Companies - application to set aside the decision of the Expert.
Before : |
Sir William Bailhache, Commissioner, and Jurats Christensen and Blampied |
Between |
Dawn Patricia McLachlan and Robert John McLachlan |
Representors |
And |
Busy Bees Holdings Limited |
Respondent |
Advocate O. A. Blakeley for the Representors.
Advocate S. J. Alexander for the Respondent.
judgment
the COMMISSIONER:
1. On 11 January 2021, Advocate John Kelleher was appointed by the parties as a joint expert (the "Expert") to determine a dispute between the parties to this action. That dispute concerned the purchase of two companies, Organic Kids Limited and Organic Kids (Castle Quay) Limited (together "Organic Kids") by the Respondent from the Representors, which purchase was undertaken by way of a share sale and purchase agreement dated 8 November 2019 (the "SPA"). Organic Kids Limited operated a childcare nursery at La Providence, St Peter (the nursery is referred to as "OKLP") and Organic Kids Castle Quay Limited operated a nursery at Castle Quay, St Helier (the nursery is referred to as "OKCQ"). The dispute centred on alleged breaches of warranty by the Representors. On 25 April 2022, the Expert published his determination of the matters referred to him. These proceedings concern an application by the Representors to set aside the decision of the Expert on a number of grounds, details of which appear below.
2. In very short summary, after owning and operating children's nurseries for twenty-five years, the Representors decided to retire and sell Organic Kids. The Respondent agreed to purchase the two companies, the terms of purchase being contained in the SPA with completion on 8 November 2019. The price was £5,125,000.
3. Following completion, the Respondents alleged the Representors had committed thirteen breaches of the warranties given in the SPA and, by a formal letter of claim dated 5 November 2020, claimed damages of £1,610,400 in respect of OKCQ and £607,560 in respect of OKLP. In accordance with the SPA, the matter was referred for expert determination as previously described.
4. The parties agreed that the expert determination would be governed by the Academy of Expert's Rules for Expert Determination, with some amendments proposed by the Expert (the "Rules"). Witness statements were exchanged along with documentary evidence. Skeleton arguments were also exchanged and over a three-day hearing in January 2022, the witnesses were cross-examined.
5. The Expert found that there had been the following breaches of warranty:
(i) The warranty at Clause 15.2 of Schedule 3 which was in these terms:
"Each Company has all necessary licences and consents for the proper operation of its assets and the carrying on of its business and copies of all such licences and consents are Disclosed. All such licences and consents are in full force and effect and there are no circumstances of which the Vendors are aware which could lead to their non-renewal or to their termination."
The circumstances giving rise to that breach of warranty were found by the Expert also to amount to a breach of the warranty at Clause 7.2 of the principal agreement in these terms:
"7.2 The Vendors hereby warrant and represent (on a joint and several basis) to the Purchaser that save as set out in Clause 7.3(c) they are not aware of any other fact or matter which renders or might upon its disclosure render any such information misleading or incomplete."
The Expert found that a breach of these warranties had arisen for the following reasons, to be found at [286] of his Award:
"In my view, the words 'licences and consents' are broad enough to encompass the registration of the Nurseries and the conditions attached to such registration. The agreement to restrict numbers at OKCQ until such time as further qualified staff could be engaged to satisfy ratios did mean that for a time the Registration of OKCQ was not in full force and effect so long as that agreement subsisted. Clause 15.2 was therefore breached. Clause 7.2 was also breached since the Respondents were aware of the agreement and why it had been entered into and it was plainly relevant to the extent of the Registration. I can see an argument that such agreement was probably unenforceable since CEYS [ the Child Care and Early Years Service] had no power of itself to restrict numbers. However, the key point is that OKCQ had agreed to such a restriction and thereby recognised that it could not operate up to its full complement until the relevant number of further staff had been recruited.
287. As I have found there was no restriction in place at OKLP, this warranty was not breached."
(ii) The warranty contained in Clause 14 of Schedule 3, which was in these terms:
"Each Company has obtained all licences, permissions, authorisations and consents required for carrying on the Business effectively in the places and in the manner in which such business is now carried on. Each Company holds a valid registration or licence under the control of Housing and Work (Jersey) Law 2012 and the Day Care of Children (Jersey) Law 2002 and has at all times complied with the provisions of the said law and all regulations, orders and codes of practice applicable to the companies and the business including filing accurate manpower returns with the Population Office."
At [290], the Expert summarises the Representors' position in this way:
"In relation to this allegation of breach, the [Representors] accept a technical breach of this Warranty, that is that there may have been times during the operation of the nurseries where the required ratios of staff to children may not have been satisfied, although this was occasional and limited in time. It is asserted that the [Respondent] was aware of this as it had seen the Mazar's report.
291. It is correct that the [Respondent] had seen the Mazar's report, but that has no bearing on the warranties which were caveated in regard to material seen by the [Respondent] only respect of material that formed part of the disclosure bundle. The Mazars report was not part of the disclosure bundle."
(iii) The warranty in Clause 15.1 of Schedule 3, which is in these terms:
"Neither company nor any of its officers, agents or employees during the course of their duties in relation to either company has done or omitted to do, any act or thing, the doing or omission of which is, or could be, in contravention of any statute, statutory instrument, notice, order, decision, judgment, regulation or the like in force in the island of Jersey and which act or omission could give rise to any fine, penalty, default proceedings or other liability or sanction on either company or any of their officers."
The Expert's finding in relation to this breach of warranty, which the Representors had accepted was a technical breach in relation to ratios but did not accept it could have resulted in a sanction, is at [296] of his Award:
"I find that this warranty was breached. A breach of the ratio requirements and any other of the Statutory Requirements for Early Years Provision plainly could have resulted in a sanction. The word 'sanction', to give it an ordinary meaning, must mean some form of penalty for a breach of a law or such like. In this case, maintaining ratios was a condition of registration of both nurseries. Under Article 12(e) of the Day Care Law, 'a person who - without reasonable excuse contravenes or fails to comply with - (i) a requirement imposed on the person under Article 4, shall be liable to a fine of level 3 on the standard scale'. Article 4, it will be recalled, empowers the Minister to impose requirements on a party who registers under the Law. Pursuant to Article 12A were either of the Organic Kids entities to be found guilty of an offence, inter alios its directors could also find themselves guilty of an offence if the offence by the corporate entity was a result of their consent, connivance or neglect. Furthermore, a contravention of a requirement imposed until Article 4 is an express ground for the Minister to cancel a registration. It seems to me the power to vary a requirement under Article 4(2) could also be used as a form of sanction for breach.
297. I cannot however be precise in assessing the extent or gravity of any such breaches. This is because of the uncertainty in relation to the CEYS representatives had concluded as of 24 September... and in relation to the date and authorship of the September 2019 report and the possibility that it may have been influenced by events after the completion date. In relation to the March / June 2019 reports, as I have recorded above, the status of them is unclear. Whilst, there is at least one admission of being out of ratio, that was clearly de minimis and the risk of a sanction accordingly likely to be very limited indeed. I note no sanction was threatened and some months had elapsed before the date of the reports and the completion date.
298. I am not persuaded that the separate complaints from parents risked a sanction."
(iv) The warranty in Clause 15.3 of Schedule 3, which was in these terms:
"Each company has obtained all licences and consents required to operate the Business as a setting for at least the number of children currently on its books and is registered under the 2002 Law in relation to the business and has complied in all material respects with the conditions of such registrations."
At [306] of his Award, the Expert reached his conclusions on this basis:
"In my view, the key point here derives from the wording of the Warranty which invites the question did each of the Organic Kids entities have the required registration sufficient for at least the number of the children on its books? Whilst, I know what numbers were authorised at each nursery, I have no evidence of what numbers were on the books at Completion. Nonetheless, it is not suggested that the number on the books was higher than the number indicated on the relevant registration certificate so the warranty is not breached. Furthermore, any pro tem agreement reached with CEYS as to numbers at OKCQ did not serve to alter the terms of registration."
(v) The warranty in Clause 15.4 of Schedule 3, which was in these terms:
"Each company has complied and continues to comply with the Early Years Statutory Requirements in Jersey in relation to the Business."
At [311] to [316] the Expert dealt with this particular claim for breach of warranty. He did not find any detailed breaches of warranty, but he noted at [316.1] that it was accepted by the Representors that there had been some breaches of the ratios requirements. That was sufficient to have breached the warranty. It was clear that in some respects the Expert accepted the views of the Representors on the alleged breaches of the Early Years Statutory Requirements were accepted.
(vi) The warranty in Clause 15.5 of Schedule 3 which was in these terms:
"There are no adverse findings, actions, recommendations, requirements requested by CEYS or any regulatory or other authority in relation to either company or the business which are outstanding including without limitation any potential breaches of the 2002 Law or the Early Years Statutory Requirements in Jersey."
The Expert noted that the Representors had accepted that the ratios were breached at various times and that was sufficient for his finding that the warranty had been breached. However, he was uncertain as to what the breaches were or how serious they were.
6. It is important to note the Expert's view of the breaches of warranty which he found. Many were accepted to be de minimis and therefore of no consequence. However, there was an agreement in place prior to the completion date between CEYS and OKCQ that the number of children at OKCQ would be restricted to the then current numbers until such time as CEYS was satisfied the nursery had a sufficient number of qualified staff to justify any increase in the number of children in attendance (subject of course to the ceiling on that number determined by the conditions of registration). The Expert accepted that the Respondent was not made aware of this agreement by the Representors and discovered it only after the completion date. Accordingly, the key breach was the breach of warranty at Clause 15.2 of Schedule 3 that the registration for OKCQ was 'in full force and effect' coupled with the warranty in Clause 7.2 that the Representors were unaware of any fact which 'renders or might upon its disclosure render' that representation 'misleading or incomplete'. On the contrary, he found the Representors were aware of the agreement in place. There was no equivalent agreement or cap imposed by CEYS in relation to OKLP and therefore no equivalent key breach of warranty in relation to OKLP.
7. The detail in respect of the breaches of warranty are described in more detail at [27] to [37] below. As the Expert commented, the focus on children numbers at OKCQ as the material breach was important given the manner in which the Respondent calculated its loss. That calculation was in fact broadly the basis of the Expert's award of damages (the "Award").
8. There was substantial agreement between the parties as to the way in which the Court should approach the Expert's determination as a matter of law, albeit there were some points of difference.
9. As was summarised in the Skeleton Argument of the Representors:
(i) The general rule is that the parties to an expert determination are bound by the Award even if it is based on a mistake, and even if the mistake is obvious - see Nikko Hotels (UK) Ltd v MEPC Plc [1991] 2 EGLR 103.
(ii) However, the parties are not bound by the award if the expert has materially departed from his instructions - see Jones v Sherwood Computer Services Plc [1992] 1 WLR 277 at 287.
(iii) As an expert is subject to an implied (if not expressed) duty of fairness, the expert will materially depart from his instructions if he fails to act fairly with regard to one or other party in a material way - see Griffin v Wainwright [2017] EWHC 2122.
(iv) The parties are not bound by an award if the expert has made it in bad faith - see Ackerman v Ackerman [2011] EWHC 3428.
(v) Bad faith includes making an award which the expert knows to be materially incorrect - see Times Travel (UK) Limited v Pakistan International Airline Corporation [2021] UKSC 40; [2021] 3 WLR 727.
10. In his Skeleton Argument, Advocate Alexander rightly emphasised that the appointment of the Expert was pursuant to the contract between the Representors and the Respondent - and accordingly the principle la convention fait la loi des parties is a fundamental principle which governs the basis upon which the Court should receive an application of the present kind. He agreed that, if the agreement between the parties did not expressly provide otherwise, an expert's decision will be open to challenge:
(i) On the ground of fraud or collusion - as noted by Lord Denning MR in Campbell v Edwards [1976] 1 WLR 403 at 407:
"It is simply the law of contract. If two persons agree that the price of property should be fixed by a valuer on whom they agree, and he gives that valuation honestly and in good faith, they are bound by it. Even if he has made a mistake they are still bound by it. The reason is because they have agreed to be bound by it. If there were fraud or collusion, of course, it would be very different. Fraud or collusion unravels everything."
(ii) The decision of an expert may (but will not inevitably) be set aside if the expert fails to treat the parties fairly by, for example, granting one party more time than the other to complete a particular procedural stage (see Hickman v Roberts [1913] AC 229); by addressing an issue with only one of the parties (see Griffin v Wainwright [2017] EWHC 2122); or by failing to act independently and impartially (see Beevers v Port Philip Sea Pilots [2007] VSC 556). He argued that the test for partiality requires actual bias, on the basis of Bernhard Schulte GmbH & Co KG [2004] EWHC 977 (Comm) and not just conflicts of interest or an apparent lack of independence.
(iii) If the parties had empowered the expert to make a decision in relation to a particular issue, the fact that the expert has reached the 'wrong' answer is irrelevant if the expert addresses that issue. However, if the parties did not in fact refer a decided issue to the expert, or if the expert answers a different question from the one put to them, then the expert will be taken to have exceeded his jurisdiction and the determination will not be binding - see Jones v Sherwood Computer Services Limited [1992] 2 All ER 170.
11. Advocate Alexander therefore submitted that the following were relevant principles:
(i) Expert determination is a purely contractual process and therefore its scope and terms may be freely agreed by the parties to the relevant agreement. That agreement is the definitive authority for the scope of the expert's instruction, the extent of the expert's powers, any procedure and principles governing the determination process and the ability to challenge the expert's decision.
(ii) The Court is not empowered to re-write, or interfere in, expert determination agreements into which parties capable of contracting have entered with their eyes open. The function of the expert is to make the decision, and that is not the function of the Court where the decision has been entrusted to the expert.
(iii) The Court's jurisdiction can be invoked to set aside an expert's decision where it can be shown that:
(a) there was fraud, collusion or actual bias;
(b) the expert exceeded his jurisdiction (as prescribed by the agreement between the parties); or
(c) the expert materially departed from his instructions (as prescribed by the agreement between the parties).
12. In summary therefore, the Respondent's position is that where an expert's analysis and exercise of judgment falls within the scope of his instructions, in the absence of fraud, collusion or actual bias, the decision will not be open to challenge, whether the conclusions are right or wrong. In such circumstances, the parties have chosen to be bound by the expert's decision, for better and for worse. Unless the agreement expressly requires it, there is no inherent requirement for the rules of natural justice or due process to be followed in order for an expert determination to be valid and binding as between the parties.
13. The area of potential difference between the parties as to the law was made apparent in further submissions from Advocate Blakeley. He accepted that he had pleaded his case as though the position under English law were also the position under Jersey law - that is, the parties are bound with the expert's decision, right or wrong, if as a matter of contract that is what they have agreed, subject to the exclusions which are mentioned above. However, under English law he submitted that the obligation to act fairly was procedural and not substantive. It would not matter if the mistake leads to injustice if the expert acted procedurally fairly. Advocate Blakeley submitted that we should not follow that, and we should make our own determination of fairness as a matter of substance and not as a matter of procedure. Put another way, he made the submission that if an expert's decision was obviously wrong, it could not be fair.
14. It is important to record Advocate Blakeley's submissions in relation to his contention that the Award should be set aside on the grounds of the Expert's bad faith. It is particularly important to do that because the Expert was not called to give evidence by either party to answer the criticisms which Advocate Blakeley made on behalf of the Representors. Advocate Blakeley was careful to emphasise that there was no suggestion that the Expert had acted fraudulently, in the sense of seeking any personal gain for himself as a result of his Award, nor seeking to cause the Representors any improper loss. His argument was rather that the Expert must have known that his final decision was wrong, and yet he still issued it. The reason for that submission was that a draft of the Expert's decision was circulated to the parties, in similar fashion to the way in which the Court circulates a draft judgment, seeking the parties' submissions as to any factual errors. In this case, Advocate Blakeley did make submissions as to factual errors, which we will come to later, and the Expert did make some alterations to his draft determination and Award - but nonetheless did not change the substance of his decision or the Award. Advocate Blakeley submitted there was no logical way of justifying the approach that was taken and, because the Expert must have known that the determination was wrong, it should be set aside on the grounds it had been made in bad faith.
15. At the hearing before us, submissions were made by both Advocate Blakeley and Advocate Alexander. We had the benefit of a number of documents, although we suspect not all the documents that were before the Expert. Furthermore, the proceedings before the Expert were recorded and at least in part transcribed; but it is clear that we have not had transcripts of the entire proceedings before the Expert.
16. Finally, we add that Advocate Blakeley called Mrs McLachlan to give evidence before us, which she did, and she was cross-examined. Advocate Alexander called Mr Eccleston to give evidence before us. Mr Eccleston is employed by the Respondent and it was his calculations of loss that were substantially adopted by the Expert. He was cross-examined before us by Advocate Blakeley.
17. Given that the Representors made allegations of bad faith against the Expert and fraud against Mr Eccleston, we have naturally had to consider the evidence which was given to us insofar as it was material to that issue. Otherwise, we did not think the evidence was particularly relevant to what we had to determine. We are not, after all, determining what we would have assessed by way of damages for the breaches of warranty which were found by the Expert. However, Mr Eccleston's evidence was helpful in explaining the calculations which were put before the Expert, to which we will refer later in this judgment.
18. In his Skeleton Argument, Advocate Blakeley summarises the principal issues as follows:
(i) Whether the Award of the Expert was fair, which included whether it was irrational or illogical in either or both of two respects, each of which was critical to the conclusion that damages should be awarded in the sum of £1,610,400.
(ii) If so, whether once the Representors had pointed the errors out to the Expert after he circulated the draft Award, the correct position was so plain and obvious that it should be inferred that his decision to finalise the Award without correcting the errors and awarding only nominal damages was made with knowledge of the error and therefore in bad faith.
(iii) Alternatively, in respect of the second error in the Award, whether the Respondent procured that Award by fraud, namely by dishonestly misleading the Expert in relation to a material question of fact.
19. We therefore address the first point, namely the two alleged errors. The first of these concerned the finding by the Expert that there had been a single material deficiency in relation to OKCQ, namely that the agreement between OKCQ and CEYS, as evidenced by an email dated 26 September 2019 (the "September Agreement") which related to the number of children who could be present at the nursery, was not provided to the Respondent in advance of signature of the SPA.
20. The second alleged error in the draft Award was in the assessment of the effect of the breach of warranty on the value of OKCQ. The Respondent's case was that the price of £5.125 million was calculated using an EBITDA (earnings before interest, taxation, depreciation and amortization) figure of £700,000 and an implied EBITDA multiple of 7.32. By adopting the figures in a schedule provided by Mr Eccleston, the Representors claim that the Expert acted irrationally, because they did not reflect the relevant EBITDA figures at all material times.
21. The chronology of events was as follows. The Expert circulated his draft decision by email on 16 February 2022. On 28 February, Advocate Blakeley wrote to him to invite him to re-open the expert determination because it was said he had fallen into material error and, if those errors went uncorrected, a serious injustice would result. On 4 March 2022, Advocate Alexander also wrote to the Expert addressing Advocate Blakeley's submissions in his letter of 28 February. It was said there was no basis upon which the expert determination should be re-opened, and that the right course was for the Representors' contentions in Mr Blakeley's letter of 28 February to be summarily dismissed and the expert report released as a final report. Advocate Blakeley made a response to Advocate Alexander's letter by email on 11 March.
22. The Expert circulated a revised draft on 5 April. That draft included some suggested corrections from Advocate Alexander which were unobjectionable amendments on the basis of typographical errors or stylistic corrections from the first draft. As far as Advocate Blakeley's comments were concerned, the Expert made changes of a substantive nature to his findings as to the state of OKCQ at the completion date - these appear at [252], [253], [255] and [335] of the revised draft. The Expert also added a postscript running to thirty-two paragraphs giving further explanations of his reasoning in the light of Advocate Blakeley's complaints. Messrs Mourant submitted a number of typographical errors on that draft, and made some further submissions in relation to interest and costs. Advocate Blakeley made submissions by letter dated 13 April, in effect setting out the objections which he has raised in the current proceedings. On 25 April, the Expert wrote to the parties to indicate that he had considered Advocate Blakeley's letter carefully, but he stood by the terms of the determination, a draft of which was circulated on 5 April.
23. We deal first with the procedural objections raised by Advocate Blakeley. The central point here is that the Expert permitted Mr Eccleston to give evidence adopting a schedule of loss which was sent to Advocate Blakeley by Messrs Mourant on 5 November 2020, as opposed to being appended to a witness statement by the party responsible for preparing the schedule. It is said the Expert compounded this error by permitting Mr Eccleston to adopt the schedule and therefore to include it within the evidence which the Expert received.
24. To the extent that this is a procedural objection, the Expert dealt with it at [14] to [27] of the postscript to his Award. He relied in part upon the Rules, as varied by the parties, which, it had been agreed, would govern the process to be adopted. Those rules in summary permitted the Expert at his discretion to receive and take into consideration any information submitted to him by either party in such manner as he thinks fit and give that information such weight as he considers appropriate. The Expert also relied upon the fact that Advocate Blakeley had responded on 18 January 2021 to the Mourant letter of 5 November 2020 with a point-by-point rebuttal in pleading form, addressing points in response to the section of the Mourant letter entitled 'Loss suffered by [the Respondent]'. He noted that in the pack of supporting documents setting out the claim pursuant to Rule 1/6 of Part 2 of the ADR, there was attached supporting documents including the Mourant letter of 5 November 2020, and the submissions made express reference to that letter, to the schedule and to the model about which Mr Eccleston gave evidence. He also noted that the Representors' submissions in July 2021, included detailed contentions on the quantification of loss with criticism of the model adopted by the Respondent as the basis for calculations of its loss. Finally, he noted that Advocate Blakeley was able to cross-examine Mr Eccleston in detail about the provenance and interpretation of the schedule, without prejudice to his objection to its admissibility, and therefore there was in his opinion no unfairness to the Representors by permitting that evidence to be given.
25. We do not consider the procedure adopted by the Expert to have been unfair to the Representors, and in our judgment there is nothing in these complaints of Advocate Blakeley. It is clear that he was aware of the Respondent's contentions as to the basis upon which, if a breach of warranty were established, the loss should be calculated. Indeed, the Expert refers to the fact that at the hearing there was general agreement that the normal method of calculating damages in a breach of warranty claim is to assess the difference between the price paid for the shares which reflects the value with performed warranties and their actual value with the breach of warranty as at the completion date. The model represented one way of calculating that value: and the real criticism which Advocate Blakeley advances in this respect is that it was the wrong way to make that calculation. We will return to the substance of that point but in terms of procedure, it seems to us to be clear that the Representors and Advocate Blakeley were well aware of what would be said against them, had the opportunity to criticise it and question the basis upon which it was advanced, and indeed had the opportunity, if so advised, to provide their own evidence as to how the difference between the price paid for the shares and their actual value as at the completion date ought to be assessed but chose not to suggest any alternative methodology.
26. For these reasons, the procedural criticisms are rejected.
27. In order to understand the substance of the criticisms raised by Advocate Blakeley, we now need to consider the nature of the breach of warranty in more detail. In doing so, we adopt the findings of fact made by the Expert in his Award. Indeed, Advocate Blakeley did not seek to re-open those findings of fact; instead he made a number of submissions as to why the Expert, in his view, reached the wrong conclusions upon them.
28. OKCQ was registered under the 2002 Law with CEYS. The certificate of registration dated 25 October 2018 indicates that registration was subject to a number of conditions, including that the number of children which might be accommodated at the premises did not exceed sixty-nine and 'the conditions of registration accompanying this certificate are adhered to at all times'. There were specific details relating to numbers - within the maximum of 69 children (aged birth to school entry age), there were divisions as to 21 in the first class (babies and toddlers up to pre-school entry), no more than 24 children in the second class (babies and toddlers up to pre-school entry where they are confidently mobile toddlers), and no more than 24 in the third class (the pre-school unit for those aged rising 3 and who are toilet trained, up to the age of school entry).
29. The Respondent alleged before the Expert that it understood it was buying a nursery business which was operating properly with no existing or historical compliance, regulatory or other issues, but, in fact, it had bought a business which was beset with compliance issues, complaints from parents and staffing difficulties. The Respondent relied upon the findings in a CEYS September 2019 report which referred back to the March / June 2019 reports. The first March 2019 report refers to a visit by CEYS to OKLP on 6 March 2019. As there was no finding of any breach of warranty in relation to OKLP, we need consider that no further. The same comment relates to the second March 2019 report.
30. However, there was a visit by CEYS to OKCQ on 6 June 2019 in relation to a complaint from a parent received on 5 June 2019. That report indicated that five actions needed to be taken by OKCQ - in particular, with immediate effect, the nursery 'must work with CEYS and inform the department in writing if ratios can't be met', and 'must be fully staffed and able to meet the ratios of children expected on each day'. The issue in particular was that, at the time of the visit, the baby area, toddler area and pre-school area were each short of one staff member and therefore out of ratio of staff to children. Perhaps this was not entirely surprising given that four staff had left their employment on 31 May for what Mrs McLachlan described in her testimony as 'gross misconduct'.
31. The second June 2019 report concerned a visit on OKCQ on 18 June 2019 in relation to complaints received on 13 and 15 June 2019. It raised six issues of concern, noting that, amongst other things, the staff/children ratios had not been met on three separate days that month, that the staff were not appropriately qualified, and were unable to provide the level of appropriate care and communication required at transition. The report required that 'the nursery must work with CEYS and inform the department in writing if ratios are not met' and 'the nursery must ensure that safeguarding concerns are addressed'.
32. It appears there were no comments from the Representors as a response to these criticisms.
33. There is a nomenclature issue in relation to the September 2019 report because, although on its face the date of the report is unclear, it describes the review date as October 2019. Nonetheless, it contains a number of issues which essentially go to the question of ratios. The Expert found at [108] that under the sub-section entitled 'Next Steps' there was the following passage:
"We have agreed with the organisation the following emergency measures:
(1) A variation to the conditions of registration as follows; currently 45 children attend this setting, 14 children in the pre-school, 16 in the toddler room and 15 in the baby room.
(2) Numbers must not increase without permission from CEYS and if there are any changes in the situation, regarding staffing ratios, the organisation must inform CEYS as soon as possible.
(3) Organic Kids Castle Quay will not take on any new children, irrespective of a decrease in numbers, without written permission from CEYS.
(4) CEYS will have a robust and ongoing approach to supporting and evaluating progress. As a result, this organisation will be subject to a further full quality and compliance review within the next twelve months to ensure sustained progress is maintained for the safety and welfare of children. If at any time CEYS feels that the requirements are not being met or that the organisation does not have the capacity or resources to improve, then a referral to the Minister will be made under [the 2002 Law] with recommendations to suspend the registration of this organisation."
34. The Expert then referred at [116] and [117] to emails of which only the first appears to have been included in the disclosure bundle. This email dated 25 September 2019 from Mrs McLachlan referred to "the annual re-registration last week at Castle Quay" and the "feedback meeting with them yesterday (very boring as they are very boring people) together with Leianne, the manager and Sandra, Early Years consultant who used to do that job (former head of childcare registration) who has worked for us since her retirement". The Respondent argued before the Expert that the email wrongly presented a positive impression of the meeting.
35. The second email dated 26 September 2019 was one from Rebecca Roxburgh at the Education Department to Mrs McLachlan in reply to one of the same date which also referred to the productive meeting on Tuesday, noting that the full review report would be provided within a month. However, the email emphasised that safeguarding standards needed to be prioritised and there had to be some urgency in addressing them. It continued:
"We all agreed due to difficulties around staff recruitment and retention standards 1.8, 1.9 and 1.10 are unachievable for Organic Kids Castle Quay at this time and that more time needs to be allowed for you to develop capacity. within your team. We accept your sensible suggestions to mitigate the impact of the recruitment difficulties by maintaining the number of children and ratios at the current level and using your most reliable and knowledgeable staff as team leaders in the baby, toddler and pre-school rooms.
To confirm; [sic] you currently have 45 children in total, 14 children in the pre-school, 16 in the toddler room and 15 in the baby room. You will not exceed these numbers without confirmation from CEYS that you have capacity within your team to do so. If there is any changes[sic] in the situation regarding staffing and ratios you or Leanne [sic] will let us know as soon as reasonably possible..."
36. The Respondent became aware of this email in an email exchange on 18 November 2019, i.e. after completion, when Ms Roxburgh of CEYS confirmed those numbers again.
37. At [247] to [255], the Expert addressed the condition of OKCQ from a regulatory point of view at the completion date. He noted that the evidence did not provide a satisfactory answer to the issue, because while he had some evidence from late September and evidence of the real difficulties as at 15 November 2019, he was lacking a detailed snapshot as at the completion date of 8 November 2019. He did note, however, that prior to the completion date there was clearly an issue about ratios and that this was caused by a lack of qualified staff, and in turn by difficulties in recruitment. On that point, CEYS was pragmatic and allowed the present position to remain, but there was to be no increase in children until the appropriate number of additional staff had been recruited. The potential increase in numbers was directly linked to staffing numbers. The Expert therefore noted that there was a difference between the registration certificate which permitted OKCQ to accommodate 69 children, provided there was an appropriate ratio of staff to children, with the agreement on 24 September 2019 that the number of children would not be increased without confirmation from CEYS that it had capacity within the staff team to do so, the agreed ceiling on numbers being 45 children.
38. This forms the basis for the claim for breach of warranty as set out above.
39. The SPA does not contain any helpful provisions as to how the loss for breach of warranty should be calculated. In those circumstances, we consider the Expert was right, as far as this went, to approach the quantification of loss by reference to the value of OKCQ at the completion date on the basis that there was no breach of warranty, and its value on the basis of the breaches which had been found. The SPA in our judgment settles the value of the shares without breach of warranty because it contains the price agreed between vendors and purchaser. In this case, the Representors asserted before the Expert that the Respondent had failed to mitigate, and they pointed to Clause 7.10 of the SPA which states that 'Nothing in this agreement shall be deemed to relieve the purchaser from any duty to mitigate its loss....'. In our judgment, the Expert was correct to say this:
"337...Whilst accepting that mitigation typically has no application where the measure of damages is the difference in value between the value of the company as warranted and its true value, it is argued that mitigation should apply here since the restriction on numbers at the nurseries were [sic] capable of being lifted upon application to CEYS once the requisite number of additional qualified staff had been taken on to satisfy the necessary ratios. On the evidence, the [Respondent] failed to take on the additional staff and then apply to CEYS for the restriction to be raised. The implicit point here is that CEYS could not refuse an increase where ratios would be properly met.
338 The problem faced by the [Representors] in this respect is well summarised by Salzeddo, Fraud and Breach of Warranty (at paragraph 8.29):
"It is important to note that if a breach of warranty of quality is established, then it does not avail a vendor to argue that the purchaser would have paid the same even if the correct information had been given in the warranty. That argument confuses the tort and contract measures of loss. A warranty does not amount to an inducement to purchase, but only a contractual understanding that if matters are not as warranted, damages will be paid. The enforcement of damages is a matter of enforcing the secondary obligation to pay damages for the breach of the contractual undertaking, not a matter of compensating for reliance on a misstatement. In many circumstances, a tort claim is more beneficial for a claimant, but this is one respect where breach of warranty is a superior claim: the claimant does not need to establish anything about its own conduct in a hypothetical world. If a purchaser buys and the warranty is breached, then damages are the difference between what the vendor promised and what the vendor delivered. The same point means that a Respondent vendor is unlikely to be able to get any argument of failure to mitigate off the ground: the purchaser had no opportunity to mitigate the loss because the loss is defined as the receipt of a business worth less than the one that was promised."
40. We agree with that approach insofar as mitigation of loss is concerned, as far as that goes, but that does not mean, as we shall see, that the assessment of a proper sum by way of damages can be made without accurate linkage of the award to the breach - nor does it mean that there is never any scope for mitigation arguments, or something akin to them, to be run. Where the business has a lower value by reason of the breach of warranty, the cost of putting the business back to where it would have been without the breach of warranty may well be relevant in establishing its value with the breach. That cost is not so much the application of mitigation of loss principles, but an exercise in valuation - how one values a business with a particular set of circumstances (in fact on this hypothesis amounting to a breach of warranty) will take into account the cost of ameliorating them.
41. In his evidence to the Expert, and indeed before us, Mr Eccleston was clear that there was more than one way of calculating the actual value of OKCQ at the completion date. The approach which he adopted was that its value should be calculated by reference to its actual EBITDA at that date. He considered that to be appropriate because the Respondents' assessment of the value, and therefore the price it was prepared to pay, was based on a warranted EBITDA of £700,000 for the twelve months up to the completion date and the application of a multiplier.
42. The Expert dealt with this calculation in the following way:
"342. The financial model recreated a profit and loss statement for OKLP and OKCQ using 'using [sic] standard BPH income and cost methodologies which reconciles to the financial information provided to [the Respondent by the Representors] and then flexed the 'relevant performance parameters against the caps on operating capacity imposed by CEYS'. The model accordingly adjusts the income, staffing requirements and variable cost elements to produce a revised EBITDA..."
43. The Expert then summarised the main arguments against the Respondents' approach to quantification. He rejected the procedural argument that he should not have regard to Mr Eccleston's evidence, which filled in the gaps as to the basis upon which the schedule had been prepared. He noted that the model had assumed that all the warranties alleged to have been breached had been so breached, and, as some were found not to have been breached, a further calculation would need to be undertaken. He concluded that a key variable in the calculations was the number of children at the nurseries and he had taken that into account in considering the level of damages.
44. Thirdly, he noted that the Representors took issue with the occupancy percentage applied to the nurseries. He summarised the position in this way:
"346. By way of specific illustration, in relation to OKCQ the model calculated that based on the registered capacity of 69, the nursery had achieved an occupancy full time equivalent of 49.9 which gave an occupancy percentage of 73%. In the scenario that numbers had been capped at 46, it then applied the same percentage (in fact it had been rounded to 72%). The criticism made was that just because the numbers were capped did not mean it would only have achieved 72% occupancy i.e. it could have been as high as 100%. Mr Eccleston accepted the possibility, but indicated that in trying to model what the [Respondent] argued was the actual position on the completion date (i.e. numbers were capped) it was a fair assumption that the percentages would be the same. I find that his approach was a reasonable way to proceed. It was open to the [Representors] to have sought disclosure of the actual figures had they wished to do so.
347. I find that using an EBITDA approach is a reasonable way to proceed, not least given that that was the approach taken to both the parameters of what the [Respondent] may have been willing to offer and did in fact pay.... On the evidence before me I am satisfied that the calculation has been properly and consistently undertaken."
45. It is convenient at this time to address a specific point raised by Advocate Blakeley in relation to the evidence of Mr Eccleston. It is asserted that in his evidence he deliberately misled the Expert. We consider that there is absolutely no basis for that contention. The extract from [346] which we have set out above shows that the Expert was well aware of the argument over the carrying forward of the 72% occupancy. He refers expressly to the fact that Mr Eccleston accepted that the percentage occupancy could have been higher. This is not conduct which is consistent with any attempt to mislead. Indeed, in the evidence before us, we did not form the view that Mr Eccleston was in the slightest respect an untruthful witness. We disagree with the approach which he took to valuing loss; and we take into account that of course, being employed by the Respondent, he would look to assess the quantification of loss in the most advantageous way to the Respondent he could whilst at the same time to acknowledge the need to justify it logically; and having regard to his evidence, we consider that both before the Expert and before us his evidence was given in an entirely straightforward way.
46. There is one additional comment which we think ought to be made before we come on to consider the model in more detail. Advocate Blakeley submitted before the Expert and before us that the breaches of warranty which had been found were of little consequence - in his view, any award of his damages should be absolutely minimal. To reach that conclusion would be to acknowledge implicitly that problems with the regulator would be of little concern to a purchaser. We do not agree that that is correct. Any purchaser, when it is acquiring a regulated business which cannot operate without the approval of the regulator and must operate within the conditions which the regulator imposes, is bound to have the closest regard to the regulatory position. It is not just that there were actual restrictions which were agreed between OKCQ and CEYS, as is clear from the September 2019 agreement; it is also, in practice, that it would be obvious to the vendors, as indeed to the purchasers if there had been no breach of warranty, that the regulators would be all over this business for at least twelve months following the completion date. In this case, it appears that CEYS was not satisfied of the position until May 2020. There is all the difference in the world between an operator who can run the business in accordance with its registration and one who is looking over his shoulder at the regulator knowing that any particular breach, in this case of staffing ratios or numbers of children, could result in the registration being suspended.
47. Mr Eccleston closed his evidence before us by saying that had he known about the 2019 September report he would have ensured the Respondent pulled out of the transaction. In other words, as he put it, had they known that OKCQ was in effect a distressed asset, the Respondent would not have purchased it, or, if it had done so, would have applied a very different multiplier and a different EBITDA. In those circumstances, the complaint by Advocate Blakeley that the losses actually sustained would not have amounted to the figure awarded misses the point - the Respondent would not have purchased the business at all, or at a much lower figure - which of course prompts the question whether the Representors would have sold at the figure that the Respondent contends for. It was submitted that they obviously would not have done so. We understand and largely accept that the purchase might not have gone ahead, but we do not consider that the temporary restrictions on children numbers made the business a distressed asset.
48. We now turn to the model. The Expert dealt with the basis of calculation of loss on the warranty claim between paragraphs [340] and [352] of his Award. The Expert started by noting that the Respondent had submitted that the actual value of the nurseries should be calculated to their reference to their actual EBITDA at the completion date. The reason that EBITDA was relevant was that the Respondent assessed the value on that basis in reaching a conclusion at the price it was prepared to pay and did in fact pay - that price was based on a warranted EBITDA of £700,000 for the twelve months up to the completion date and the application of a multiplier.
49. The Expert described the model thus:
"The financial model recreated a profit and loss statement for OKLP and OKCQ using 'using standard BBH income and cost methodologies, which reconciles to the financial information provided to [the Respondent by the Representors]' and then flexed the 'relevant performance parameters against the caps on operating capacity imposed by CEYS. The model accordingly adjusts the income, staffing requirements and variable cost elements to produce a revised EBITDA' (Mourant's letter dated 5 November 2020 paragraph 51).
343. The [Representors'] main arguments against the [Respondent's] approach to quantification were as follows. First, it was argued that the submissions and evidence as filed had failed to include the underlying data to the calculations and provided an insufficient explanation of the approach taken. Advocate Blakeley therefore objected to any attempt to remedy these deficiencies at the hearing...
344. It should be noted that the model setting out the sum claimed and the elements of the calculation, with a broad explanation of the approach taken were provided to the [Representors] via Mourant's letter of 5 November 2020. That has given the [Representors] ample time to seek further information about the approach and there was nothing to stop them seeking an order from me that this be provided, should that have proved necessary. It would likewise have been open to the [Representors] to instruct an expert to critique the [Respondent's] approach and calculations. It did neither of these things. In any event, Advocate Blakeley was clearly able to test the approach in his detailed cross-examination on Mr Eccleston (which he made without prejudice to his main contention that no further explanation should be allowed) and in his submissions.
345. Second, it was argued that the loss calculated via the EBITDA model was based on a finding that all the warranties alleged to have been breached have been so breached. Thus if some were not breached, a further calculation would need to be undertaken. A similar line was taken in the cross-examination of Mr Eccleston. Given that a key variable in the calculations was the number of children at the nurseries, it seems to me this argument would have been better framed as: if the Expert does not find the numbers of children who could attend were restricted, then the claimant cannot recover for a breach of warranty based on those reduced numbers. That is in effect the result of my findings on number restrictions and informs the level of damages that I have awarded (see below).
346. Third, the Respondents took issue with the occupancy percentage applied to the nurseries in the scenario where numbers were kept.... The criticism made were that just because numbers were capped did not mean it would only have achieved 72% occupancy i.e. it could have been as high as 100%. Mr Eccleston accepted the possibility, but indicated that in trying to model what the Respondent argued was the actual position on the completion date...it was a fair assumption that the percentages would be the same. I find that his approach was a reasonable way to proceed...
347. I find that using an EBITDA approach is a reasonable way to proceed not least given that that was the approach taken to both the parameters of what the [Respondent] may have been willing to offer and did in fact pay...."
50. As a result of this line of thinking, the Expert accepted the Respondent's approach to establishing the true "as is" value of OKCQ, namely £140,000 then multiplied by 7.32, the factor which was used to calculate the original purchase price. That gave a total figure of £1,024,800.
51. Accordingly, the Expert concluded that the Respondent's loss of bargain was what it paid for the shares less the difference between the warranted value and its actual value, namely £1,610,400 (£2,635,200 less £1,024,800).
52. The criticisms which Advocate Blakeley made of the model before the Expert have been renewed before us.
53. Essentially the Respondent's model comes out with an EBITDA of £140,000 for OKCQ, rather than £360,000, leading to reduced income from £857,000 to £574,000. The model also shows a reduction in capacity from the registered total of 69 to the September agreement total of 46, but as the occupancy percentage was carried forward at the same rate, the occupancy full-time equivalent was reduced under the model from 49.9 to 33.3; 49.9 being 72% of the registered maximum, and 33.3 being the figure generated by taking 72% of the September agreement maximum of 46. This of course had the equivalent impact on income and thus on EBITDA.
54. We will come shortly to the criticisms of the model itself, but it is right in our judgment to note that under Clause 3.3 of Schedule 3 the Representors warranted that the EBITDA for OKCQ and OKLP would be not less than £700,000 for the twelve month period ending on the completion date. The result of the calculations which were adopted by the use of the model revealed a reduced EBITDA for OKCQ which was not only artificial but plainly wrong. Given that the justification provided by Mr Eccleston for his model was that the Respondent had calculated the price it was prepared to pay for the nurseries by applying a multiplier to EBITDA, in our judgment it is impossible to justify as fair the conclusions which the model would require one to adopt. It may well be that EBITDA was reduced for the period from the Completion Date until the restrictions on children numbers at OKCQ were lifted, but that is not the figure which went into the calculations on which the Respondent applied its multiplier; and it is that reduced EBITDA for the period after completion, if there was one, which could have been more properly used (without the application of a multiplier) to calculate the loss because that is the figure which is fairly linked to the breach of warranty.
55. Another way of putting that objection is that we are proceeding on the basis that the value of the nurseries was correctly assessed at the price set out in the SPA of £5.125 million. If the value of the shares as warranted was calculated by the Respondent on the basis of an EBITDA of £700,000, and in fact that EBITDA figure was reached, there would seem to be no rational reason for calculating the value of the shares with the breach of warranty based on a multiplier applied to a lower EBITDA.
56. We now consider the model in more detail.
57. OKCQ was registered for 69 children, but there was no warranty as to the number of children who actually attended. We have to recall, when considering the model, that the breach of warranty essentially is that the Representors did not disclose to the Respondent the existence of an agreement with CEYS that in effect varied the permitted number of children under the registration by reducing it to 46 children unless CEYS agreed. The model assumes that if the cap on the number of children is reduced from 69 to 46, that same percentage reduction will be applied to the occupancy or full-time equivalent children attending the nurseries: we think that is a false assumption and accordingly, the model was wrong in suggesting that full-time equivalent occupancy would necessarily drop from 49.9 to 33.3 simply because the permitted maximum had been reduced. Advocate Blakeley submitted that if the nursery attracted 50.1 full-time equivalent children with a registered maximum of 69, there was no reason why the numbers would necessarily drop to 33 if the permitted maximum was 46. We agree that this is a fair criticism, even though we think that Advocate Blakeley's example does not necessarily work to illustrate the point he was making. He posed the possibility of a theatre which has a maximum capacity of 100 people. If the maximum capacity were to be reduced to 75 people, and the average attendance had been 70, he submitted there would be no reason to think that any loss would be sustained at all because the 70 average could still be met within the maximum seating capacity of 75. In our view, this analogy is incorrect. For example, if the average attendance was 75, then it could have been 100 on some occasions and 50 on others - and of course on the occasions when it was 100, that would not be possible because the permitted maximum capacity was only 75. Nonetheless, the point that it is not right to assume that there will be the same percentage drop in attendees as the percentage drop in maximum numbers as capped by CEYS seems to us to be a fair one.
58. The analogy is useful in bringing to the forefront other concerns about the model. It is clear that the FTE occupancy figure is absolutely critical to the income figure. There could have been proper enquiry about the actual FTE occupancy - those figures were available. Nonetheless, despite the Expert being aware that there were figures available to him, no proper enquiry was made about the underlying assumption which the model makes that where the maximum capacity drops, the FTE occupancy will drop by the same percentage as has the maximum capacity.
59. In our judgment, the assessment of damages by the Expert was unfair, and, because there was a flaw in the analysis of Mr Eccleston which he (the Expert) accepted, the Award was Wednesbury unreasonable. Accordingly, it cannot stand. This is not a case of an Expert making a mistake in carrying out his instructions as in Jones v Sherwoods Services Limited [1992] 1 WLR 277, or Veba Oil Supply and Trading GmbH v Petrotrade Inc [2001] EWCA Civ 1832. What the Expert has done is reach a decision which, because it was Wednesbury unreasonable, is not something which either party expected him to do when they agreed on his appointment. For the avoidance of doubt, we do not consider the Expert acted in bad faith - that is that he deliberately issued his award knowing it to have been wrong.
60. An equally valid way of looking at it is to say that the agreement between the parties was that the Expert should act fairly. We do not think that he acted in a procedurally unfair way for the reasons we have given earlier. However, in our view, on this particular contract and the rules which were agreed to apply to the Expert's determination, the obligation to act fairly is substantive as well as procedural. If you had asked the parties prior to the engagement of the Expert whether they would accept that he might come back with an unfair determination and they would still be bound by it, we have no doubt that, faced with that question in the abstract, (both objectively and subjectively) they would have resolutely rejected the suggestion.
61. In reaching our conclusion that the Award should be set aside, we are also clear that there should be no reopening of the conclusions of fact which the Expert reached. Advocate Blakeley submitted that the Court could adopt a blue pencil exercise and sever the determination of the Expert into two parts - liability and quantum. He went on to submit that in respect of any part that is unenforceable, the Court could make it plain that the findings of fact remain binding, and that either the matter should be remitted to the same Expert, or to a different expert to have a fresh determination on quantum.
62. This approach was broadly agreed by Advocate Alexander - if the Award were set aside, he agreed that there should be a mechanism to settle a fair result.
63. In the anticipation that this dispute will either be referred back to the Expert or to a different expert if the parties so agree, for the assessment of an appropriate award of damages as compensation for the breaches of warranty, we make these additional comments:
(i) The primary function of the Expert, which is implicit in his appointment, is to award compensation for the losses which were liable to result from the breaches of warranty. It is essential that the award is directly linked to the loss which flows from the breach of warranty, rather than to some calculation of what the Respondent would have offered for the shares had it been aware of the true position. The measure of damages of Representors' breach of contract is the sum required to put the Respondent in the financial position in which it would have been if the Representors had performed the contract and delivered what they promised to deliver (see Snell v Thacker [2006] JLR 142, and in the Court of Appeal at [2007] JLR N [2].
(ii) Double compensation must be avoided. It would be open to the Respondent to claim for actual expenditure flowing from the breaches of warranty or for loss of profits which have been sustained, but not both. Either of those figures would in theory be capable of demonstrating the difference in the value of the shares as warranted and the value of the shares as acquired with the breach of warranty but it seems unlikely that the Respondent could claim both.
(iii) We see no reason why the Respondent should not also be able to establish within the claim for actual expenditure or loss of future profits an amount of loss which flows from the additional management expenses of having to satisfy the regulator that the business was being managed appropriately. In our judgment, such losses would be reasonably in the contemplation of both vendors and purchaser had they applied their minds to the issue before entering the contract because, as we have indicated earlier in this judgment, a problem with the regulator when running a regulated business is no small matter, as the very continuation of the business is potentially at risk.
64. We will hear the parties if necessary on the question of costs. There is liberty to apply in relation to any difficulties encountered over the remission of the calculation of damages to the Expert.
Authorities
Nikko Hotels (UK) Ltd v MEPC Plc [1991] 2 EGLR 103.
Jones v Sherwood Computer Services Plc [1992] 1 WLR 277.
Griffin v Wainwright [2017] EWHC 2122.
Beevers v Port Philip Sea Pilots [2007] VSC 556.
Bernhard Schulte GmbH & Co KG [2004] EWHC 977 (Comm)
Ackerman v Ackerman [2011] EWHC 3428.
Times Travel (UK) Limited v Pakistan International Airline Corporation [2021] UKSC 40; [2021] 3 WLR 727.
Campbell v Edwards [1976] 1 WLR 403.
Hickman v Roberts [1913] AC 229.
Jones v Sherwood Computer Services Limited [1992] 2 All ER 170.
Veba Oil Supply and Trading GmbH v Petrotrade Inc [2001] EWCA Civ 1832.