Scottish Court of Session Decisions

The pursuer has reclaimed against the interlocutor of the temporary judge dated 8 December 1998 by which, after hearing parties on the procedure roll, he excluded from probation certain averments of the pursuer, and restricted the scope of the first conclusion of the summons accordingly. He allowed parties a proof before answer in respect of their remaining averments.

The principal object of the action is the enforcement of a royalty agreement dated 12 April 1991 between Ronald William Watt, of whom the pursuer is the trustee in sequestration, and the defenders, referred to in the agreement as "the company". The first conclusion seeks count and reckoning by the defenders for all royalties due and payable by them to Mr. Watt in terms of the agreement. The main dispute between the parties at this stage of the action is the extent of the defenders' liability to account.

It is convenient at the outset to refer to certain provisions of the royalty agreement. The preamble to the agreement states that Mr. Watt had developed and was the beneficial owner of certain technical information relating to the manufacture, assembly and commercial operation of certain security products, and was the beneficial owner of certain patent rights. These products were designed to provide security for empty premises. Under Clause 5.1.1 Mr. Watt granted to the defenders an exclusive right to use the Technical Information to manufacture the products anywhere within the stated Territory. Under Clause 5.1.2 he granted to the defenders "an exclusive right to use sell or otherwise deal in the Products manufactured under Clause 5.1.1 anywhere in the Territory". The word "Products" is defined by Clause 1.1 as meaning "the products and all relative products deriving from and to be derived from the Know-how, the Technical Information, the Patent Rights and/or the Improvements". The latter terms are also defined in Clause 1.1.

The liability of the defenders for payment of royalties is governed by Clause 6. Clause 6.1 states:

Clause 6.2 makes provision for the ascertainment of the Net Sales Value "if any Products are incorporated in any other equipment or apparatus sold by the Company at a price which is included in the price for other equipment or apparatus".

"Net Sales Value" is defined in Clause 1.1 as meaning:

In Article 3 of the Condescendence, as amended in the Inner House, the pursuer avers:

In addition the pursuer makes averments as to statements made by the defenders' managing director at the execution of a commission and diligence on 7 March 1997, namely that the defenders supplied products to Doorguard, that Doorguard supplied the products to customers, and that the defenders had no operational staff but that Doorguard had 80 staff in the field.

Article 3 of the Condescendence also contains averments that the defenders had paid some royalties for the period up to March 1995, but none for any sales since then. The defenders had not since 1 March 1991 accounted for any royalties on any dealing of their products by Doorguard, or for any royalty for any sales by them to Doorguard. They had deliberately concealed the true royalties payable by them. It is contended that supplies to customers by Doorguard were in the circumstances supplies which royalties were due by the defenders.

In terms of the first conclusion the pursuer seeks count and reckoning for all royalties

The main issue in this reclaiming motion is whether the temporary judge was correct in holding that royalties were not payable on the leasing or hiring of products by Doorguard, and on that basis, excluding certain averments of the pursuer, and restricting the first conclusion by excluding the words from "including" to "Ltd.".

In presenting submissions on behalf of the pursuer in the reclaiming motion Mr. Ellis accepted that he required to show that the pursuer had relevantly averred that products which were leased or hired (i) fell within the description of "products...sold or otherwise supplied for money or money's worth" in Clause 6.1; and (ii) fell to be treated as having been so supplied by the defenders and not by Doorguard, in respect that, as he put it, Doorguard were merely the "channel" by means of which the defenders supplied such products. If, on the other hand, this was not well-founded, there was a "supply" of the products by the defenders to Doorguard, and royalties would accordingly be payable in respect of that supply. What appeared to lie behind this approach to the identity of the supplier was that the pursuer considered that royalties based on the leasing or hiring of products by Doorguard would be greater than those payable on a supply of those products to them by the defenders.

We turn then to the first of the two propositions which Mr. Ellis sought to establish. It was common ground that it depended on a correct interpretation of the royalty agreement.

Mr. Ellis submitted that, according to its ordinary meaning, the expression "supplied for money or money's worth" included any commercial supply such as leasing or hiring. Clause 6.1 did not restrict the meaning to some form of transfer of property. It would be extraordinary if commercial exploitation by leasing or hiring did not attract liability in royalties. This would have given little protection to Mr. Watt.

In support of this approach Mr. Ellis founded on the terms of Clause 5.1.2. It was, he submitted, related to Clause 6.1, since liability in royalties was the counterpart of the rights granted. The expression "use, sell or otherwise deal in the products" in Clause 5.1.2 plainly covered leasing and hiring.

In response Mr. Robertson for the defenders emphasised that Clause 6.1, which was the key provision, had to be read along with the definition of "Net Sales Value" in Clause 1.1. That definition provided the basis for the calculation of the royalty in every case. Where there was an arms length transaction exclusively for money, it was the sales price on the ex-works invoice; otherwise it was the fair market price. The language excluded the use of the consideration for lease or hire.

Mr. Ellis sought to deal with the definition of Net Sales Value by submitting that there was no reason why the consideration for a lease or hire should not be treated as providing an element of the price on which a royalty could be based. It was appropriate that the pursuer should obtain 5% of the benefit of what amounted to a turnover for accounting purposes. There did not have to be a sale. Mr. Robertson responded to this argument by pointing out that periodic payments, as in the case of lease or hire, gave rise to difficulty when an attempt was made to fit them into the definition. Would each periodical payment qualify as the Net Sale Value or only the first? The first alternative did not square with the wording of the definition which envisaged a single figure. The latter would not make sense, especially if the first rent was at a particularly low level.

Another provision which was brought into the argument was Clause 5.2 which states:

Mr. Robertson maintained that this wording was inconsistent with the idea that the leasing or hiring of products could attract a royalty. Mr. Ellis maintained that the important aspect of the rights to which Clause 5.2 referred was that of manufacture. It was not necessary for the parties to be precise as to what followed manufacture. The word "sell" was used in a loose sense. Clause 5.2 did not control the scope of Clause 6.1.

We are satisfied that products which are leased or hired do not fall within the description of the expression "supplied for money or money's worth" in Clause 6.1. That provision requires to be considered in the context of the agreement as a whole, and in particular the definition of the Net Sales Value which forms the basis on which royalty is calculated. That definition plainly refers to a sales value of the products, whether it is the price set out in the ex-works invoice or is one agreed between the parties as being the fair market price. We fully accept the defenders' argument that there is no room in that definition for the importation of a periodic consideration as in the case of lease or hire. As both parties recognised in their submissions, the royalty agreement is disconcertingly inconsistent in its terminology. However, there is, in our view, no trace of the agreement extending to transactions such as lease or hire. As Mr. Davidson, senior counsel for the defenders, pointed out, the agreement is capable of being put into effect without the need to imply that such transactions are covered. In particular it is not necessary for that implication to be made in order to give the agreement commercial efficacy.

For these reasons we consider that the pursuer has failed to demonstrate that he has a relevant case in support of the proposition that royalties are payable in respect of the leasing or hiring of the relevant products.

In view of this conclusion it is not necessary for us to consider whether the pursuer has made good the second proposition, namely that the products leased or hired fall to be treated as having been leased or hired by the defenders. However, Mr. Ellis was at pains to point out that the pursuer's averments did not limit the transactions between Doorguard and customers to the leasing and hiring of the products. They extended to their sale. In these circumstances there remains the question whether these sales to customers fall to be treated as sales by the defenders.

Mr. Ellis submitted that Doorguard should be treated as the same legal persona as the defenders. Accordingly the transfer of products between them did not involve a supply. There was no supply until Doorguard disposed of the products to customers. In the present case he founded on the following factors: (i) that the defenders and Doorguard were associated companies, having the same shareholders and directors; (ii) that they had the same office; (iii) that the defenders controlled the products, and that Doorguard could not deal with them without the defenders' approval and consent; (iv) that the defenders had no operational staff but Doorguard did have, from which it followed that sales transactions were handled only by Doorguard; (v) that accounting between the defenders and Doorguard was not on an open market basis; and (vi) that the defenders had apparently not chosen to treat themselves as a separate entity from Doorguard since they had not paid royalties on the supply of products by them to Doorguard.

There is no doubt that it is a fundamental principle that each company in a group of companies is a separate legal entity possessed of separate legal rights and liabilities (Adams v. Cape Industries plc [1990] 1 Ch. 433 at page 532). Mr. Ellis made it clear that his contention was not based on an interpretation of the royalty agreement which refers only to the defenders as "the Company". His proposition was that Doorguard was indistinguishable from the defenders, in respect that both companies formed part of one business organisation. In support of this line of argument he referred to the recognition that there may be special circumstances in which a limited company may be regarded as the façade concealing the true facts (Woolfson v. Strathclyde Regional Council 1978 SC (HL) 90, per Lord Keith of Kinkel at page 95). By way of illustration he referred to Gilford Motor Co. [1933] Ch. 935, in which an injunction was pronounced against a company which had been set up as a cloak or sham or mere device to conceal an individual's breach of covenant. In Jones v. Lipman [1962] 1 W.L.R. 832 an order for specific performance was made against a company which had been set up in order to avoid the implementation of the sale of land. The company was described by Russell J. at page 836 as being "the creature of the first defendant, a device and a sham, a mask which he holds before his face in an attempt to avoid recognition by the eye of equity".

Mr. Ellis made it clear that he could not go so far as to maintain that these epithets applied to Doorguard, but he maintained that the circumstances he averred gave rise to a possible inference that there had been concealment. The reality was that Doorguard was a channel by means of which the defenders supplied the relevant products.

We are satisfied that this line of argument is unfounded. In the first place, it is essential, when considering any claim that the court should have regard to "the reality", to bear in mind the nature of the remedy which is sought. In cases such as the Gilford Motor Co. v. Horne and Jones v. Lipman the court enforced an obligation as to performance not only against the individual but also against the company which he had set up in order to evade performance. The order was pronounced against the company in the recognition that the company was doing the individual's bidding. Whether epithets such as sham were required is perhaps open to question (Yukong Line Limited v. Rendsburg Investments Company (No. 2) [1998] 1 W.L.R. 294 at page 307) but that is not of moment for present purposes. In the present case the effect of the pursuer's argument is that the rights and liabilities of Doorguard were indistinguishable from those of the defenders. This proposition cannot be reconciled with the fundamental principle of corporate personality which was enunciated in Salomon v. A. Salomon & Company Limited [1897] AC 22. In the second place the pursuer's averments do not in any event provide a factual basis for the argument advanced by Mr. Ellis. There is no averment that, or from which it might be inferred that, Doorguard were created in order to conceal anything or in order to avoid liability in the payment of royalties. We do not overlook the fact that the pursuer does make averments that the defenders deliberately concealed the true royalties payable by them. However, these averments do not relate to the incorporation of Doorguard and appear to be relied upon irrespective of its formation. Furthermore we observe that in the circumstances averred by him the pursuer states that Doorguard "supply the products to customers on behalf of the defenders and as their agents". This implies a relationship of principal and agent which is inconsistent with the assertion that Doorguard should be regarded merely as the defenders under a different name.

For these reasons we consider that the pursuer has made no relevant averments from which it may be inferred that products supplied by Doorguard fall to be regarded as having been supplied by the defenders.

In the result we agree with the temporary judge that the pursuer's averments in support of the passage in the first conclusion from "including" to "Doorguard Limited" are irrelevant, and in withholding from probation the sentence in Article 3 of the Condescendence from "The defenders" to "Limited" at page 13D of the reclaiming print. It was agreed between the parties that in addition it followed that the following averments of the pursuer should also be withheld from probation, namely (i) from "The shareholders" to "organisation" on page 11B-C; (ii) from "S.P.S. (Doorguard) Limited" to "the defenders" at 11E-12A; (iii) from "In these circumstances" to "their agents" at 12B; (iv) from "The pursuer contends" to "by the defenders" at 14C; and (v) the words "and the dealings of S.P.S. (Doorguard) Limited" at 21C.

It remains for us now to deal with a number of subsidiary issues. It is no longer in dispute that the averments made by the pursuer as to the statements made by the defenders' managing director at the execution of the commission and diligence on 7 March 1997 should be remitted to probation. The defenders no longer maintain that the temporary judge should have upheld their attack on the relevancy and specification of the pursuer's averments in Article 4 of the Condescendence which is directed to obtaining decree for payment of the true amount due under the royalty agreement.

The remaining issue relates to the relevancy and specification of the pursuer's averments in Article 5 of the Condescendence which are in the following terms:

Mr. Ellis conceded that these averments were defective in point of specification such that they were not in a fit state to go to proof. However, in view of our conclusions in the earlier part of this opinion, it is plain that they suffer from a fundamental lack of relevancy. The basic complaint appears to have been that by licensing or sub-contracting to Doorguard the defenders deprived the pursuer of the royalties which he would have otherwise received. However, in view of our conclusions that the defenders and Doorguard fall to be treated as separate legal entities the relevant sale or supply of products was by the defenders to Doorguard and it is on this basis that the royalty requires to be determined. In these circumstances there is no room for a complaint that the defenders deprived the pursuer of a royalty by means of licensing or sub-contracting to Doorguard the right to deal with the products. For these reasons we consider that the pursuer's averments in this Article of Condescendence are irrelevant.

Parties were in agreement that, in the event that the liability of the defenders to account was restricted to the extent that we have held to be the case, the only live issue in that respect was that of prescription. It was agreed that in these circumstances preliminary proof on the question of prescription should be allowed.

We will accordingly recall the interlocutor of the temporary judge, exclude from probation the pursuer's averments in support of that part of the first conclusion which begins with the word "including" and ends with the word "Limited"; and the pursuer's averments in support of the third conclusion. We will allow the parties a preliminary proof directed to the seventh plea in law for the defenders.