construction daily before the court reaffirmed by the House of Lords in Chartbrook v Persimmon Homes. I need do no more than set out the following from the speech of Lord Hoffmann;

"14. There is no dispute that the principles on which a contract (or any other instrument or utterance) should be interpreted are those summarised by the House of Lords in Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896, 912-913. They are well known and need not be repeated. It is agreed that the question is 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. The House emphasised that "we do not easily accept that people have made linguistic mistakes, particularly in formal documents" (similar statements will be found in Bank of Credit and Commerce International SA v Ali [2002] 1 AC 251, 269, Kirin-Amgen Inc v Hoechst Marion Roussel Ltd [2005] RPC 169, 186 and Jumbo King Ltd v Faithful Properties Ltd (1999) 2 HKCFAR 279, 296) but said that in some cases the context and background drove a court to the conclusion that "something must have gone wrong with the language". In such a case, the law did not require a court to attribute to the parties an intention which a reasonable person would not have understood them to have had.

15. It clearly requires a strong case to persuade the court that something must have gone wrong with the language and the judge and the majority of the Court of Appeal did not think that such a case had been made out. On the other hand, Lawrence Collins LJ thought it had. It is, I am afraid, not unusual that an interpretation which does not strike one person as sufficiently irrational to justify a conclusion that there has been a linguistic mistake will seem commercially absurd to another: compare the Kirin-Amgen case [2005] RPC 169 at pp. 189-190. Such a division of opinion occurred in the Investors Compensation Scheme case itself. The subtleties of language are such that no judicial guidelines or statements of principle can prevent it from sometimes happening. It is fortunately rare because most draftsmen of formal documents think about what they are saying and use language with care. But this appears to be an exceptional case in which the drafting was careless and no one noticed...

20. It is of course true that the fact that a contract may appear to be unduly favourable to one of the parties is not a sufficient reason for supposing that it does not mean what it says. The reasonable addressee of the instrument has not been privy to the negotiations and cannot tell whether a provision favourable to one side was not in exchange for some concession elsewhere or simply a bad bargain. But the striking feature of this case is not merely that the provisions as interpreted by the judge and the Court of Appeal are favourable to Chartbrook. It is that they make the structure and language of the various provisions of Schedule 6 appear arbitrary and irrational, when it is possible for the concepts employed by the parties (MGRUV, C & I etc) to be combined in a rational way….

25. What is clear from these cases is that there is not, so to speak, a limit to the amount of red ink or verbal rearrangement or correction which the court is allowed. All that is required is that it should be clear that something has gone wrong with the language and that it should be clear what a reasonable person would have understood the parties to have meant. In my opinion, both of these requirements are satisfied".

It is also particularly instructive to read the later paragraphs about "correction of mistakes by construction"

Submissions of the Parties

10. Mr Downes for the Claimants submits that the starting and finishing point is to give the words in issue their natural and ordinary meaning. No other meaning can be attributed to those words unless they would "flout business commonsense" which is not the case here. He emphasises that the fact that a contract may appear unduly favourable to one party does not of itself mean that something has gone wrong with language. Moreover he says the clause makes commercial sense as it stands. The buy back option is referable to the future profits of the business except that if the turnover falls below 90% of the level expected in 1994 the price will be adjusted to reflect this fall. However the Claimants were guaranteed to get their money back adjusted for inflation. Essentially the Defendant was promising that its management of the business would not lead to an erosion in the real value of the Claimants' original investment. That does not approach being nonsensical and clause 9.3.3(ii) should mean precisely what it says.
11. Mr Thompson for the Defendant takes as a threshold issue the question whether the period over which a loss of turnover as a result of loss of Publishers Contracts is the period between July 1995 and three months after notice exercising the option is given or simply the three month period after the giving of notice. He contends that it is the entire period for three reasons. First if the shorter period had been intended there would have been reference to a period explicitly between the giving of the notice and the end of the 3 months. Secondly the structure of the reduction mechanism requires the period to be the same as that over which the loss of turnover is calculated ie from July 1995. Thirdly the more limited period would, if applied, produce an absurd result. The profits formula operates by reference to the accounts of the previous two completed years with a year end of 30 June. A loss of turnover within a completed year will be reflected in that year's accounts. A loss within the 3 month period after notice will be reflected in the application of the formula. However a loss sustained in the period between the year end and the giving of notice would result in no adjustment at all. Mr Downes responds that the natural construction is to limit the period to that in which notice is current. He suggests that words like "has been" connote recent events and submits that in the real commercial world a Claimant will give notice at a point where he has up to date data before the year end.
12. Although my ultimate decision would be the same on either construction I should state my view on which of the two periods should be preferred. The matter must of course be looked at as at the time the contract was entered into and the provisions examined as a whole and simultaneously. It is a broader exercise than taking as Mr Thompson does the question of the period and then using the answer to that to resolve the main issue. As I see it there is symmetry between the three months notice and the same period being used in 9.3.1 and in 9.3.3(i). "Has lost" and "has been" is more consistent with a period being shorter rather than longer. It is also improbable that the loss of contracts would need to be addressed specifically for periods when this financial setback has already been reflected in past annual accounts. The anomaly of losses not being reflected if they occur between the year end and the giving of notice is more minor than that which arises if the period is the longer one. It is common even for professionally drafted commercial agreements to contain anomalies and flaws resulting from drafting errors, from the parties and their advisers not thinking through thoroughly all aspects of a complex transaction or from the messy product of negotiation and compromise. I shall return to that point.
13. Mr Thompson relies first upon the inadequacies of the adjustment mechanism when applied to the profits formula and secondly on its readiness of application and perfect fit with the RPI formula. He submits that if the adjustment mechanism is triggered by a loss over the entire period since July 1995 its application would be perverse. Losses of turnover occurring prior to the last completed year end would be adjusted for anyway in the profits figure derived from the accounts. Application of the mechanism would thus involve a double counting of that reduction. If the Claimants' approach is preferred the result is the anomaly to which I have already referred if the loss of turnover takes place after the last year end but before notice.
14. In contrast he points to the common base date of both the RPI formula and the adjustment mechanism being the date of the agreement. The RPI formula is based on the value of the shares in July 1995 adjusted for inflation and the benchmark for loss of termination is the same date that set out in the schedule. He says the commercial purpose of the adjustment mechanism was to limit the price payable to the Claimants under the "option" if the company has suffered significant losses of turnover from loss of the Publishers Contracts. If the adjustment mechanism is not applied to the RPI formula the Claimants have a guaranteed payment of the value of the shares in July 1995 adjusted for inflation with no risk of loss but with the opportunity for gain by invoking the profits formula when exercising the option. Mr Thompson submits that this amazingly generous price structure cannot have been intended.
15. In response Mr Downes relies first upon what he submits is commercial sense. The RPI formula is not absurd but reflects a return far less that that which an investor in a private company would expect from a medium term investment. He also identifies a series of different situations in which the application of the reduction mechanism to the profits formula would be logical and commercial. These in turn are contested by Mr Thompson.

Decision of the Court

16. The factual matrix is commonplace with a background of parties entering a merger for a variety of reasons and with a range of bargaining strengths and weaknesses. The merger is recorded in a pair of relatively complex agreements containing terms which were no doubt heavily negotiated. It is clear and understandable that those drafting the Agreement did not subject the potential meaning of the clauses to the same full and exceptionally able analysis they have received from Counsel in this case. There are what appear to be anomalies which result, no doubt, not only from what with the wisdom of hindsight are seen to be shortcomings in drafting but also from bargaining and compromise. That is often the case with commercial contracts and the parties often then shape what they do and when they do it to navigate around or exploit difficulties created by the drafting. In this case the subjective intentions of the parties are of course inadmissible but one sees from the evidence and infers from the absence of a claim for rectification that there is disagreement between them about what they had in mind when agreeing the clause in dispute. But of course for the purpose of construction one assumes that they agreed and derives that agreement from the words used in the contract set against the background and in the context of the deal as a whole.
17. The reduction in price per share is explicitly limited to 9.3.3(ii). The parties have, for whatever reason, opted to choose not simply "9.3.2", certainly not "9.3.2(i)" but 9.3.2(ii). They have done so in the course of being advised by solicitors on both sides who in the usual way will have carefully checked and cross checked, among other things, the references in clauses of the Agreement to other clauses and to definitions. I recognise that there are 'exceptional cases' in which 'the drafting was careless and no one noticed' (Chartbrook Para 15). But on the face of things there is no doubt about the natural meaning of the words chosen and no room for inferring an obvious mistake. There is no obviously wrong date or number. Applying the reduction mechanism to the profits formula and not to the RPI formula may be favourable to the Claimants but it does not make the structure arbitrary and irrational as in Chartbrook, there are no competing natural meanings as in ICS , nor obvious defects of omission.(see Homburg Houtimport-v-Agrosin [2004] 1 AC 715.)
18. There are anomalies in the application of the reduction mechanism to the profit formula in 9.3.(ii) but these are minor , particularly when considered in the context of what I hold to be the shorter not the longer period in 9.3.3(i). Those are precisely the type of anomalies which are daily resolved by purposive commercial construction should a snag materialise. Furthermore there is a commercial logic in the contract being held to mean what the Agreement says when it relates to a reduction in turnover, a more natural aspect of a profits calculation than of one related to the RPI.
19. I accept that the reduction mechanism can be applied to the RPI formula without difficulty. That is one pointer in the direction of Mr Thompson's argument but a difficulty of application in the profits formula warrants a purposive interpretation to that clause in context and not necessarily one that abandons the explicit language and substitutes a different formula.
20. The issue is not whether I prefer Mr Thompson's approach to construction to that of Mr Downes. It is first whether there is an error or absurdity produced by the ordinary meaning of the language used and, secondly, if there is, whether it is clear that reasonable people in the position of the parties at the time would have objectively intended, in effect, that reference in 9.3.3(i) to 9.3.2(ii) should be to 9.3.2(i). On the face of things neither requirement is met. It is just another case where a particular provision may appear generous. Whether it actually is generous depends on many factors. I cannot usefully evaluate, and should not, the rival contentions about the commercial good sense or the economic consequences of the clause being applied to one formula rather than the other. It would be impossible, without much more evidence, to work out who was getting a good or bad deal. The superficially favourable RPI formula could be the result of concessions in other areas. The comparative benefits to the merger of particular assets being injected and the particular synergy and value in the merged operation are unclear. So is the whole question of who needed or wanted the merger most. These are not matters which Judges are well equipped to evaluate, certainly without a considerable amount of additional evidence. The very fact that such an investigation would be required illustrates that this is not the category of case where relief based on Chartwell can or should be granted. If these provisions could be opened up, so too could those in countless other contracts with unfortunate results for the certainty at the heart of English contract law.

Conclusion

The Claim succeeds and the Claimant may have a Declaration in terms to be agreed or determined by the Court. I shall be grateful if Counsel will let me have corrections of the usual kind as soon as convenient and a draft order and a note of any other matters requiring decision, not less than forty eight hours before this judgment is handed down.