Scottish Court of Session Decisions

What is in issue in this case is the extent, and therefore the effect, of binding contractual agreement between the parties in December 1990. The pursuers then arranged to acquire equipment by way of finance leases in which, ultimately at least, the second defenders are lessors. The second defenders are a wholly-owned subsidiary company of the first defenders and the defences and representation for the defenders is joint. The pursuers aver that a finance lease typically transfers many of the risks and rewards of ownership to the lessee in return for payment of a rental, that most finance lessors fix the rental as if the transaction is a loan, that the rental is fixed with a view to a full return to the lessor of capital and interest, that it is therefore influenced by prevailing interest rates and that it is not uncommon for finance lessors to match their funding costs to their lending rates to minimise the loss from interest rate movements. The pursuers aver that until 1990 they dealt with Concord Leasing and that the finance leases between the pursuers and Concord Leasing provided for fluctuations in interest rates, the interest rates being calculated quarterly or six-monthly. In the event of interest rates declining, Concord would be obliged to pay the pursuers a rebate. If the interest rates had increased the pursuers would be obliged to make a balancing payment to Concord. The pursuers aver that they entered into negotiations with the defenders in 1990 and that the defenders initially were represented in the negotiations by Paul Eversfield, and subsequently by Raymond Keane. Mr Keane was managing director of both the first defenders and the second defenders. At that time interest rates were "very high" and the pursuers insisted that the arrangement should provide for fluctuations in interest rates along the lines of the arrangement with Concord Leasing. The pursuers aver that Mr Keane agreed that the defenders would "meet the Concord deal" and the parties agreed that interest rates should be recalculated annually. The pursuers further aver that Mr Keane advised the pursuers that the defenders did not yet have available a standard form of variable interest rate lease. Mr Keane therefore asked the pursuers to sign one of the existing standard forms but stated that he would issue a side letter. It is agreed that on 17 December 1990 a letter, referred to by the parties as "the side letter", was signed by Mr Keane on the first defenders' notepaper. It was faxed and posted to the pursuers on that day. It was addressed to the pursuers' financial accountant and it is agreed that it refers to leasing of the equipment with which this action is concerned. The letter reads:

The pursuers aver that 14% was the base rate of the Midland Bank at 19 December 1990. The pursuers further aver that, on 18 December 1990, Mr Spencer, the pursuers' chairman and managing director, signed two finance leases, subsequently numbered.2928-9 and 2929-7, on behalf of the pursuers. The leases were also signed by Mr Keane on the same day, all the signatures being adhibited at the pursuers' premises. These leases related to the whole of the equipment specified in the heading of the side letter. At the time of signing, no company other than the first defenders was mentioned as lessor on the leases, nor had any other company been mentioned in discussions and negotiations concerning the leases. Mr Keane had thereafter taken the leases away, leaving a copy with Mr Spencer. A number of alterations were thereafter made by the first defenders to the written leases, involving the insertion of the date "19/12/90" (sic) against each signature and the insertion of Mr Spencer's name (in the form "T. Spencer") in the box for the signature for the lessee and "Summit Lease Finance (No.2) Limited" was inserted above Mr Keane's signature after the words "for and on behalf of" in the box relating to lessor. The pursuers aver that in these circumstances the leases were originally concluded with the first defenders as lessors and that the first defenders' interest in each lease, together with the equipment, was subsequently transferred to the second defenders. The term of each lease was specified as seven years. Rental payments were to be made monthly in arrears and the payments entered in the leases related to a sum to be paid on each of the first six rental monthly payment dates, an increased sum on the next six such dates and a further increased sum on each of the seventy-two subsequent monthly rental dates. A declaration of the lessee in each lease stated,

At the first anniversary of the leases the pursuers claimed that they were entitled to a rebate of rental as the Midland Bank base rate at 19 December 1991 was 10.5%. The defenders maintained that fixed rental was payable under the leases, the fluctuating rebate/increase provision envisaged in the side letter being superseded by the fixed rental provision in their standard form lease signed by the parties subsequently. The present action is simply the logical development of this issue bringing matters up to date, with the base rate on subsequent anniversary dates again being very much lower than that on 19 December 1990. In the result, the pursuers now claim £27,774.61 in respect of one lease and £185,559.26 in respect of the other, with interest from citation.

Mr McLean, for the defenders, submitted on procedure roll that the action should be dismissed as irrelevant. He submitted in particular that the side letter could not be given contractual effect in light of the existence of the signed leases, which post-dated that letter. The defenders' position was that the side letter was issued during pre-contract negotiations and in no way affected the terms of the leases subsequently signed, which clearly involved only fixed rental payments with no rebates or increases payable in the event of interest rates declining or increasing, as the case might be. The use of such a pre-contract letter to alter the terms of a subsequent contract was not permissible (McBryde on Contract 19.07, 19.11 and 19.12). It appeared that the pursuers' primary position was that the side letter constituted a collateral agreement. Whatever its terms, such a side letter could not have the effect of varying an essential term of a complete written contract. (McBryde 3.09; Norval v Abbey (1939 S.C.724); Perdikou v Pattison & Others (1958 S.L.T.153); McInally v Esso Petroleum Co Ltd (1965 S.L.T.(Notes) 13); Irons v Partick Thistle Football Club Ltd (1997 S.L.T.983); Wake v Renault (UK) Ltd (1996 T.L.R. 514).

Mr McLean next submitted that if the side letter could not comprise an effective collateral agreement for present purposes, the pursuers were driven to rely on declaration 3 in the declarations of lessee in the two leases. This paragraph did envisage the possibility of there being an agreement ante-dating the lease and being effective in construction of the lease but such other agreement required to be in writing signed by the lessor. In the present case, only the second defenders were shown as lessor in the respective leases. The side letter did not bear to be signed on behalf of the second defenders, being on the first defenders' notepaper, albeit that Mr Keane was managing director of both the defenders. Furthermore, paragraph 1 of the declaration of the lessee in each of the two leases stated,

This made it plain that the first defenders as vendors of the machines and the second defenders as lessors were not only different companies but had different functions in the operation of the agreements. Accordingly, there could be no question of declaration 3 of the declarations of the lessee in each lease operating to enable the fixed rental agreement in terms of the leases being effectively varied to constitute a fluctuating rental type of agreement.

Mr McLean next submitted that, in any event, any agreement evidenced by the side letter was unenforceable or void through uncertainty. It bore to confirm an oral agreement and the pursuers' averments on record provided insufficient specification of what the Concord deal was which the agreement between the parties was alleged to "meet". Furthermore, the pursuers averred that recalculation annually was agreed, a difference from the Concord position. Also, there was no specification by the pursuers of what the defenders' "margin" was. Also, there was no adequate specification of the mechanism by which rebates/increases were allegedly agreed to be made. Also, there was no justification for reference to Midland Bank base rate in particular. Accordingly, the side letter was fatally lacking in detail as to how the alleged fluctuating rental arrangement was to operate. In their claim in the present action the pursuers had been driven to produce a calculation which involved implications which could not be properly made as a matter of law (McBryde 4.21; The "Strathlorne" Steamship Company Limited v Hugh Baird & Sons Limited (1916 S.C.(H.L.) 134); Anderson v Commercial Union Assurance Company plc (1998 S.C.197); Steels Aviation Services Limited v H Allan & Son Limited and another (O.H.. (unreported) 20 May 1998); G Scammell & Nephew Limited v Ouston (1941 A.C.(H.L.)251). What the Court was being invited to do here was to make a contract for the parties on a vital matter, namely the price payable under the contract and this was not permissible (ibid). Furthermore, there was no need to imply a contract in the present circumstances as the price was clearly stated in the two leases.

Mr McLean submitted that, in any event, the averments by the pursuers in Condescendence 9 as to the side letter confirming a collateral agreement which did not purport to alter or amend the leases should be excluded from probation, as should the averments in Condescendence 7 as to the pursuers' belief and averment as to the original basis of conclusion of the agreements and subsequent transfer.

Mr Drummond Young, for the pursuers, submitted that the case should be sent to proof before answer, excluding only certain averments of the defenders in their Answer 7. He said that the pursuers' case was based on a collateral agreement in express terms contained in the side letter of 17 December 1990. Being a collateral agreement, the side letter falls within the exception to the general parole evidence rule. Alternatively, declaration 3 of the declarations of the lessee in the leases specifically contemplated that prior agreements might exist effective to qualify the terms of the leases. When the leases were originally executed the first defenders were the lessors. No other company was named who could be the lessor. There was a subsequent transfer of the equipment itself and a transfer of the landlord's interest in the equipment to the second defenders. In any event, as a matter of business efficacy, the first defenders must have entered into the agreement evidenced by the side letter on their own account and as agent for any other company within the Summit Group which might become the lessor. The pursuers had averments as to the normal position to that effect. Even if the second defenders were to be regarded as lessors throughout, it was clear from the whole structure of the side letter that it must have been intended to have some function with regard to the leases duly entered into. The obvious way in which it would operate would be on the first defenders' behalf and also that of any subsidiary who might become the lessor. Mr Keane was managing director of both the defenders. It was clear that agency should be inferred and proof of agency was a matter of fact. So far as declaration 1 of the declarations of lessee is concerned its purpose was clear, namely to get rid of any liability on behalf of the lessor for the condition of the machines. It had no relevance to the matter of agency so far as the side letter was concerned. The defenders' standard form of lease was signed on 18 December 1990 when there was no mention of the second defenders in the leases. It was only subsequently that successively the dates were inserted and reference to the second defenders as lessor in each case was first made. At the meeting when the documents were signed there was no reference to any company other than the first defenders. It was clear that at the outset the first defenders were the lessor in each case and that there was subsequent transfer to the second defenders of the lessor's whole interest. Even if the requirements of declaration 3 of the declaration of lessee were not satisfied so far as the side letter is concerned, that side letter qualified as a collateral agreement. (Dickson on Evidence Vol.2, 1033). In commercial contracts the argument for admitting collateral agreements was stronger than in other cases. Wake's case demonstrated that it was easier to import collateral agreements where standard forms were used. In the present case, the pursuers had averments about the unavailability of a standard form for a fluctuating interest agreement although the defenders planned to have suitable standard forms for that purpose. In Wake's case the collateral agreement qualified the duration of the agreement and thereby altered an essential term of the agreement. In the present case, the collateral agreement involved no contradiction of the terms of the leases. All that was happening was that each year, if and only if interest rates had changed from the initial rate, a rebate or additional payment as the case might be would pass. This had to be a freestanding payment because such payment would be required following year seven in particular, and also because the annual rebates involved demonstrated that the monthly payments were liable to be substantially less than the annual rebate due, making offset of rent at the expiry of the month following an annive

Mr Drummond Young submitted that the contention for the defenders that it could be said on parties' pleadings that the side letter was superseded by the leases was clearly wrong. This contention was contradicted flatly by the circumstances in which the side letter was issued in terms of the pleadings. The side letter was issued only one to two days before the leases were signed. The pursuers maintain that the side letter was the final position so far as taking into account fluctuation of interest rates is concerned. The side letter referred to confirming prior discussions. The pursuers set out in Condescendence 10 the method of calculation which they maintain can be reasonably implied from their earlier averments. It was unnecessary to produce Concord agreements to illustrate their averments on their dealings with Concord. All the express terms of the collateral agreement were to be found in the side letter itself. (Investors Compensation Scheme Limited v West Bromwich Building Society and Hopkin & Sons and others (1998 1 W.L.R. (H.L.) 896); Bank of Scotland v Dunedin Property Investment Co Ltd (1998 S.C.657). It was not in dispute that the side letter referred to the equipment concerned in the leases. As an ancillary agreement it assumed that detailed leases would be concluded. This was in contrast to, for example, the case of Scammell, where the existence of the alleged contract itself was in issue. The reference to Midland Bank base rate came from the defenders' own form, in terms of which overdue rental was to be subject to penalties based on such a rate. In any event, it was agreed that all major banks' base rates materially coincided. In the result, what was left in issue by the side letter was the amount of rebate or increased payment and when such amount was payable. The pursuers aver general practice on this matter and after proof will suggest what parties, acting reasonably, would intend in that situation. In this case, the defenders had not averred specific alternative methods of calculation, as it is open for them to do. One of the established situations for implication of terms was business efficacy (Liverpool City Council v Irwin and Another (1977 A.C.(H.L.) 239). In this case there was express agreement to allow a rebate or increase of rent in the event of interest rate fluctuation. It might be suggested as a commercial necessity to determine how the calculations should be done and commercial necessity is an established situation justifying implication of terms of a contract. (ibid). However, here the pursuers founded rather on the also well-established situation legitimate for such a purpose of general practice and what the parties were likely to adopt as reasonable persons. This was very much a matter for proof.

Mr Drummond Young also advanced a brief submission to the effect that averments in Answer 7 should not be admitted to probation. These averments are averments as to the defenders' practice in arranging lines of finance and as to alleged inability of Mr Keane to sign on behalf of the second defenders, and also averments as to common practice for a lease to be completed and signed for the first defenders for and on behalf of a subsidiary company which was to be the lessor, and that execution of the lease documentation by the prospective lessee constituted an offer to lease, reference being made to a declaration 2 of the declaration of the lessee, the terms of which it is unnecessary for me to relate for immediate purposes. It was not averred by the defenders that the pursuers were aware of such matters. Contracts are to be construed objectively and not subjectively. (Gloag on Contract, 2nd edition, page 398; Lord Hoffman in the Investors Compensation Scheme Ltd case (1998 1 W.L.R.(H.L.) at page 913).

In reply, Mr McLean said that the final subsidiary submission for the defenders appeared to assume that these averments were to do with construction of the contract whereas they were to do with the issue of agency. On the main issue, there was a fatal lack of specification by the pursuers of mechanism to implement what was referred to in the side letter and a fatal lack of specification as to what the Concord agreements had comprised. The side letter was not unintelligible but it was incomplete.

In my opinion, the submission for the pursuers that they are entitled to a proof before answer on their averments is correct. I also conclude that the defenders' averments attacked on behalf of the pursuers should not be excluded from probation for the reasons given by Mr McLean. On the main issue, it seems to me that it would be quite wrong to deprive the pursuers of the opportunity of proving that, while each lease is apt to comprise a binding contract complete in itself, nevertheless the Court should conclude that in the circumstances of the case the leases did not supersede the side letter and the side letter is capable firstly of comprising an independent collateral agreement affecting the leases and/or an "other agreement", whether collateral or not, within the meaning of Declaration 3 in the leases, and secondly by use of permissible implication in the light of evidence to be led for the pursuers in support of their averments to support the claim by the pursuers calculated in Condescendence 10. I agree with the submission of Mr Drummond Young on the main issue and in particular agree that the authorities cited are in some instances supportive, and in the others at least consistent with such a view in the particular circumstances averred by the pursuers in this case. If the pursuers prove their averments this is a case where they have given notice to Mr Keane, who was managing director of and acted variously for both the defenders, that the pursuers had previously contracted with Concord for finance leasing purposes, and in particular done so on a basis which took account of future interest rate changes, were interested in doing business with the defenders only if the defenders could provide at least as good terms as Concord, that those terms must include taking account of interest rate variation, that it was a result of the pursuers' requirements that Mr Keane issued the side letter, that part of the point of the side letter was that the defenders did not have at that time a standard form of contract for agreements taking account of interest rate fluctuation although they intended to obtain them, and that without any suggestion of subsequent negotiation the leases concerned were signed on the following day on behalf of the pursuers in the objectively reasonable, as well as the subjectively reasonable expectation that the side letter was effective to apply to at least a lease or leases specifically envisaged by the negotiators as at the time of the side letter being sent and as further mutually envisaged subsequently signed on the defenders' only currently available standard forms and that any fine detail in mechanism of the resulting fluctuating interest rebate or increases could be readily agreed between reasonable people in the circumstances averred. So far as fine tuning of mechanism is concerned, the agreement in the side letter could logically work in either party's favour depending on movement in interest rates, which could have gone, of course, even higher rather than lower. They might also have been higher one year than the initial rate and lower than that rate in the following year. Accordingly, all the more agreement on what I have described as fine tuning could be reasonably expected. As matters stand, at least, the defenders do not advance any alternative mechanism to that proposed by the pursuers in Condescendence 10. Even if they were to seek to suggest alternative mechanisms, it could emerge at proof that the practical difference between mechanisms suggested was small in monetary terms and this would tend to reinforce, in my opinion, the justification for allowing the pursuers to lead evidence in support of their proposed calculation. It is said for the defenders that the issue goes to an essential matter in the leases, namely the price payable. In a sense, this is so, but it seems to me that the deficiency in mechanism inherent in the side letter could well tur

Act: Drummond Young, QC

Macroberts

Alt: MacLean

McGrigor Donald

23 October 1998