England and Wales High Court (Commercial Court) Decisions

IN THE HIGH COURT OF JUSTICE
QUEEN'S BENCH DIVISION
COMMERCIAL COURT

		Royal Courts of Justice 7 Rolls Building, Fetter Lane London, EC4A 1NL
		11 March 2016

The Hon. Mr Justice Popplewell:

Introduction

1. The Claimant ("Challis") is an English company specialising in the design, manufacture and distribution of a range of water saving products aimed at reducing water and energy consumption and consumer cost. The Defendant, British Gas ("British Gas"), is the well known licensed supplier of gas and electricity. The dispute arises under two successive agreements between the parties relating to a product developed by Challis known as a water widget. The water widget is a device designed to be inserted into shower heads to reduce the flow of water by aerating it, thereby saving energy. In this action Challis claims £1,672,177.49 on the grounds that such sum represents additional carbon credits obtained by British Gas arising out of Challis' supply of water widgets.
2. The agreements were made against the background of the Government's Carbon Emission Reduction Target ("CERT") scheme, introduced to give effect to a reduction in carbon emissions pursuant to the Kyoto Protocol. The CERT scheme originally covered the period between April 2008 and April 2011, but was later extended to 31 December 2012. It was administered on behalf of the Gas and Electricity Markets Authority by the Office of Gas and Electricity Markets ("Ofgem"). British Gas was subject to obligations to promote schemes in domestic households which achieved carbon emissions reductions. The agreements between the parties provided for Challis to supply water widgets directly or indirectly to consumers in a way which enabled British Gas to obtain carbon credits to count towards its obligations.
3. Under the CERT scheme, products which achieved a requisite degree of innovation qualified for a market transformation uplift ("MTU") such that an additional 50% of carbon savings could be attributed to them for the purposes of the energy supplier's CERT target. The water widgets qualified as such innovative products. The dispute between the parties is, in essence, whether on a true construction of the agreements British Gas was obliged to pay to Challis an additional 50% to reflect the uplift in the carbon credit. Challis claims that it was entitled to be paid by reference to the MTU uplift obtained by British Gas from Ofgem in relation to the water widgets. British Gas contends that the agreements contained a fixed price formula which provided for defined payments irrespective of the carbon credits ultimately awarded by Ofgem to British Gas or the application of the MTU uplift.

The Law

4. There is an abundance of recent high authority on the principles applicable to the construction of commercial documents, including Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896; Attorney General of Belize v Belize Telecom Ltd [2009] 1 WLR 1988; Chartbrook Ltd v Persimmon Homes Ltd [2009] 1 AC 1101; Re Sigma Finance Corp [2010] 1 All ER 571; Rainy Sky SA v Kookmin Bank [2011] 1 WLR 2900; Arnold v Britton [2015] AC 1619; and Marks and Spencer PLC v BNP Paribas Securities Services Trust Co (Jersey) Ltd [2015] 3 WLR 1843. The Court must consider the language used and ascertain what a reasonable person, having all the background knowledge which was reasonably available to the parties in the situation in which they were at the time of the contract, would have understood the parties to have meant. The content of such background knowledge is what is commonly referred to as the factual matrix. It is not necessary to find some ambiguity in the language before having regard to the factual matrix, and a consideration of the factual matrix may indicate that the meaning which the parties would reasonably be taken to have intended can be given effect despite the fact that it was not, according to conventional usage, an "available" meaning of the words or syntax which they had actually used. The approach to contractual construction is what Lord Neuberger MR described in Re Sigma Finance Corp [2009] BCC 393 at paragraph [98] as "an iterative process" which involves "checking each of the rival meanings against the other provisions of the document and investigating its commercial consequences", an observation endorsed by Lord Mance in the Supreme Court in that case at paragraph [12].

The CERT Scheme and other background to the Agreements

5. The Electricity and Gas (Carbons Emissions Reduction) Order 2008 ("the Order") required Ofgem to impose obligations on energy suppliers such as British Gas to deliver schemes achieving carbon emission reductions in domestic households between 1 April 2008 and 31 December 2012. Under the Order each large energy supplier was set a carbon emissions reduction obligation by reference to its share of the domestic market (articles 6(1) and 7), which it was obliged to meet by promoting qualifying actions to domestic energy users (article 9). The qualifying actions were divided into four categories, namely demonstration actions, market transformation actions, priority group flexibility actions, and standard actions (article 2(2)). The Order also set out various sub-targets and contained mechanisms to oblige or encourage suppliers to meet their overall targets in particular ways. One of the sub-targets was that 40% of each supplier's overall carbon obligations should be met by actions carried out in a "priority group" (article 13) which consisted of domestic consumers in receipt of certain benefits or aged over 70 (article 2(1)). On 31 July 2010 the Order was amended to include a "super priority group obligation", requiring suppliers to offer measures to a sub-set of the priority group (article 13A).
6. Market transformation actions had to be different from existing measures and significantly more effective in reducing carbon emissions (articles 2(3)(b) and 12(3)(b)). To encourage the use of such measures, the MTU could be applied to them if the supplier so elected, increasing by a uniform 50% the reduction in carbon emission attributed to such actions (articles 15(3)(b) and 19(4)). There was a cap of 10%^[1] of a supplier's overall carbon emissions reduction obligation which was permitted to be met by market transformation actions, applicable across all categories of heating, lighting and insulation (article 9(3)). Market transformation actions which exceeded the 10% cap could still be useful to a supplier as actions generating the relevant reduction in CO₂, but there would be no MTU available in respect of them.
7. Suppliers were obliged to notify Ofgem of any scheme they intended to use to meet their carbon emissions reduction obligations within one month of commencement of such scheme (article 11). The notification had to include sufficient information to show how the supplier intended the action to be within one of the four categories. Under article 12 Ofgem was then obliged to determine whether it approved the action within the particular category and notify the supplier of the decision. It was also obliged under article 15 to provide an estimate of the reduction in carbon emissions for an action it approved as a qualifying action. Article 15(3) provided for MTU to apply to market transformation actions in the following terms:

"(3) To estimate the reduction for a market transformation action, [except a market transformation action which is the provision of a real-time display or a home energy advice package,] the Authority must—

(a) apply to that action the appropriate carbon co-efficient values set out in Schedule 3; and

(b) increase the reduction in carbon emissions expected to be achieved by that action by 50%."

8. Once approved, suppliers were encouraged to report the interim progress of the schemes. Ofgem would then record the interim estimates of resulting carbon emission reductions, in a process known as "banking". Suppliers also had to submit quarterly progress reports.
9. Following the end of the scheme period on 31 December 2012 (as extended), suppliers had to notify Ofgem not later than 31 January 2013 of the number and type of qualifying actions which they had completed in the priority group and outside the priority group (article 19). On receipt of that notification Ofgem had to determine the reduction in carbon emissions to be attributed to those actions, and notify the supplier by 30 April 2013 (articles 19 and 22(1)). In making such final determination, the 50% MTU was provided for in article 19(4) in terms materially identical to article 15(3). Suppliers who failed to meet the targets were susceptible to fines.
10. Before the parties entered into any written agreement, Challis had already been in discussion with Ofgem to establish the carbon saving which could be attributed to the widget if used in the CERT scheme by an energy supplier. This involved supporting scientific evidence, and resulted in Ofgem agreeing on or about 26 January 2010 that the widget would have a carbon saving "score" for the purposes of the scheme of 84.8 kg of CO₂ per year over a life time of 12 years, which was equivalent to 1.10176 tonnes of CO₂ saving per widget. The carbon score was confirmed in a letter from Ofgem to Challis of 28 January 2010.
11. There followed discussion between Challis and British Gas, and joint presentations by them to Ofgem in April and May 2010, seeking approval of the proposed scheme for promotion and distribution of the widgets. Ofgem informally gave its approval to the scheme as a market transformation qualifying action on or about 16 June 2010 (later formally confirmed in a letter of 5 November 2010). By the time of the conclusion of the first of the two agreements between Challis and British Gas on 29 June 2010, therefore, the parties believed that the scheme would qualify as market transformation activity, and had in mind that it was very likely that it would qualify for MTU, which was one of its attractions to British Gas in seeking to meet its obligations under the Scheme. As a result of an express discussion, both parties understood that the carbon score of 1.10176 tonnes per widget was net of any such MTU.
12. Two features of the CERT Scheme are of importance to the current dispute:

(1) The 10% cap on market transformation activity which was permitted to qualify for MTU had been increased from 6% with effect from 21 July 2009 and might foreseeably have been adjusted up or down again during the currency of the agreements between the parties. British Gas might have promoted market transformation actions across all schemes, including heating, lighting and insulation, which exceeded in total the 10% cap (or any modified cap). This was what in fact happened, and was foreseeable by both parties at the time of the agreements as a natural incident of the CERT scheme. The widgets fell within the "heating" category of savings under the scheme, which was a smaller proportion of the savings than lighting and insulation, all of which would potentially contribute towards the 10% cap on claimable market transformation activity. In those circumstances, there would be a decision to be made by British Gas in January 2013, after the end of the scheme period, as to which qualifying actions it chose to notify as making up the 10% for which it claimed MTU. That was entirely within British Gas' discretion. Challis' pleaded case in this action originally included a claim that British Gas was obliged to claim MTU for all widgets supplied by Challis, but that claim was abandoned shortly before the hearing. Mr Challis gave evidence to the effect that the water widget was such an attractive product, and so cost effective as an energy saving device, that it was the common assumption of the parties at the outset that MTU would be claimed on all of them, although he did not go so far as to suggest that anything was said expressly to that effect. I am unable to accept that there was any such common assumption. Mr Challis' evidence was premised on cost effectiveness being judged by the very low cost of manufacture by Challis; but this was not the cost which was relevant to an analysis by British Gas of the relative cost effectiveness of all its different schemes which qualified as market transformation activity; that depended upon the cost to British Gas of paying the suppliers of goods or services. The evidence showed that the water widget scheme was far from the most cost effective to British Gas across its whole programme, and I have little doubt that British Gas made no a priori assumption that all widgets would be used to claim MTU. Nor was Challis justified in thinking that British Gas was proceeding on that basis. Accordingly the agreements fall to be interpreted on the footing that the parties contemplated that it would not be until January 2013 that it would be possible to determine which, if any, of Challis' supply of water widgets contributed to British Gas' MTU uplift.

(2) Leaving aside MTU, there was in any event no certainty about what carbon savings would be attributed by Ofgem to Challis' supply of water widgets until final notification to British Gas of its carbon credits in April 2013, again after the end of the scheme period. Article 15 required Ofgem to provide in advance an estimate of the relevant carbon savings for actions which it approved as qualifying actions, but it was not bound by that estimate when making its final determination under article 19, as was made clear in the official guidance issued by Ofgem in January 2008 at paragraph 6.13. The epithet "banking" as applied to the interim notification process is therefore misleading: it did not mean that credit for carbon savings in those amounts were bound to be awarded by Ofgem. The parties' agreements (at clause 6.4) expressly recognised the possibility of Ofgem recalculating the carbon savings attributable to the widgets during the period of the agreements.

The Agreements

13. The first agreement between the parties was dated 29 June 2010 ("the 2010 Agreement"). Its title was "AGREEMENT FOR CERT CREDITS". British Gas was defined as "the Company" and Challis as "the Supplier". The 2010 agreement provided amongst other things:

"WHEREAS

(A) The Company is a licensed supplier of gas and electricity in the United Kingdom to a range of domestic and commercial customers;

(B) The Supplier specialises in the design, manufacture and distribution across the UK and Europe of a range of water saving products aimed at reducing water & energy consumption and bills;

(C) The Company holds gas and electricity supplier licences and is subject to a Carbon Emissions Reduction Target ("CERT Target"), pursuant to which it is obliged to provide, install or subsidise energy efficiency measures in homes across Great Britain;

(D) As part of meeting the CERT Target, the Company is willing to pay the Payment (as defined below) to the Supplier on the terms set out in this Agreement.

(E) The Parties wish to enter into this Agreement to record the terms governing the relationship between each of them and in respect of the promotion of certain energy efficient products in order to partially fulfil the Company's obligations under CERT and to operate a scheme acceptable to Ofgem in order to allow the Company to claim credits from Ofgem which count towards the CERT Target.

1. DEFINITIONS AND INTERPRETATION

1.1 In this Agreement unless the context otherwise requires the following words shall have the following meanings:

…

"CERT" means the Carbon Emissions Reduction Target under the Electricity and Gas (Carbon Emissions Reduction) Order 2008, as amended from time to time, or any replacement scheme;

"Credits" means carbon emissions credits that arise from the carbon savings derived from the Products, and which the Company use to count towards its CERT obligation;

"Payment" means the amounts to be paid by the Company to the Supplier under this Agreement as set out in Schedule 4;

"Products" means those products listed in Schedule 1;

"Scheme" means the scheme relating to the Products operated by the Company and approved by Ofgem for the receipt of Credits as modified, amended or replaced from time to time;

2. TERM

2.1 This Agreement shall commence on the Commencement Date and shall continue for the entire period that the Product continues to be an eligible product (for the purposes of the Company's CERT target) under CERT, unless terminated earlier in accordance with its terms.

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6. CALCULATION OF PAYMENT

6.1 The Company shall pay the Payment to the Supplier.

6.2 The Payment is calculated as set out in Schedule 4 and is a fixed amount based on the carbon savings for the Products as agreed between Ofgem and the Company under the Scheme provided that the Supplier shall only be entitled to claim or receive payment:

6.2.1 in respect of one Product per Consumer household as per Ofgem guidance from time to time (unless the regulations of the Scheme and applicable under CERT from time to time enable the Company to claim Credits in respect of more than one Product per Consumer household) but ignoring for these purposes any Products distributed by or at the direction of the Company otherwise than under this Agreement; and

6.2.2 for so long as the Supplier and the Products are compliant with the regulations of the Scheme and applicable under CERT from time to time, provided that this Clause 6.2.2 shall only entitle the Company to recover any Payments already made to the Supplier where the provisions of Clause 17.3 apply.

6.3 The Parties agree that the maximum aggregate amount of Payments by the Company under this Agreement and any amounts payable by the Company under Clauses 12.6 or 12.7 shall not exceed £4,000,000 (excluding VAT).

6.4 The Parties acknowledge that the carbon savings may be recalculated by Ofgem during the Term. If Ofgem do recalculate the carbon savings, the Parties shall use reasonable endeavours (without financial obligation) to agree and implement a mutually acceptable method of mitigating the effect of the recalculation on the terms of this Agreement provided that if the parties (each acting reasonably and in good faith) shall not be able to reach agreement on such mitigation within 20 working days of notification of the recalculation by Ofgem, such obligation to agree and implement a method of mitigation shall cease. Notwithstanding any steps that the parties may agree to take to mitigate the effect of a recalculation by Ofgem of carbon savings, (and without prejudice to the foregoing) the Parties acknowledge that the Payment may change as a result of a recalculation by Ofgem of the carbon savings. Any change to the Payment shall be directly proportionate and in relation to the recalculation by Ofgem of the carbon savings. The Supplier agrees to act bona fide and in good faith in giving all reasonable consideration to accepting the new Payment provided that the Supplier receives 4 weeks' prior written notice of the change or, if Ofgem implement a change to the savings which will take effect before the expiry of such 4 week period, that the Company promptly notifies the Supplier upon the Company becoming aware. If the Supplier is unwilling to agree the new Payment either Party shall be entitled to terminate the Agreement under clause l2.4.

7. PAYMENT

7.1. During the first 4 months of the Term, the Supplier shall submit an invoice with the Weekly Report setting out the Payment claimed in respect of that week and thereafter the Supplier shall submit invoices on a monthly basis setting out the Payment claims in respect of that month in each case pursuant to this Agreement.

7.2 The Company shall, unless the parties otherwise agree, pay the amount of any invoice submitted by the Supplier within 28 days of the date on which the Company receives the invoice or is deemed to have received the invoice pursuant to the provisions of Clause 20 (whichever is the earlier).

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9. CONTRACT EXTENSIONS

9.1 The Forecast Delivery Plan sets out the Supplier's reasonable expectation for manufacture and supply of Products in the domestic market in Great Britain over the period 12 months from the Commencement Date. The Parties acknowledge that the Forecast Delivery Plan may envisage the manufacture and supply by the Supplier of more Products than those for which the Company is obliged to pay the Supplier pursuant to this Agreement as at the Commencement Date. During the Term the Parties shall keep under review the performance of the Supplier as compared with the Forecast Delivery Plan and the Supplier shall keep the Company reasonably informed on a regular basis (not less than monthly) as to such performance and as to status of the Supplier's negotiations with any third parties for the distribution or supply of Products by such third parties.

9.2 In the event that:

9.2.1 the Company has made Payments to the Supplier pursuant to clause 7 in an amount in excess of £3,000,000; or

9.2.2 the Supplier is negotiating an agreement with a distributor or Customer (the terms of which reasonably anticipate supplies of Products which would, but for Clause 6.3, cause the Company to be obliged to make Payments to the Supplier in excess of £4,000,000 in aggregate under this Agreement) and such negotiations are considered by the Supplier (acting reasonably and in good faith) to be likely to culminate in the successful conclusion of a legally binding agreement with that third party and the Supplier can demonstrate to the reasonable satisfaction of the Company that such negotiations are well progressed (including, without limitation, by providing to the Company of copy of the signed heads of agreement between the Supplier and the relevant third party in good faith),

the Supplier may by written notice to the Company request that the terms of this Agreement are varied only by replacing the figure of "£4,000,000" in Clause 6.3 with "£10,000,000" ("First Extension Notice").

9.3 In the event that:

9.3.1 the Company does not notify the Supplier within 2 weeks of the date of receipt (or deemed receipt) by the Company of the First Extension Notice that the Company wishes to proceed with the variation set out in the First ExtensionNotice; or

9.3.2 the Company notifies the Supplier at any time following receipt (or deemed receipt) by the Company of the First Extension Notice that the Company does not wish to proceed with the variation set out in the Extension Notice.

the provisions of Clause 25.3 shall cease to apply in respect to the Supplier with effect from 9am on the first Business Day following the date on which the period of 2 weeks specified in Clause 9.3.1 expires or (if earlier) the Company notifies the Supplier pursuant to clause 9.3.2. The Supplier shall continue to work in good faith towards delivery of Products for the Company up to the maximum aggregate value of £4,000,000 unless in the Supplier's reasonable discretion continuing to do so would adversely affect the business interests of the Supplier.

9.4 In the event that:

9.4.1 the Company has elected to proceed with the variation pursuant to clause 9.3 and the Company has made Payments to the Supplier pursuant to clause 7 in an amount in excess of £7,500,000 under this Agreement; or

9.4.2 the Supplier is negotiating an agreement with a distributor or Customer (the terms of which reasonably anticipate supplies of Products which would, but for Clause 6.3, cause the Company to be obliged to make Payments to the Supplier in excess of £10,000,000 in aggregate under this Agreement) and such negotiations are considered by the Supplier (acting reasonably and in good faith) to be likely to culminate in the successful conclusion of a legally binding agreement with that third party and the Supplier can demonstrate to the reasonable satisfaction of the Company that such negotiations are well progressed (including, without limitation, by providing to the Company of copy of the signed heads of agreement between the Supplier and the relevant third party in good faith),

the Supplier may by written notice to the Company request that the terms of this Agreement are varied only by replacing the figure of "£10,000,000" in Clause 6.3 with "£37,500,000" (Final Extension Notice").

9.5 In the event that:

9.5.1 the Company does not notify the Supplier within 2 weeks of the date of receipt (or deemed receipt) by the Company of the Final Extension Notice that the Company wishes to proceed with the variation set out in the Final Extension Notice; or

9.5.2 the Company notifies the Supplier at any time following receipt (or deemed receipt) by the Company of the Final Extension Notice that the Company does not wish to proceed with the variation set out in the Final Extension Notice,

the provisions of Clause 25.3 shall cease to apply in respect to the Supplier with effect from 9am on the first Business Day following the date on which the period of 2 weeks specified in Clause 9.5.1 expires or (if earlier) the Company notifies the Supplier pursuant to clause 9.5.2. The Supplier shall continue to work in good faith towards delivery of Products for the Company up to the maximum aggregate value of £10,000,000 unless in the Supplier's reasonable discretion continuing to do so would adversely affect the business interests of the Supplier.

….

12.3 Either Party may at its convenience terminate the Agreement or any part thereof at any time by l2 months' written notice to the other Party.

12.4 The Company may terminate the Agreement by not less than 28 days' notice if the Company (acting reasonably and in good faith) is reasonably able to demonstrate to the Supplier considers that the Company is suffering or may suffer damage to its goodwill, reputation and/or its relationship with Ofgem, DECC or any other government or regulatory body as a result of continuing to pay the Supplier under this Agreement in respect of carbon savings or anticipated carbon savings associated with the Products where Ofgem, DECC or another relevant government or regulatory body indicates that such payments, whilst compliant with the specific regulations of the CERT Scheme, are inconsistent with the spirit and intent of or do not deliver the purpose of the CERT Scheme.

…….

12.7 The Company may terminate this Agreement with immediate effect if the Scheme is altered for whatever reason, other than through the fault of the Company, so that the Company is unable to obtain Credits under the Scheme (whether specifically under this Agreement or generally under the Scheme). The Supplier may terminate this Agreement with immediate effect if the Scheme is altered so that the Supplier and the Products are no longer compliant with the regulations of the Scheme and applicable under CERT from time to time and as a result does not or will not receive Payment pursuant to the operation of Clause 6.2.2.

17. LIABILITY AND INDEMNITY

…

17.3 The Supplier will not be entitled to retain Payments in circumstances where Ofgem refuses to grant the Credits relating to such Payments due entirely to the negligent act or negligent omission of the Supplier or of any subcontractor of the Supplier.

………

SCHEDULE 4 – PAYMENT CALCULATION

The Company shall pay the Supplier the Payment as calculated below:

1. For each tonne of CO₂ deemed to have been claimed by the Company (as set out in the Supplier's invoice):

1.1 £6.70 per tonne of CO₂ attributable to Consumers other than Priority Group Consumers

1.2 £8.70 per tonne of CO₂ attributable to Priority Group Consumers.

2. The Parties agree that the supply of 1 Product by the Supplier (or retailer or other third party supplied by the Supplier) to a Consumer household shall equate to 1.018 tonne of CO₂ savings.

3. Without prejudice to the provisions of Clause 6.3 (as the same may be varied pursuant to Clauses 9.2 and 9.3) the Payment shall remain as set out in paragraph 1 for up to the first 5 million Products and thereafter the price will be agreed from time to time between the Parties but in the absence of such agreement the payments shall continue at the levels set out at paragraph 1.

4. For the avoidance of doubt VAT shall be added to the above in order to calculate the full amount due to the Supplier under each and any invoice raised pursuant to this Agreement."

14. The 1.018 tonne figure in the last line of paragraph 2 of Schedule 4 arose from the widget's carbon score determined by Ofgem in January 2010. In fact that figure involved a slight rounding, the true figure being 1.0176 tonnes. In the event Ofgem used the latter in "banking" and awarding credits to British Gas, and British Gas invoiced Challis for the small difference occasioned thereby, which Challis paid.
15. The first invoice for widgets supplied under the 2010 Agreement was dated 28 June 2010, and invoices were presented regularly thereafter. The scheme was a success in that Challis rapidly distributed a large number of the widgets. As early as September 2010 it became apparent that supplies might well cause Challis to reach the £4 million cap provided for in clause 6.3. The parties did not invoke the clause 9 procedure for an extension to the cap, but as the numbers supplied "steamed through" the £4 million mark (as Mr Challis described it in evidence), it was recognised by British Gas that Challis should continue to distribute the water widgets, and British Gas would continue to pay in accordance with the 2010 Agreement without reliance on the cap. In essence British Gas waived the cap for the time being.
16. The 2010 Agreement was then renegotiated and replaced with an agreement dated 3 March 2011 ("the 2011 Agreement"). It had the same title as an "AGREEMENT FOR CERT CREDITS", with materially the same recitals and definitions as set out above. So far as payment was concerned, clauses 6.2 and 6.4 were in materially identical terms as in the 2010 Agreement. The maximum amount in clause 6.3 was raised to £21.2 million. A new clause 6.5 was added providing that British Gas would be entitled to withhold payment where it had reasonable grounds to suspect that Challis or the products had not complied with the Scheme. The payment calculation set out in Schedule 4 to the 2011 Agreement was substantially more complicated than its 2010 counterpart. It distinguished between widgets distributed as a result of marketing through Sainsbury's and those sold as a result of other marketing activities. There were 3 bands of payment depending on the number of widgets sold. The payment was again calculated by reference to a price in respect of the tonnes of CO₂ savings which were calculated on the basis of 1.018 tonnes per widget. Schedule 4 provided as follows:

"SCHEDULE 4 - PAYMENT CALCULATION

Definitions for the purpose of this Schedule 4:

"Total Products" shall mean the total number Products distributed pursuant to the Marketing Activity in excess of 176,000 units of Product and the Sainsbury's Marketing Activity.

Subject to the provisions of this Agreement, including the maximum amount payable pursuant to clause 6.3, the Company shall pay the Supplier the Payments as calculated below in accordance with the bandings set out in paragraph 1.1-1.3 (inclusive) and 2.2.1-2.2.3 (inclusive) (each a "Banding"):

1. In respect of Sainsbury's Marketing Activity

1.1 if the number of Total Products distributed is between 1 and 999,999 (inclusive) then the Payment shall be £3.70 per tonne of CO₂ attributable to the Products distributed to Consumers pursuant to the Sainsbury's Marketing Activity;

1.2 if the number of Total Products distributed is between 1,000,000 and 1,999,999 (inclusive) then the Payment shall be £4.70 per tonne of CO₂ attributable to the Products distributed to Consumers pursuant to the Sainsbury's Marketing Activity; and

1.3 if the number of Total Products distributed is above 2,000,000 then the Payment shall be £5.70 per tonne of CO₂ attributable to the Products distributed to Consumers pursuant to the Sainsburys Marketing Activity..

The parties acknowledge that the Company will make a separate payment to Sainsbury's in the amount of £1 for each Product which the Supplier distributes to Consumers via the Sainsbury's Marketing Activity in accordance with the terms of an agreement between the Company and Sainsbury's.

Notwithstanding the payment terms set out in clause 7, any payments due to the Supplier which are calculated pursuant to paragraphs 1.1, 1.2, or 1.3 above shall be paid to the Supplier in accordance with this Agreement and the Supplier shall invoice the Company for Payment in respect of the total volumes of Products distributed to Consumers pursuant to the Sainsbury's Marketing Activity as soon as reasonably practicable after conclusion of the Promotion (but in any event before the end of April 2011) to help ensure that the CO₂ can be successfully submitted towards the Company's CERT obligations in line with Ofgem guidelines.

2. In respect of all other Marketing Activity

2.1 up to a maximum of 176,000 Products distributed pursuant to the Marketing Activity:

- £6.70 per tonne of CO₂ attributable to Products distributed to Non-Priority Consumers; and

- £8.70 per tonne of CO₂ attributable to Products distributed to Priority Consumers,

For the avoidance of doubt, the number of Products distributed pursuant to the Sainsbury's Marketing Activity shall not be included in the calculation of the number of Products distributed pursuant to this paragraph 2.1.

2.2 for Products distributed in excess of 176,000:

2.2.1 if the number of Total Products distributed is between 1 and 999,999 (inclusive) then the Payment shall be £4.70 per tonne of CO₂ attributable to the Products distributed to Consumers pursuant to the Marketing Activity;

2.2.2 if the number of Total Products distributed is between 1,000,000 and 1,999.999 (inclusive) then the Payment shall be £5.70 per tonne of CO₂ attributable to the Products distributed to Consumers pursuant to the Marketing Activity; and

2.2.3 if the number of Total Products distributed is above 2,000,000 then the Payment shall be £6.70 per tome of CO₂ attributable to the Products distributed to Consumers pursuant to the Marketing Activity.

Any payments which are payable pursuant to this paragraph 2 shall be payable in accordance with clause 7 of this Agreement.

4. (sic) The number of Total Products distributed pursuant to this Agreement shall be recalculated by the Company throughout the Term and, if following such re-calculation the volume of Total Products distributed results in a change to the applicable payment Banding, any further payment due (subject to such Products still eligible for Credits) in excess of the amount already paid to the Supplier pursuant to this Agreement shall be payable to the Supplier in accordance with the provisions of clause 7.

5. The Parties agree that the supply of 1 Product by the Supplier (or retailer or other third party supplied by the Supplier) to a Consumer household shall equate to 1.018 tonne of CO₂ savings.

6. For the avoidance of doubt VAT shall be added to the above in order to calculate the full amount due to the Supplier under each and any invoice raised pursuant to this Agreement."

17. There was a variation agreement entered into on 20 May 2011 whose terms are not material to the present dispute. As a result British Gas terminated the 2011 Agreement in accordance with its terms on 15 July 2011.
18. Challis invoiced for, and was paid, a total of £14,349,380.85 in respect of water widgets distributed directly or indirectly to consumers prior to 15 July 2011. When British Gas came to claim its carbon saving credits from Ofgem 18 months later, in January 2013, part, but not all, of such activity was treated as market transformation activity by British Gas attracting the MTU credit towards its carbon emissions target. In particular, of a total of 2,776,485 tonnes of CO₂ savings attributable to the distribution of Challis' widgets, MTU was claimed and granted on only 425,593 tonnes.
19. Challis contends that the price under clause 6 of the 2010 and 2011 Agreements falls to be calculated by reference to the amount of credit that British Gas claimed from Ofgem in relation to the widgets, including in particular the 50% MTU uplift: in substance, British Gas agreed to pay Challis by reference to the entire amount of the carbon savings which Ofgem deemed to have been achieved as a result of the distribution of the water widgets. British Gas contends that the wording of clause 6 and Schedule 4 in each of the Agreements establishes that payment is to be of a fixed price amount, irrespective of the credits sought by British Gas from Ofgem. Until shortly before trial, Challis claimed that it was entitled to an uplift of the price by 50% on all widgets supplied, whether or not used by British Gas to claim MTU. By the time of the hearing Challis' claim was confined to a claim for a 50% increase in the price in respect of the carbon savings from the widgets on which British Gas had obtained MTU.
20. There was also another agreement between the parties which became known as "the factory gate agreement", under which Challis supplied widgets to British Gas, rather than directly or indirectly to customers. This provided for a fixed price of £3.30 per widget, not for a price by reference to any carbon saving or credit. This agreement is not material to the present dispute save in two peripheral respects. It illustrates, if illustration were necessary, that the parties were aware that it would have been possible to price the 2010 and 2011 Agreements at a fixed price per widget. It is also potentially relevant to the quantum of Challis' claim because British Gas contends that the latter impermissibly includes a claim in respect of widgets which were supplied under the factory gate agreement.

Analysis

21. Mr Shepherd QC emphasised that Recital E in the Agreements identified that their purpose was to enable British Gas to claim credits from Ofgem which counted towards its CERT Target; and that "Credits" was defined in clause 1.1 in terms which include MTU as "carbon emission credits that arise from the carbon savings derived from [the widgets]". However this does not assist his argument, because the payment provisions are not couched by reference to the defined term "Credits". On the contrary, they are couched in the language of "carbon savings", which is a different concept, as the definition of "Credits" itself recognises. MTU does not represent a saving in carbon emissions: it represents what is ex hypothsi not a saving in carbon emissions, but rather an additional credit towards the target as an incentive for promotion of innovative products. Articles 15(3) and 19(4) of the 2008 Order provide that Ofgem is to take the "carbon emissions expected to be achieved" by the activity and then increase it by 50%. Although the effect is to treat the uplift as an increase in carbon emissions reduction, the uplift is not a carbon saving, which is an expression used in the Agreements but not the Order. In particular:

(1) The defined term Credits is not used in the Recitals, and is only used in clauses 6.2.1, 12.7, 15.1, 17.3, 25.3.2 and 25.4.2 of the 2010 Agreement, and the equivalent provisions of the 2011 Agreement. It also appears in paragraph 4 of Schedule 4 of the 2011 Agreement. In those provisions it is there used to refer to credits which British Gas receives from Ofgem.

(2) By contrast the price payable is identified in clause 6.1 and 6.2, which does not use the defined term for that purpose. Clause 6.1 directs the reader to Schedule 4 via the definition of Payment. Paragraphs 1.1 and 1.2 of Schedule 4 express the price be payable at an identified £ figure "per tonne of CO₂ attributable to" the relevant consumer groups. This must be a reference to CO₂ savings, as is further apparent from paragraph 2 which identifies how such savings are to be calculated per widget: 1.018 tonnes of CO₂ savings per widget supplied to each household.

(3) Paragraph 1 of Schedule 4 of the 2010 Agreement (but not the 2011 Agreement) refers to this as a tonne of CO₂ "deemed to have been claimed by [British Gas] (as set out in [Challis'] invoice)". The invoices are to be weekly or monthly pay as you go invoices pursuant to clause 7. The price is therefore based on a carbon saving per widget irrespective of whether British Gas in fact claims uplift, and at a time when it will be impossible to tell what, if any, MTU will be claimed by British Gas in respect of such widgets.

(4) The explanatory words in clause 6.2 are that the price so calculated is "a fixed amount based on the carbon savings for the Products as agreed between Ofgem and [British Gas] under the Scheme." The "Scheme" is defined as the water widget scheme, not the CERT scheme. The price is said to be fixed by reference to carbon savings, not Credits. This is a reference to the carbon score set by Ofgem at the outset, not, as Mr Shepherd submitted, the final determination process by which Ofgem awarded credits to British Gas in 2013. Mr Shepherd objected that the carbon score had been agreed at the outset by Ofgem with Challis, not British Gas, prior to the Agreements; but it was also agreed as between Ofgem and British Gas in the discussions and presentations in April and May 2010 once the widgets were to be promoted by British Gas under the CERT Scheme.

(5) The price is a "fixed amount" in the sense that it is ascertainable as a price per widget which can be calculated by reference to the carbon savings per widget agreed in paragraph 2 of Schedule 4, i.e. the agreed carbon score of 1.018 tonnes per widget.

22. There is much force in Mr Gledhill's argument on behalf of British Gas that if payment was to be for credits received by British Gas, the draftsman would have used the defined term "Credit" in the relevant payment provisions. It is not so used in the critical provisions, although the draftsman does choose to use it in its proper defined sense in other parts of the price provisions: it is used in clause 6.2.1 of the 2010 Agreement and paragraph 4 of Schedule 4 of the 2011 Agreement. If the draftsman had intended to define the price by reference to credits obtained by British Gas from Ofgem, he would have used the defined term "Credit" to do so. Its careful use elsewhere is telling. This applies also to its use in clause 17.3 (clause 16.3 of the 2011 Agreement) where the parties make provision for one limited circumstance in which payment is to depend on the credits actually obtained by British Gas, by way of a clawback from Challis where a failure to obtain credits is due to the negligence of Challis or its subcontractors. The draftsman therefore used the term Credits where it was desired to make payment dependent on credits actually obtained by British Gas from Ofgem; that was not the language or drafting technique employed in the pricing provisions.
23. Mr Shepherd drew attention to the definition of MTU in articles 15 and 19 of the Order, which treated it as a reduction in carbon savings, and therefore something aptly encompassed within the concept of carbon savings when used in the pricing language of the Agreements. However the force of this argument is diminished by the fact that the Order does not have a different concept of Credits, whereas the Agreements do. The draftsmen of the latter seems to have been careful to differentiate between the two: carbon savings, not Credits, is the concept by reference to which the price is to be calculated.
24. Mr Shepherd argued that if what was intended was a fixed price per widget, it would have been easy to frame the price provisions in those terms without needing to refer to the carbon score or carbon savings. It is true that the clause could have been framed in that way. But clause 6.4 provides that if Ofgem changed the carbon score of the widget during the operation of the scheme, that would trigger a renegotiation of the price to something "directly proportionate to …. the recalculation by Ofgem of the carbon savings". For those purposes it would be necessary to have spelled out the basis for the price by reference to the carbon score initially accredited by Ofgem. There is no great drafting infelicity in doing so in the primary price provisions in clause 6.1, 6.2 and Schedule 4 rather than in clause 6.4 itself. On the other hand the reference to a fixed amount is inconsistent with Challis' construction. If the price is to include MTU but only to the uncertain extent to which British Gas choose to claim it after conclusion of the scheme, it would be hard to describe the price as a fixed amount.
25. The wording of clause 6.4 further reinforces British Gas' argument that the price is for carbon savings, not credits including MTU. It is couched exclusively by reference to carbon savings (i.e. the carbon score of 1.018 tonnes per widget) and provides for the change to the Payment to be directly proportionate to the recalculation of the carbon score by Ofgem. The expression "carbon savings" in clause 6.4 cannot include MTU because carbon savings are identified as something which may be recalculated by Ofgem during the term, whereas MTU is not a matter for Ofgem recalculation, being fixed at 50% by the terms of the Order, and in any event not calculated until after the "Term". It would be anomalous to give the same expression or concept a different meaning in clause 6.2 or paragraphs 1.1 and 1.2 of Schedule 4.
26. Each side sought to rely on the fact that the Agreements make no reference to market transformation activity or market transformation uplift. British Gas argued that had the parties intended that Challis be paid by reference to MTU they would have said so. Challis argued that since the agreement was for the credits which British Gas agreed with Ofgem, which include MTU, the Agreements would have specifically excluded MTU if that had been intended. I do not regard these arguments as furthering the debate. The parties clearly had within their contemplation the potential application of MTU to widgets supplied pursuant to the Agreements, and chose not to refer to it expressly: what they intended is to be divined from the language they used, and is coloured to a large extent by whether the price is or is not for credits.
27. The invoicing provisions in clause 7 also support British Gas' construction:

(1) They are for pay as you go invoicing, weekly for the first four months and thereafter monthly. That assumes that the price is calculable as soon as the number of widgets supplied is ascertained. There is no provision for any subsequent invoicing in 2013 to take account of MTU if and when it was claimed by British Gas following conclusion of the CERT scheme. This would be a surprising omission from the careful invoicing provisions if MTU were intended to be included within British Gas' payment obligation. The possibility of subsequent invoicing in one specific circumstance is addressed in paragraph 4 of Schedule 4 of the 2011 Agreement and would arise if, for example, a new band of Sainsbury's marketing activity were reached, because the new price applies not just to the widgets supplied in the new band but also all widgets supplied previously in the lower band. But there is no provision for subsequent invoicing for MTU.

(2) Moreover, what is to be invoiced weekly/monthly is the "Payment" claimed, Payment being a defined term and comprising the whole of the price payable under the pricing mechanism in clause 6. If the price included MTU it would not be possible to invoice weekly/monthly for "the Payment", which is what clause 7 requires. This too suggests that MTU was not included in the price. Mr Shepherd sought to meet this difficulty by submitting that the invoices under clause 7 were for Payment "in respect of that week" or "in respect of that month", and so were not for the whole of the price payable under clause 6 as the Payment. A more natural reading of the qualification "in respect of that week/month" is that the Payment is in respect of the widgets supplied during that week/month. If so, it remains the totality of the price payable in respect of the weekly or monthly supply of widgets, and excludes the notion that Payment in clause 6 allows for an additional element of the price which is only later calculable and to be invoiced in 2013.

28. There are three aspects of the cap which also support British Gas' construction:

(1) There is a cap on the total aggregate amount of Payments which Challis can recover in clause 6.3, being £4 million (excluding VAT) in the 2010 Agreement, and £21.2 million (excluding VAT) in the 2011 Agreement. Since the cap is on "Payments", which is the price defined in Schedule 4, Challis' case has to be that the cap applies to the total amount payable by British Gas, including MTU. If that were so, however, there would be no way of the parties knowing during the currency of the scheme whether or when the cap was reached: it might be any time after supply of sufficient widgets to invoice for £2,666,666, depending upon what MTU was later claimed by British Gas in respect of those widgets. If Challis continued to supply until the monthly invoicing reached £4 million, it would be running the risk that it was supplying up to 50% more products than it needed to in order to earn the maximum it could under the agreement. If on the other hand it tailored its supply to take account of the possibility of MTU it would not know how many widgets to supply in order to maximise its income until too late, after the Scheme closed. Such an interpretation is inimical to the commercial certainty which the parties would expect from their agreement.

(2) Clause 9 also assumes that the parties know when the cap has been reached as they go along. It provides for the possibility of two sequential contract extensions to increase the cap. The first involves a potential increase in the cap from £4 million to £10 million where Payments have reached £3 million and Challis anticipates aggregate Payments exceeding £4 million. The second involves a potential increase in the cap from £10 million to £37.5 million where Payments have reached £7.5 million and Challis anticipates aggregate Payments exceeding £10 million. Again, these provisions are framed by reference to the defined term "Payments" reaching or being anticipated to reach the specified amounts. This only works if Payments do not include MTU on the widgets, which cannot be known during the currency of the Scheme.

(3) The background to the 2011 Agreement was discussion and recognition from at least December 2010 that the £4 million cap under the 2010 Agreement had been exceeded. Those discussions between the parties proceeded on the expressed understanding that it was the invoiced amounts which had reached and breached the cap; in other words that the cap in the 2010 Agreement applied net of any uplift for MTU. Whilst that is not admissible as an aid to construction of the 2010 Agreement, it is relevant factual matrix to the 2011 Agreement and suggests that the cap in those agreements was also understood to be net of any uplift for MTU. Moreover the discussion between the parties in an exchange of emails on 11 February 2011 indicates that they were calculating what became the £21.2 million cap in the 2011 Agreement by estimates of amounts payable to Challis on predicted supplies of widgets which would not include any MTU. In other words the cap in the 2011 Agreement was calculated by the parties as one which was intended to exclude any MTU.

29. Mr Gledhill also argued that the amount of the cap in the 2010 Agreement indicated that it was without uplift for MTU because the maximum amount had been calculated by reference to an anticipated number of sales which would produce the maximum identified if the price were calculated net of MTU. The ultimate maximum cap in the 2010 Agreement is £37.5 million. This specific number, it was submitted, has its origin in the parties' assumption of an average price of £7.50 of carbon savings (based on a weighted average between the two prices of £6.70 and £8.70 assuming 40% supply to the priority group) multiplied by 5 million widgets as the maximum number supplied before triggering a price renegotiation under paragraph 3 of Schedule 4. However it was not clear to me that that was how the figure had in fact been reached. It would have involved an error, in that it elided the distinction between the weighted average being per tonne of carbon saving, not per widget, whereas the 5 million figure was for the number of widgets. Accordingly I reject this argument.
30. There is a further difficulty in the way of Challis' construction, which is that the Agreements do not enable a claim for MTU to be quantified accurately in circumstances in which British Gas claims MTU for less than the entirety of the widgets supplied by Challis. This arises out of the pricing in the Agreements being differential between consumer groups and marketing channels, and banded by sales volumes, whereas claims to Ofgem for MTU need only be generic to a particular number of widgets supplied to each consumer group. Suppose British Gas were simply to claim MTU for the carbon saving on half the number of widgets supplied by Challis to each consumer group. To which of the various different prices would the additional 50% which Challis claims apply? Which price, under which of the two Agreements, and through which distribution channel? The Agreements provide no answer to the question, which is a further indication that there was no intention that the prices should be increased by 50% for MTU. It is a problem which can be illustrated by the quantification of Challis' claim in this very case. In respect of the widgets supplied by Challis, British Gas claimed from Ofgem, and was granted, MTU for supply to the non priority group of 89,576 tonnes, as 50% of the 179,152 tonnes of CO₂ saving which British Gas chose to claim out of a potential of 2,138,096 tonnes for widgets supplied to this group. Challis has quantified its claim in respect of this MTU on the basis of a 50% uplift to the price of £6.70. That was the price for all supplies to non priority consumers under the 2010 Agreement, but not necessarily so for supplies under the 2011 Agreement which had a variable price under paragraphs 1 and 2 of Schedule 4. Why, one asks, should the price uplift for MTU be calculated by reference to the 2010 Agreement price? Challis' answer, that it was because the widgets on which MTU was claimed should be deemed to be those supplied first in time, has no foundation in the parties' Agreements. Why, one may also ask, is some of this saving not to be treated as referable to widgets supplied under the factory gate agreement, which attracted a fixed price per widget and on any view cannot attract a price uplift? Again the 2010 and 2011 Agreements provide no serviceable answer. One could multiply the examples of quantification difficulties to which the Agreements provide no solution by changing the permutations of potential MTU claims by British Gas. The position would become equally incoherent if there were a price renegotiation pursuant to clause 6.4.
31. There does not seem to me to be anything unreasonable or uncommercial about the construction for which British Gas contends. Challis was a small company with tight cashflow which was being paid up front at the time the widgets were supplied to consumers, long before the carbon benefit could be claimed by British Gas. British Gas was bearing a number of risks that it might not get credit for 1.018 tonnes of carbon saving per widget, increased by 50% for MTU, even for those widget supplies in respect of which it might wish to claim MTU, which was itself a matter of uncertainty. The risks included the following:

(1) There was a risk that Challis would be found not to have complied with the Ofgem requirements for the practical implementation of the supply of widgets under the scheme, the performance of which fell to Challis under the terms of the Agreements. The carbon score granted by Ofgem on 26 January 2010 was subject to certain conditions, including, for example, that the device should only be fitted to properties suited to it; only supplied to householders who specifically requested it; sold with a test bag or similar to enable customers to test its suitability and a facility for returning the product if not; and that there should be extensive customer satisfaction monitoring to ensure that it was being used. The approvals of the scheme as a qualifying action by Ofgem of 16 June 2010 and 5 November 2010 were subject to Challis complying with the procedures discussed with Ofgem and Challis/British Gas in April and May 2010. For example there was a limitation on the supply of free widgets, which had to have been requested in writing after August 2010. This execution risk, as it was described in argument, of Ofgem denying or reducing the credits for failure to ensure compliance with these conditions, fell on British Gas, who nevertheless had to pay weekly/monthly when the widgets were distributed by Challis, whose known financial circumstances might make any later clawback for breach impractical.

(2) There was a risk that the carbon score might be revised as a result of further scientific data or changes affecting what was referred to as its "additionality". The carbon saving awarded by Ofgem had to be a genuine saving over and above the energy consumption of other comparable goods or services. Accordingly as a class of products became more efficient over time, it might become harder to demonstrate the extent of the energy savings which were additional to the existing norm: there was a potentially moving baseline against which the carbon saving fell to be measured. The scientific data underlying the carbon score might also be subject to reconsideration or review. Indeed in November 2010 Ofgem raised a query that the carbon score for the Challis widgets might be too high, by reference to water pressures in showers and the longevity of the product. In the event Challis was able to allay Ofgem's concerns, but this episode illustrates one of the risks undertaken by British Gas. Clause 6.4 provided protection to British Gas against such risks only for subsequent sales; downward revision of the carbon score would affect British Gas' ability to claim credits for previous supplies without it being entitled to revisit the payments already made to Challis under clause 7 for previous supplies.

(3) There was a risk of Ofgem changing the scheme rules or guidance. This sometimes occurred. For example, at the beginning of the CERT scheme, energy saving lightbulbs qualified, and it was a popular carbon saving measure amongst energy suppliers to give them away. However there came a point at which Ofgem questioned the extent to which consumers were actually using such free light bulbs and therefore whether such supply actually resulted in energy savings. Restrictions were introduced in January 2010 requiring purchase from a retail outlet. Another example was a change to what could qualify as "innovative" with effect from 1 April 2011. A further example was the introduction in 2011 of a specific cap of 11 million on the total number of shower regulators which could qualify.

32. There is no reason to think that the allocation of risk and reward was not fairly built into the price freely negotiated between the parties as the weekly/monthly payment.

Conclusion

33. For these reasons I conclude that the price payable was the fixed price based on 1.018 tonnes of CO₂ saved for each widget, without uplift for MTU. Challis' claim fails.

Note 1   Subject to adjustment for demonstration actions, which can be ignored for the purposes of the current dispute.     [Back]