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EXTRA DIVISION, INNER HOUSE, COURT OF SESSION
Lord Kingarth Lord Wheatley Lord Clarke	[2009] CSIH 56 CA55/07 OPINION OF THE COURT delivered by LORD CLARKE in the Reclaiming Motion in the cause by INVERESK PLC Pursuers & Respondents; against TULLIS RUSSELL PAPERMAKERS LIMITED Defenders & Reclaimers: _______

Act: Currie, Q.C., Lake, Q.C.; McGrigors LLP ( Pursuers & Respondents)

Alt: Dean of Faculty, McNeill, Q.C., Delibegović-Broome; Dundas & Wilson CS LLP (Defenders & Reclaimers)

30 June 2009

Introduction
[1] In this commercial action the pursuers and respondents sue for the payment of £909,395 Sterling with interest. They also, in terms of the second conclusion of the Summons, sought a declarator, but before this court parties were in agreement that matter should be made the subject of determination by an alternative dispute mechanism entered into between the parties.

[2] The sum sued for, in the first conclusion, is a sum said to be "Additional Consideration" due to be paid to the respondents by the reclaimers in terms of contractual arrangements between the parties, whereby the respondents sold to the reclaimers certain business assets, including intellectual property rights and customer information, the assets in question relating to the manufacture of certain brands of paper. At the time of the sale, the parties executed two written agreements, the first being what was described as the Asset Purchase Agreement, the second being described as the Services Agreement. The first of the two Agreements, hereinafter referred to as the Acquisition Agreement, was the legal means by which the assets were sold to the reclaimers. By the second Agreement the respondents undertook to continue to manufacture, sell and distribute specific products for the period from 9 June 2005 until 8 November 2005, or until determination of the Services Agreement if that was at an earlier date. Subsequent to the raising of the present proceedings, the reclaimers themselves raised a commercial action in respect of alleged failures by the respondents in their performance of obligations under the Services Agreement, and also, to a limited extent, on the basis of the breach of a specific obligation contained in the Acquisition Agreement. The reclaimers seek to resist payment of the sum sued for in the present case on two distinct substantive grounds. The first is that no such payment is payable to the respondents until certain procedures provided for in the Acquisition Agreement are followed through. The second is that, in any event, the reclaimers are entitled to pray in aid the principle of retention in respect of the sum sued for in the present action by setting off against it the sums they are suing for in the other action.

The first line of defence
[3] The first substantive line of defence was discussed at debate before Lord Drummond Young. At that time, the defences to the present action did not include the second substantive line of defence, namely retention. By judgment dated 15 February 2008, Lord Drummond Young repelled the defences, as they then stood, and granted decree de plano for the sum sued for with interest. The present reclaimers reclaimed. They then sought leave to amend their pleadings before the Inner House. This motion was granted and the case was remitted to Lord Glennie. A further debate then took place before his Lordship, with both lines of defence being argued, the defence of retention having been added by amendment by the reclaimers. The discussion as regards the first line of defence, to some extent, took a somewhat different form before Lord Glennie than it had before Lord Drummond Young. In the event, by an interlocutor dated 11 September 2008, Lord Glennie repelled the defences and granted decree for the sum concluded for plus interest.

[4] The key elements of the Acquisition Agreement in relation to the consideration to be paid for the assets as sold thereunder are as follows:

Clause 2.1 is in the following terms:

"The Vendor agrees to sell as beneficial owner and the Purchaser agrees to purchase the Owned Intellectual Property Rights, the Customer Information and the Related Assets free of all Encumbrances as at the close of business on the Completion Date for the Consideration."

"Consideration" as defined in Clause 1 of the Acquisition Agreement is divided into two components, the "Initial Consideration" and the 'Additional Consideration'. The Initial Consideration and the Additional Consideration are, in turn, defined respectively by Clause 1.1 as "£5,000,000 (five million pounds) (exclusion of VAT, if any)" and 'the sum, if any, payable by the Purchaser in terms of Clause 5 and Part 5 of this Schedule up to a maximum of £2,000,000 (exclusive of VAT, if any)". Clause 5 provides that in relation to the Additional Consideration, "The provisions of Part 3 of the Schedule are to have effect". In Part 3 of the Schedule, para. 1.1, "Additional Consideration" is further addressed and is calculated according to a formula which depends on the production of certain paper products during the year from 8 November 2005 to 8 November 2006 (described as the 'Earnout Period') provided that such products were invoiced during the period from 8 November 2005 to 22 November 2006 (described as the "Invoice Period")."

[5] The formula is expressed in the following terms:

"Additional Consideration means:

(a) In the event that the Tonnage is less than 15,000, nil.

(b) In the event that the Tonnage is equal to or more than 15,000, but is less than 25,000, a sum equal to

a/1,000 x £160,000

where (a) is the Tonnage in excess of 15,000, subject to a maximum of 10,000

(c) In the event that the Tonnage is equal to or more than 25,000, a sum equal to

(a/1,000 x £160,000) + (b/1,000 x £80,000)

where:

a is 10,00 and

b is the Tonnage in excess of £25,000, subject to a maximum of 5,000".

As has been seen, production of the relevant products in respect of which Additional Consideration may be paid is measured in terms of "Tonnage". That is defined in para. 1.1 of Part 3 of the Schedule as follows:

"the amount in tonnes of the Product for which the Purchaser receives orders during the Earnout Period and thereafter issues invoices in relation to such tonnage in the Invoice Period as provided for the in the Consideration Accounts." 'Product' is defined as "Products (as defined in the Services Agreement) incorporating the Trade Marks."

The result of that last definition is to encompass paper products coated with solid bleached sulphate that incorporate two trade marks sold by the respondents to the reclaimers, those relating to their Gemini and Inver X brands. Paragraph 3(1) of Part 3 of the Schedule provides:

"The Consideration Accounts shall specify the Tonnage and a calculation of the Additional Consideration".

Paragraph 4 of Part 3 of the Schedule then provides for the finalisation of the draft Consideration Accounts. Paragraph 4.1 provides:

"The Purchaser shall prepare and serve on the Vendor within 5 Business Days of 1 November 2006 a draft of the Consideration Accounts (draft Consideration Accounts)."

The purchasers i.e. the reclaimers are, accordingly, responsible for the preparation of the initial draft of the Consideration Accounts, no doubt on the footing that, after the date of the execution of the Acquisition Agreement, they would be best placed to do so, having access to the books and financial records which would provide the basis of the accounts. Para 4.2 of this Schedule provides, however, for a challenge of the draft Consideration Accounts by the vendor (the respondents) in either of two ways. It does so in the following terms:

"The Vendor may, within the period of 10 Business Days, after service of draft Consideration Accounts on the Vendor in accordance with paragraph 4.1 (Review Period):

(a) notify the Purchaser in writing of any adjustments they consider need to be made to the draft Consideration Accounts (together with the reasons for such adjustments); or

(b) elect that the Purchasers Accountants carry out a Tonnage Audit in accordance with paragraph 5 of this Schedule."

If the vendor, in the event, does not initiate either of those procedures, during the Review Period of ten business days, then the position is provided for by paragraph 4.3, which states:

"If:

(a) The Vendor notifies the Purchaser during the Review Period that no adjustment needs to be made to the draft Consideration Accounts; or

(b) The Vendor notified the Purchaser during the Review Period that it does not wish to elect that a Tonnage Audit be undertaken;

(c) The Vendor does not notify the Purchaser during the Review Period of any proposed adjustment to the draft Consideration Accounts, the draft Consideration Accounts, Tonnage and Additional Consideration specified in it shall be the Consideration Accounts, Tonnage and Additional Consideration for all purposes of this Agreement."

On the other hand, if the vendor does notify adjustments during the Review Period, para. 4.4 deals with that situation. It provides:

"If the Vendor notifies the Purchaser during the Review Period that certain adjustments need to be made and

(a) the Purchaser and the Vendor agree, in writing, on the adjustments to be made to the draft Consideration Accounts and/or Tonnage, and/or Additional Consideration they shall jointly incorporate such adjustment into the draft Consideration Accounts and the draft Consideration Accounts as so adjusted and the Tonnage and Additional Consideration specified in it shall be the Consideration Accounts and the Tonnage for all purposes of this Agreement; or

(b) if the Vendor and the Purchaser are unable to so agree within 5 Business Days then paragraph 5 of this part 3 of the Schedule shall apply."

Pausing there, it is to be noted that the structure of the agreement's provisions so far means that if the parties are able to reach agreement as to the Consideration Accounts and, in particular, the Tonnage and Additional Consideration, a Tonnage Audit will not be required. Only if the vendor invokes the procedures in terms of para. 4.2, will the need for a Tonnage Audit arise.

[6] Para 5 of Part 3 of the Schedule describes in detail the scope, function and means of carrying out a Tonnage Audit in terms of the agreement. It states first of all at para. 5.1 as follows:

"Within 14 Business Days from date that the Vendor notifies the Purchaser that it requires a Tonnage Audit, the Purchaser shall procure:

(a) that the Purchaser's Accountants carry out the Tonnage Audit to confirm and verify the Tonnage; and

(b) deliver to the Vendor the Tonnage Audit statement."

Paragraph 5.2 goes on to provide as follows:

"In undertaking the Tonnage Audit, the Purchaser's Accountants shall act as experts and not as arbitrators, and their decision as to any matter referred to them for determination shall, in the absence of manifest error or fraud, be final and binding in all respects of the parties and shall not be subject to question on any ground whatsoever."

Paragraph 5.3, in turn, provides:

"The fees and expenses of the Purchaser's Accountants, and any other professional fees incurred by them shall be borne and paid as they direct or, failing such direction, shall be shared equally between the Vendor and the Purchaser."

Lastly, the clause provides as follows:

"5.4 Within 5 Business Days of receipt by the Vendor of the Tonnage Audit Statement, the Vendor and Purchaser shall jointly incorporate in the draft Consideration Accounts the Tonnage as determined by the Tonnage Audit Statement and shall date the Consideration Accounts and calculation of Tonnage with the date on which such adjustments are made (which date shall be the Payment Date). The draft Consideration Accounts as amended, and the Tonnage stated in it, shall be the Consideration Accounts and the Tonnage for all purposes of this Agreement."

The limited function of the audit procedure provided for can be seen. It is for the purpose of confirming and verifying the Tonnage. The measure of a tonnage, as defined, is, of course, crucial for the purpose of calculating what, if any, Additional Consideration is payable. Accordingly the function of the procedure provided for in Clause 5, Part 3 of the Schedule is to enable the purchaser's accountants to examine the draft Consideration Accounts to ascertain whether the tonnage of products as stated therein is correct. The accountants are not charged to do anything beyond that and are, in particular, not charged to fix the amount payable by way of Additional Consideration. It is para. 5.4 of Part 3 of the Schedule which, as has been seen, provides for what is to be the outcome of the Tonnage Audit.

[7] Paragraph 2.1 of Part 3 of the Schedule provides that:

"The Purchaser shall pay to the Vendor in accordance with paragraph 7, the Additional Consideration on the Payment Date."

The payment date is defined in paragraphs 4.5 and 5.4. It is, in brief, the date when the Consideration Accounts have been finally adjusted, following the review procedures.

[8] The Earnout period expired on 8 November 2006. The factual position that emerged thereafter is not subject to any material dispute between the parties and is reflected in various items of correspondence which have been lodged in process. On 18 November 2006 the reclaimers served draft Consideration Accounts on the respondents. The tonnage specified in those accounts was 20,668 tonnes. On 5 December 2006 the reclaimers served amended Consideration Accounts on the respondents which were said to contain the reclaimers' final tonnage figure. The tonnage figure provided in those last mentioned accounts was 20,683.72 tonnes. It is a matter of agreement that if that figure is correct the Additional Consideration payable by the reclaimers under the agreement to the respondents, is the principal sum sued for in the first conclusion of the Summons in the present proceedings. Pausing there, it should be noted that, had the respondents done nothing after the receipt by them of the 5 December amended accounts and, in particular, during the review period of ten business days referred to in the Agreement, there is no doubt that the sum payable as Additional Consideration would have been the sum in question by virtue of the operation of the provisions of Clause 4.3 of Part 3 of the Schedule. In the event, what happened was that following the submission of the Amended Consideration Accounts, representatives of the respondents attended at the reclaimers' premises to inspect their books and records. Thereafter the respondents' solicitors, Addleshaw Goddard, wrote to the reclaimers' solicitors, Dundas & Wilson, intimating adjustments that they considered were required to be made to the draft Consideration Accounts (the letter in question is dated 11 December 2006 but both sides were in agreement that it was received on 19 January 2007). The parties then agreed to extend the period during which the reclaimers might respond to the respondents' proposed adjustments, the agreed extension being until 30 January 2007. On 30 January 2007 the reclaimers' solicitors contacted Messrs Addleshaw Goddard to say that the reclaimers were unable to agree the adjustments proposed by the respondents. They went on to say:

"In addition Tullis Russell (the reclaimers) has ascertained that the Tonnage figures used to calculate the Draft Consideration Accounts incorrectly included tonnage that relates to non-branded paper. This paper does not fall within the relevant definitions in the Acquisition and Services Agreements (the 'Agreements') ... Tullis Russell anticipate that the revised Tonnage figure will be approximately 16,500 tonnes and are currently preparing revised Draft Consideration Accounts that will correct this error. The revised Drift Consideration Accounts should be intimated to you during the course of tomorrow, at which point Inveresk will be invited to agree the revised Draft."

No revised draft consideration account were, in the event, intimated by Dundas & Wilson. On 31 January 2007, the day of receipt by them of Dundas and Wilson's letter of 30 January 2007, Addleshaw Goddard wrote to Dundas & Wilson to state that the respondents considered that no agreement could be reached between the parties in respect of the tonnage and the Consideration Accounts and that a Tonnage Audit would be required. On 2 February 2007 Addleshaw Goddard wrote again to Dundas & Wilson, inter alia, to the following effect. "We note that you have chosen not to provide us with revised draft Consideration Accounts or revised Tonnage figures. There is no scope in the Acquisition Agreement for the revision and replacement by Tullis Russell of the Draft Consideration Accounts and we should be grateful if you would also confirm therefore, that the Tonnage figures to be provided to PwC will be those provided to Inveresk with your letter of 5 December 2006. These are the Tonnage figures which were presented to Inveresk and were the only Tonnage figures presented for the purposes of the verification and review exercise conducted at the Markinch premises of Tullis Russell on 10/11 January 2007". On 2 February 2007, Dundas & Wilson replied to the following effect.

"... We cannot agree with your suggestion that PwC should be restricted to having sight of the draft Consideration Accounts of 5 December 2006 when these are manifestly incorrect in Tullis Russell's opinion."

Under cover of that letter, Dundas & Wilson sent to the respondents revised tonnage figures showing the final tonnage of 16, 051.71 tonnes. It appears that such a figure, if correct, would bring out the sum of £168,273.60 as the Additional Consideration payable under the acquisition agreement rather than the figure sued for in the first conclusion in the present proceedings.

[9] On 5 February 2007 the reclaimers instructed PwC to carry out a Tonnage Audit. No audit in the event has been carried out, pending the resolution of the present dispute. By letter dated 14 March 2007, Addleshaw Goddard wrote to Dundas & Wilson and stated that the respondents no longer wished to insist on their proposed adjustments to the draft Consideration Accounts and that a Tonnage Audit would accordingly not be required. It is the respondents' position that the draft Consideration Accounts, tonnage and Additional Consideration specified therein fall to be regarded as the Consideration Accounts, tonnage and Additional Consideration for all purposes of the Acquisition Agreement. The reclaimers have a general plea to the relevancy of the respondents' pleadings. In addition, with regard to the first substantive line of defence, they tendered the following pleas-in-law

"2. Parties having agreed to refer the subject matter of this action to expert determination in terms of the Asset Purchase Agreement dated 9 June, 2005, this Court has no jurisdiction and the action should be dismissed.

3. Separatim, before any other thing is done, the parties having agreed to refer the subject matter of this action to expert determination, the action should be sisted pending the outcome of that determination."

Those pleas are supplemented by averments to the effect that the expert determination provisions in the Acquisition Agreement have become operative because parties have not agreed the Tonnage and neither party can reverse that position.

"The Tonnage Audit has not been completed as yet, due to the pursuers' refusal to comply with their duties and obligations in that respect under the Asset Purchase Agreement. By this action, the pursuer are trying to avoid the expert determination provisions in the Asset Purchase Agreement" (Answer VI).

[10] Lord Glennie, in his judgment, noted that in the submissions made on behalf of the reclaimers before him, their position had somewhat changed from that adopted in the debate before Lord Drummond Young. In particular, it was no longer being asserted, as it had been before Lord Drummond Young, that the Tonnage Audit was a precondition to entitlement for payment of Additional Consideration and that as a result, the present action was premature. Moreover, it was not any longer being contended that when the matter had been referred to a Tonnage Audit, there it had to remain, regardless of whether or not there remained a dispute between the parties. What was being argued before his Lordship by the reclaimers was that, since no agreement had been reached between the parties as to the adjustment to be made to the Draft Consideration Accounts by 30 January 2007, then by virtue of the provisions of paras 4.4(b) and of Part 3 of the Schedule, a Tonnage Audit required to be carried out. The Lord Ordinary noted that senior counsel then appearing for the reclaimers, conceded that it would have been open to the respondents, even after the Tonnage Audit had commenced, to withdraw their proposed adjustments and thereby agree the figures put forward by the reclaimers. If the result of that was that any outstanding dispute disappeared then it was accepted that there would be no purpose in proceeding further with the Tonnage Audit. The substantive point being made on behalf of the reclaimers was, however, that by the time the respondents purported to withdraw their proposed adjustments and agree the figure which was put forward by the reclaimers, the reclaimers had revisited, or amended, their own Draft Consideration Account. It was in that situation no longer open to the respondents "to accept something that was no longer being put forward". The parties were then in dispute as to the correct tonnage and that matter required to be determined by a Tonnage Audit.

[11] Lord Glennie rejected the foregoing submissions. He did so on the footing that they failed to pay proper regard to the terms of paragraph 4 of Part 3 of the Schedule to the Acquisition Agreement. The argument, on behalf of the reclaimers, proceeded on the basis that it was always open, until agreement was reached, or a Tonnage Audit had been carried out, for the reclaimers to revise the Draft Consideration Accounts which they had served in accordance with para. 4.1. This, the Lord Ordinary considered ran counter to the machinery set out in paragraph 4 for determining the Additional Consideration. At para. 21 of his Opinion, the Lord Ordinary went on to describe that machinery, as he construed the Acquisition Agreement. Within that machinery his Lordship held there was

"... no room, in the absence of agreement, for the Purchaser to submit a revised draft of the Consideration Accounts. Nor is there room, in the absence of agreement, for the Vendor to delay its response beyond the 10 business days since, as soon as that time has expired without a response from the Vendor, the draft served by the Purchaser in terms of para. 4.1 becomes final. Nothing that either party does after that time can alter that, except by agreement."

Later in paragraph 22 of his Opinion his Lordship said,

"It seems to me to be clear that the Tonnage Audit must take place on the basis of the draft Consideration Accounts served by the purchaser and the adjustments, if any, proposed by the vendor. To my mind it is clear also that those documents define the scope of the Tonnage Audit to be carried out. The experts are to 'confirm and verify' the Tonnage; but that must mean the tonnage put forward in the draft Consideration Account. If it were not otherwise clear, it seems to me that this construction is reinforced by the terms of para. 5.2, which provides that the Accountants carrying out the Tonnage Audit will act as experts and that "their decision as to any matter referred to them for determination" shall be final and binding with certain limited exceptions. The words, 'as to any matter referred for determination' point very strongly to an understanding that the Tonnage Audit is not a general assessment of tonnage in the round but is constrained by the positions adopted by the parties in the draft Consideration Accounts and the proposed adjustments (if any)."

Accordingly at para. 23, the Lord Ordinary opined:

"... it seems to me that the defenders' arguments must fail. Having served their draft Consideration Accounts, the Purchasers are stuck with them. Those draft Consideration Accounts are the Consideration Accounts to which the Vendors, if they so wish, are entitled to propose adjustments. If no agreement is reached on those adjustments, then it is those draft Consideration Accounts and the proposed adjustments which are referred to the expert for his determination. If the Purchaser cannot revise its draft Consideration Accounts, it must be open to the Vendor to drop its objections (in the form of its proposed adjustments) and indicate that it is content to accept the position put forward in the draft Consideration Accounts served in accordance with para. 4.1. It is nothing to the point that the defenders themselves have now reconsidered their position. The mechanism agreed by the parties does not allow for that".

It should be noted that in his opinion, at paragraph 16, Lord Drummond Young in disposing of the reclaimers' arguments, at the previous debate, was of the opinion that in "Part 3 of the Schedule ... is merely a means of dispute resolution, and in cases where the parties are not in dispute, it is redundant." His Lordship reached the conclusion that as a result of Addleshaw Goddard's letter of 14 March 2007 and what was contained in, and communicated thereby, there was no dispute between the parties because the figure put forward by the defenders in the draft Consideration Accounts for tonnage was accepted as correct, as were the consequential calculations.

[12] In moving their reclaiming motion before the court, counsel for the reclaimers approached matters on a somewhat different basis, again, than had been their position before Lord Drummond Young and Lord Glennie. The position adopted on behalf of the reclaimers before this court was that the Acquisition Agreement, properly construed, had the following effects. The level of tonnage for the purposes of Additional Consideration was to be determined either by agreement, or by an expert carrying out a Tonnage Audit. On the agreed facts, the parties had not reached agreement on the level of tonnage for the purposes of calculating the Additional Consideration. There was nothing in the contractual provisions enabling either party to revise the position they had communicated to the other, in a way which would unilaterally, rather than by agreement, impose a particular level of Tonnage as "The Tonnage". Accordingly, the only way whereby the amount of Additional Consideration could now be arrived at was by an expert carrying out a Tonnage Audit. While the contract, as the Lord Ordinary had observed, sought to provide a speedy machinery for determining the Additional Consideration, the basic position was that the parties were not in agreement in this case at any point in time as to what that Additional Consideration should be. The relevant provisions were, however, designed to get at the "correct" number regarding the tonnage. The expert who was to carry out the Tonnage Audit would be acting as an expert and not adjudicating upon a dispute. There was a serious inherent contradiction arising from the approach adopted by the Lord Ordinary. It was a key element of his construction of the Acquisition Agreement that there was simply no room for either party to review their initial position. Yet that was exactly what the respondents were being allowed to do following the Lord Ordinary's Opinion - they were being allowed to withdraw their proposed adjustments and thereby avoid the Tonnage Audit taking place. Reference was made to various well known authorities as to the way in which commercial agreements should be construed. In particular the court was referred to Prenn v Simmonds [1971] 1 W.L.R. 1381 per Lord Wilberforce at 1384A-B, 1385H Mannai Investment Co Ltd v Eaglestar Life Assurance Co Ltd [1997] AC 749 per Lord Steyn at 771A-B, BCCI v Ali [2002] 1 A.C. 252 per Lord Hoffman at page 269B-G, Bank of Scotland v Dunedin Property Investment Co Ltd 1998 SC 657 and City Wall Properties (Scotland) Ltd v Pearl Assurance plc (2007) CSIH 79. These authorities were cited to support the proposition that the construction which the reclaimers urged upon the court produced a commercially sensible result and was, in addition, in accordance with the aims of the contract. The Tonnage Audit procedure required that the auditors "verify" the tonnage figure. One of the meanings of "verifying" provided in the Oxford English Dictionary was "the act of demonstrating or proving something to be true". The purpose of the Tonnage Audit was to demonstrate that the tonnage figure in the draft accounts was correct or true. That still required to be done before the respondents were entitled to sue for Additional Consideration.

[13] While it was accepted that the respondents did not, in support of their position, in terms, seek to argue that the provisions regarding the ascertainment of the tonnage figure were imposed solely for their benefit and, accordingly, that they were entitled to waive those provisions, that, in effect, was what they were contending for. Reference was made to Manheath Ltd v HJ Banks & Co Ltd 1996 S.C. 42, at page 49 where Lord President Hope discussed the circumstances in which a contractual provision may be construed as having such an effect. The case of Infiniteland Ltd v Artisan Contracting Ltd [2006] 1 BCLC 632 was cited. The two respondent companies in that last-mentioned case had entered into a contract for the sale of three subsidiary companies to the purchaser for the price of £1,000,000 plus the aggregate net asset value of the three companies as at a specified date. A clause in the Purchase Agreement provided for adjustment of the purchase price, if the net asset value of the three companies proved to be substantially different from the parties' estimate and for disputes to be determined by a nominated expert according to a specified procedure, which had to be intimated within certain time limits. The contract also contained certain warranties. The purchaser, without invoking the procedure, designed to adjust the purchase price, sought to sue for breach of warranty in support of a claim for an adjustment of the price. The Court of Appeal held that, where a party claiming payment under a contract failed to take the steps which he was required to take in order to establish his entitlement to payment of an adjustment in the purchase price, he was not entitled, having chosen not to allow the contractual machinery to operate, then to ask the court to enforce the contract on the basis that the agreed machinery was not essential. If the machinery for determining the price was agreed by the parties when they made their bargain, a party could not seek the assistance of the court to enforce the contract if he himself had chosen not to invoke the contractual machinery. That case was relied upon, it seemed, for the general proposition that where the parties agree the basis upon which a price or other consideration is to be arrived at, they are bound by their agreement to follow the agreed procedure. Such a non-controversial proposition is supported by what the Lord Chancellor had to say in Caledonian Insurance Co v Gilmour (1892) 20 R (H.L.) 13 at page 15, cf also Norwich Union Life Insurance Society v P&O Property Holdings Ltd [1993] 1 EGLR 164. In the present case, the issue that arose was concerned with contractual machinery for determining an issue of fact. The issue of fact was the tonnage which had been ordered during the Earnout Period. The parties had expressly specified two methods for determining that fact. In the first place they were free to reach an agreement about that fact within the time period specified in the Acquisition Agreement. Alternatively the ascertainment of that fact required to be carried out by the nominated expert. What was intended by the parties was that the exercise of ascertaining the Additional Consideration payable would begin by reference to draft Consideration Accounts and would end with Consideration Accounts. Two possible routes were agreed by the parties as to how that journey might be taken and completed. There was no third way to arrive at appropriate destinations.

[14] The respondents' approach to matters, it was said, was one which lacked sense and certainty. It involved contending that right up until the point of the experts' determining matters, the respondents could unilaterally terminate the audit exercise and revert to the figure in the draft Consideration Accounts, even though by that point in time it was apparent to everyone that the figure in the draft accounts or in the proposed adjustments was completely erroneous. The position of the reclaimers was correctly recorded by the Lord Ordinary at paragraph 17 of his Opinion when he stated as follows.

"Ultimately the question was not, as the pursuers contended, whether the defenders had made out a defence to the claim but rather: had the pursuers made out their entitlement to the sum claimed by way of Additional Consideration? The defenders simply sought to enforce the agreed machinery for working out what was due. Either the Additional Consideration, via the draft Consideration Accounts was agreed within a fixed time or it was to be fixed by the Tonnage Audit. By 30 January 2007, the extended date for the parties to agree, no agreement had been reached and the parties were in dispute. The Tonnage Audit was the only remaining way of resolving the dispute".

While the Lord Ordinary, at para. 20 of his Opinion, recorded that senior counsel, then instructed for the reclaimers "did not deny that it would have been open to the pursuers, even after the Tonnage Audit had commenced, to withdraw their proposed adjustments and thereby agree the figures put forward by the defenders", the Dean of Faculty, on behalf of the reclaimers, now disclaimed that proposition. It was clearly envisaged that the figure provided in the draft Consideration Accounts would not thereafter be held to be sacrosanct. There was room, provided for in Clause 4.4 of the Part 3 of the Schedule, for the respondents to put in additional adjustments or to adjust their existing adjustment or to withdraw their adjustments but the withdrawal of adjustments, in such a situation the Dean of Faculty contended, was in itself an adjustment of the draft Consideration Accounts. The provisions of Clause 4.4(b) had been engaged by that fact. The contrast between the word "elect" found in Clause 4.2(b) of the third part of the Schedule and the wording in Clause 4(4)(b) was marked. Once the parties had moved to operate under Clause 4.4, a Tonnage Audit required to be carried out. If the parties had intended to provide that, after the expiry of the five business days specified in Clause 4.4(b), the vendor could terminate unilaterally the audit and claim Additional Consideration on the basis of the draft Consideration Accounts they could have so specified. They had not done so. Each stage specified in Clause 4.3 used the expression "Review Period". It was only during that period that the respondents could alter their position.

[15] The reclaimers' submissions went on to contend that the draft accounts proffered by them could be seen as an offer which was open for acceptance within a specified period. What had happened here was that the respondents had made a counter offer. The original offer therefore had lapsed. Reference was made in this respect to Gloag on Contract (2^nd Ed) page 37. The provisions in the Acquisition Agreement regarding the date of payment furthermore undermined the position of the respondents. The parties had been at pains at para. 4.5 of Part 3 of the Schedule to fix, with some precision, the payment date on the basis of certain hypotheses. They had not included, among those hypotheses, the position which the respondents now argued was provided for by virtue of the Agreement. That was a strong indication that they had never intended that such a situation should arise under their Agreement.

[16] The key to the present dispute was the terms of the letter from Addleshaw Goddard of 14 March 2007. In that letter, the agents for the respondents purported to seek payment in terms of para. 4(5) of Part 3 of the Schedule. But para. 4.5 did not provide for a payment being made in the situation which had arisen namely, the respondents seeking to stop the Tonnage Audit proceeding after they had requested it.

[17] In response to these submissions, the respondents argued that the question was whether on the one hand the Additional Consideration was now due to be paid or whether, on the other hand, it was not payable because no Tonnage Audit had taken place. The Consideration Accounts, it was submitted, were the key element in the procedure for fixing the Additional Consideration. The Tonnage Audit procedure was made available to provide the respondents with a check on figures contained in those accounts. It required to be employed only when there was no agreement as to the reclaimers' figures. It was not a procedure designed by the parties to allow the reclaimers to alter figures contained in the draft Consideration Accounts. As matters have developed, the respondents are in agreement with the figures in those accounts. In that situation, there was no need for a Tonnage Audit and the parties' contract, properly construed, did not require that it take place, before payment was sought. It was not open to the reclaimers to produce new or revised accounts seeking to alter the figures which they had put forward as to the quantity of the relevant type of paper sold. That last proposition had been conceded on behalf of the reclaimers, before the Lord Ordinary. Moreover, it was important to note that in discussion before this court, junior counsel for the reclaimers had conceded that there was nothing in the Agreement to prevent the respondents from withdrawing their proposed adjustments. The reason that no Tonnage Audit had occurred in this case was that the reclaimers had insisted that they were entitled to revise their figures. That contention had delayed matters being resolved. If either of the concessions made by the reclaimers was soundly based, there was no defence to the respondents' claim based on the provisions of Part 3 of the Schedule.

[18] The contract did not require that the tonnage figure be "correct" or "right". It simply required that it be agreed. It was only the respondents who, in terms of the Agreement, could initiate the machinery for challenging the tonnage figure. The machinery was designed to arrive at a price for goods invoiced over an 18 month period. It was not designed to provide an adjudication. The terms of the Agreement were consistent with the respondents having the unilateral right to abandon the procedure under Clause 4.3 of Part 3, prior to the experts reaching their determination, just as the respondents had the unilateral right to commence the process. It had to be recognised that a Tonnage Audit in terms of Clause 5 of Part 3 of the Schedule was required only where the parties had not otherwise agreed the appropriate figure. The auditors' role was a circumscribed one namely, simply to confirm and verify the figure.

[19] The Tonnage Audit was not designed to make choices between two competing contentions as to what the figure should be. The respondents' agent's letter of 14 March 2007 made it plain that no adjustments were required by the respondents to the draft Consideration Accounts and that they should be regarded as effective for the purpose of the contract. The respondents in so doing, were not waiving any right. They were confirming consent to the figures in the relevant accounts. The draft Consideration Accounts were still "in play" at that time. To demand that a Tonnage Audit should, nevertheless, be carried out at that stage, was not a commercially sensible position to adopt and was simply productive of uncertainty rather than certainty. What was the purpose, in terms of the Agreement in having a Tonnage Audit if, as had properly conceded by the reclaimers, they were not entitled to submit new draft accounts? There was, as of the date of the respondents' agent's letter, no longer a challenge to the reclaimers' figures set out in the draft Consideration Accounts. Once the figures in the accounts were accepted, there was no reason for any audit. The reclaimers seemed to be arguing that the respondents were personally barred from accepting the accounts which they had been invited to accept. There was no basis, in law, for such a proposition.

[20] It was accepted on behalf of the respondents that there was nothing expressly provided for in the contract as to when the payment date should be in the circumstances actually arisen. The Lord Ordinary had taken an appropriate approach to this question at paragraph 43 of his Opinion. The payment arose when the figure in the draft Consideration Accounts was not challenged or no longer challenged or at the conclusion of any Tonnage Audit. As the Lord Ordinary put it, at para. 43:

"Put broadly, the Payment Date is the date when the Consideration Accounts are finalised in their original or amended form. The Additional Consideration is to be paid within ten business days of the payment date: para. 7.2(a). Interest runs from that date on any late payment: para. 7.3."

[21] Lastly, it was submitted, on behalf of the respondents, that if the reclaimers had not sought to change their position, with regard to the contents of the Consideration Accounts, no one could have seriously argued that the respondents, having initially elected to seek a Tonnage Audit, were prevented from withdrawing that request even though they were content with the reclaimers' figures. It was the actings of the reclaimers in seeking to do what they were not entitled to do, in terms of the Acquisition Agreement, namely to substitute new accounts for the original ones, which they claimed now prevented the respondents agreeing the original figures and withdrawing their request for an audit. The position of the reclaimers distorted the meaning of the contract in an attempt to support an illegitimate change of position on their part. That pointed to the construction placed on matters by the respondents being sound. There was no relevant defence to the respondents' claim based on the reclaimers' arguments as to the construction or the provisions of the Acquisition Agreement.

Decision
[22] In respect of this branch of the reclaimers' defence to the action, we have reached the conclusion that it is irrelevant. Both sides were at one, before us, that the question raised by the reclaimers' defence in this respect fell to be answered by simply construing the relevant provisions of the parties' agreement, according to normal canons of construction in commercial agreements. For example, the reclaimers did not, in support of their position, argue that there was any implied term of some kind which had the consequences they argued for. In approaching the matter, therefore, on the basis upon which both parties invited us to proceed, we have been unable to find anything in the express language of the Acquisition Agreement which entitled the reclaimers to alter the figure for tonnage once they had proffered it to the respondents in the draft Consideration Accounts. It is because they wished to do so that they find it necessary to submit that the respondents, once they have intimated proposed adjustments in terms of Clause 4.2, and these are not agreed to by the reclaimers, are obliged to allow a Tonnage Audit to proceed to its conclusion, no matter that subsequently, and prior to, any determination by the nominated auditors, the respondents consider that the tonnage figures in the draft Consideration Accounts put forward to them by the reclaimers are acceptable. The reclaimers complained before us that there was an illogicality in the Lord Ordinary's approach to the question in that, on the one hand, he took the view that the contract meant that the reclaimers could not alter their position in relation to the figure in the Consideration Accounts whereas the respondents were entitled to do so but, in reality, what the Lord Ordinary, in our view, was saying was that, without agreement of the other side, neither party can adjust the original figure set out in the draft accounts. In our opinion, the wording of the parties' Agreement does not have the effect the reclaimers contend for. As counsel for the respondents submitted, it would be untenable for the reclaimers to argue, in a situation where they themselves had not sought to alter their position regarding the tonnage figure, that the respondents having initially sought an Audit, could not alter their position by withdrawing their proposed adjustments to the accounts before any Tonnage Audit was complete, and agreeing the figures which the reclaimers had put forward. It appears that the reclaimers' argument, however superficially attractive, distorts the very limited purpose of the Tonnage Audit, as expressed in the language of the parties to the contract. As Clause 5.1(a) of Part 3 of the Schedule provides, the purchaser's accountants are "to carry out the Tonnage Audit to confirm and verify the Tonnage". As has been noted, the "Tonnage" is defined in Clause 1.1 of Part 3 of the Schedule as meaning:

"the amount in tonnes of the product for which the purchaser receives orders during the Earnout Period and thereafter issues invoices in relation to such tonnage in the Invoice Period as provided for in the Consideration Accounts."

Ex hypothesi, if a Tonnage Audit is to take place, the Consideration Accounts which the auditors have to have regard to, are the draft Consideration Accounts prepared by the reclaimers and the figure contained in those accounts is the figure which has to be "confirmed" and "verified". The experts' role is not, as the provisions of the Agreement have been expressed, to adjudicate, in general, between contesting figures proffered by each side. Far less is it to determine what the Additional Consideration, if any, is to be. The persons appointed are not appointed to act as arbiters in relation to such matters or indeed more generally. The limited role of the auditors in these respects is perfectly understandable in the context of the Agreement as a whole. The "Additional Consideration" performs the function of interposing, in the provisions regarding the consideration payable, machinery whereby the consideration will reflect the performance of the assets transferred. The parties have chosen to rely on sales of specific products for the calculation of that payment. The sales in question take place after the assets have been transferred to the reclaimers. It is they, therefore, who are the sole party in possession of all the information required to arrive at the figure for additional consideration. The machinery employed in Part 3 of the Schedule has, as its purpose, a requirement that the reclaimers provide the necessary information and permission to the respondents, if so advised, to challenge it. The definition of "Tonnage Audit" in Clause 1.1 of Part 3 of the Schedule describes it as meaning "the external verification of Tonnage". The "Tonnage" is defined in Clause 1.1 of Part 3 of the Schedule as "the figure provided for in the Consideration Accounts" and that is the meaning it has to bear where it appears in Clause 5(1)(a) as to what the purchasers' accountants have to confirm and verify. As the respondents submitted, this limited scope of the machinery is consistent with the use of the word "audit" to describe the process. It is important also, in our opinion, to keep in mind, having regard to the agreed facts in this case that the respondents never did seek a Tonnage Audit in terms of Clause 4.2(b) of Part 3 of the Schedule. What happened was that they notified proposed adjustments to the draft accounts in terms of Clause 4(2)(a). We cannot see anything in the language of the Agreement that prevents the respondents from withdrawing proposed adjustments before any Tonnage Audit is commenced or indeed completed. The purpose of the relevant provisions, in our judgement, is to seek, if possible, agreement to the reclaimers' figures in the draft Consideration Accounts. If the respondents are prepared to agree that figure, that purpose has been fulfilled and the audit machinery is rendered redundant. The reclaimers' approach to the issue, in our opinion, did not pay adequate attention to what the contract expressly provided for. The submission, as noted, was that the purpose of the relevant positions was to arrive at the "correct" or "true" tonnage figure to form the basis of the Additional Consideration, and that, if the parties could not agree as to that figure, then it was to be arrived at by the third parties nominated in the contract. But that, in our view, is to ignore the carefully drafted provisions of the contract which set out that the Additional Consideration, and the tonnage on which it is calculated are to be determined by reference to the tonnage figure as set out in the draft Consideration Accounts. Adjustment to the Consideration Account may be notified by the respondents. If the proposed adjustments to the Consideration Accounts cannot be agreed, then a Tonnage Audit takes place to "verify" and "confirm" the figure first proposed in the draft Consideration Accounts. There is nothing, we repeat, in the language of the Agreement, however, that prevents the respondents withdrawing their proposed adjustments and indicating their agreement with the figure in the draft Consideration Accounts, thus rendering the auditor's task of verifying and confirming it redundant. In particular, we do not consider that the provisions regarding payment as set out in para.4.5 of Part 3 pf the Schedule can be read to have that effect. While those provisions do not expressly deal with the situation that has arisen, in the present case, we are at one with the Lord Ordinary in holding as he did at para.43 of his Opinion, that the situation that has arisen can be accommodated within the provisions for payment. As he said, the payment date is the date when the Consideration Accounts are finalised in their original or amended form. The Additional Consideration is to be paid within 10 business days of the payment date: para.7.2(a) of Part 3 of the Schedule. Accordingly we agree with counsel for the respondents that the intention of the parties in the situation that has arisen, although not expressly provided for, falls to read as being that payment was due when the draft Consideration Accounts were no longer being challenged on the withdrawal of any proposed adjustments and prior to the completion of any Tonnage Audit. We are of the view that the concessions, recorded above, made on behalf of the reclaimers at various times, one of which was ultimately expressly withdrawn by the Dean of Faculty, were, in fact, correctly made, and are supportive of the respondents' position. It seems to us that the reclaimers are now inviting the court to distort, or add to, the plain language of the Agreement possibly to rescue them from an unforeseen consequence. It is not the function of the court to do so in commercial contracts.

The Second Line of Defence - Retention
[23] In advancing their second line of resistance to payment of the sum sought by the respondents, the reclaimers seek to rely on the law in relation to retention. This line of defence arises from the following circumstances. As noted above, after the reclaimers had reclaimed the Interlocutor of Lord Drummond Young, they were given leave to amend their pleadings and in amending, added pleas in relation to retention. The averments supportive of those pleas are to be found in Answer VIII and are as follows:

"Esto any sums are due by the defenders to the pursuers (which is denied), they are entitled to retain them pending payment of their claims against the pursuers in terms of the Commercial Action CA31/07 referred to in Answer 1. Reference is made to the pleadings in that action. The transaction in which the defenders bought from the pursuers the Gemini brand of paper products and related business and assets involved two agreements, the Asset Purchase Agreement and the Services Agreement. In the Commercial Action CA31/07, the defenders seek certain sums by way of damages from the pursuers, on the basis of breaches of the Services Agreement and also breaches of certain post-sale obligations of the pursuers under the Acquisition Agreement. Separatim, the pursuers themselves being in breach of their contractual obligations to the defenders, on the basis of mutuality of contractual obligations are not entitled to the payment sought in the action."

The Commercial Action CA31/07 referred to is still at the stage of adjustment. As noted, at the outset of this Opinion, the transaction between the parties was embodied in two written agreements. The submission of the reclaimers upon which this branch of their defence was based was that the two Agreements, though contained in separate documents, and separately executed, fell to be read and taken together as involving a bundle of reciprocal rights and obligations, which potentially allowed the operation of the law of retention, in respect of claims rising from breach of any of them. To understand this argument, it is necessary to have regard, to some extent, to the provisions of the Services Agreement and its purpose.

[24] It was explained to the court by the reclaimers, and this was not disputed by the respondents, that the main reason that the transaction was embodied in two Agreements was for certain tax advantages. Although this may have been the underlying reason for the transaction between the parties being entered into in those two Agreements, they are productive of separate and different legal consequences. The Acquisition Agreement was, in law, the vehicle whereby the assets were sold by the reclaimers to the respondents. The second, the Services Agreement, provided for the reclaimers continuing to manufacture, sell and distribute specific products for the respondents for a period of five months from the date of the sale. The purpose of the Services Agreement was to provide for continuity in the manufacture and distribution of the product and to facilitate the integration of such manufacture into the reclaimers' existing business - see the preamble to the Services Agreement. The Services Agreement came into effect on 9 June 2005, "the Effective Date" as defined in the Agreement. It continued in effect until the Completion Date which was defined as either 8 November 2005 or earlier termination. Clause 2.1 of the Services Agreement sets out its purpose in the following way:

"The parties recognise that the purpose of this agreement is to allow Tullis Russell (the reclaimers) time to integrate the manufacture and distribution of the Products into its existing operations without adversely impacting on the manufacture and supply of the Products in the period prior to the Completion Date and to protect the value of Tullis Russell's investment in the Owned Intellectual Property Rights in terms of the Asset Purchase Agreement. In consideration of the fee identified in Clause 3 below and at the request of Tullis Russell, Inveresk shall during the life of this Agreement......"

The clause then goes on to provide the specific services which the respondents are to perform. Clause 3 of the Services Agreement provides for the reclaimers to pay the respondents a monthly fee of £1 million amounting to £5 million in total over the five months of the Agreement. It was confirmed to the Court that this sum has been paid. The Services Agreement contains two further provisions imposing obligations or undertakings on the respondents. It is these that the respondents rely upon in the commercial action they have raised against the reclaimers for damages. It is upon breaches of these that the reclaimers, in part, found, in this part of their defence. The first of the provisions is Clause 14.6. Clause 14 as a whole provides for the reclaimers to pay for stock handed over to them at the end of the Services Agreement and a mechanism for determining the amount to be paid therefor. Clause 14.6 deals with the situation where there may be customers' claims, defined in the Services Agreement as "all claims, demands or proceedings by any customer relating to any stock, the Licensed Products or any other Product manufactured or supplied by Inveresk after the Effective Date but prior to the Completion Date". Clause 14.6 is in the following terms:

"Tullis Russell (the reclaimers) agrees and undertakes to settle on behalf of the Licensee (the respondents) any Customer Claims having an aggregate value of not more than £200,000 inclusive of all related costs and expenses and shall be entitled to retain the sum of £200,000 from the Stock Payment to be applied in settling any Customer Claims in terms of Clause 14.7. Inveresk shall indemnify and keep Tullis Russell indemnified against all Losses and Expenses incurred by Tullis Russell and arising from Customer Claims to the extent that the aggregate value of such Customer Claims exceeds £200,000."

[25] The second provision in the Services Agreement, the breach of which is relied upon in the reclaimers' action CA31/07 is Clause 16.2(d) of the Services Agreement. Clause 16 as a whole is concerned with certain undertakings, provided by the respondents, following the Completion date. In particular it provides, in Clause 16.2, that

"Except with the prior written consent of (the reclaimers), (the respondents) shall not, whether on its own behalf or whether directly or indirectly on behalf of any person or business, .....

(d) or at any time after the Completion Date, do or say anything which is likely or intended to damage the goodwill or reputation of the Owned Intellectual Property Rights or which may lead any person to cease to do business with the Purchaser on substantially equivalent terms to those previously offered or lead any person not to engage in business with the Purchaser......"

[26] It will be noted that in the reclaimers' averments, quoted above, in support of their retention defence, they refer to the Commercial Action CA31/07 being concerned with not only claims of breach by the respondents of the Services Agreement but also with "breaches of certain post sale obligations of the (respondents) under the Acquisition Agreement". The reference to these last mentioned breaches of the Acquisition Agreement, it transpires, are references to breaches of Clause 15.4 of the Acquisition Agreement. It is in the following terms:

"The Vendor (the respondents) shall promptly notify the Purchaser (the reclaimers) of any claims against the Vendor brought by any third party in respect of any goods manufactured or services provided by the Vendor derived from any of the Assets and the Vendor shall not without the Purchaser's prior written consent take any steps in relation to such claim which might reasonably expect to damage the commercial interests of the Purchaser."

[27] It remains to mention two further clauses in the Agreement which were referred to in the discussion of this line of defence. The first is Clause 16 of the Acquisition Agreement which is to the following effect:

"This Agreement (together with the documents referred to in it or executed at Completion) constitutes the entire Agreement and understanding between the parties with the respect to its subject matter and replaces and supersedes all prior oral and written agreements, understandings, representations and correspondence regarding such subject matter."

The second is Clause 22.2 of the Services Agreement which is to the following effect:

"This Agreement including the Schedule, and the Asset Purchase Agreement of even date contain the whole agreement between the parties in respect of the subject matter of this Agreement and supersede and replace any prior written or oral agreements, representations or understandings between the parties relating to the subject matter. The parties confirm that they have not entered into this Agreement on the basis of any representation that is not expressly incorporated into this Agreement."

The expression in Clause 16 of the Acquisition Agreement "together with the documents referred to in it or executed at Completion," embraces, by definition, the Services Agreement.

[28] The Lord Ordinary, Lord Glennie, upheld the respondents' submission that the reclaimers' averments regarding retention, having regard to the contractual arrangements between the parties, were irrelevant. As a preamble to doing so, his Lordship at para. 29 of his Opinion, endeavoured to summarise the way in which the two Agreements were intended to work. He did so as follows:

"The Asset Purchase Agreement was completed on 9 June 2005. As at that date, the defenders paid the Initial Consideration and acquired the business and the assets. Nothing remained to be done under the Asset Purchase Agreement save for the calculation, in due course and by reference to subsequent events, of the Additional Consideration. On the same date, the Services Agreement came into effect for a period of five months from 9 June 2005. During this period, in order to help the defenders integrate the business with their existing operations, the pursuers provided services to the defenders in the form of continuing to manufacture, sell and distribute certain products for them. The Services Agreement came to an end on 8 November 2005. Thereafter the pursuers had no further involvement in the business - the defenders conducted it by themselves without any further assistance from them. All that remained to be done was the calculation of the Additional Consideration payable by the defenders under the Asset Purchase Agreement. To that end, the Schedule to that Agreement identified a further period of just over one year from the end of the Services Agreement (from 8 November 2005 to 22 November 2006, encompassing the Earnout Period and the Invoice Period to which I have already referred). That period was simply the period chosen by the parties for assessing sales by reference to which the Additional Consideration was to be calculated - it involved no further activities for the pursuers apart from their participation in the process of calculating the Additional Consideration."

The Lord Ordinary then went on in his Opinion, to consider the law of retention under reference to various authorities on the topic and the parties' submissions thereanent. The Lord Ordinary reached the conclusion that the averments regarding breaches of Clause 15.4 of the Acquisition Agreement contained in action CA3/07 and incorporated into the present action were irrelevant for the purpose of a defence in the present action. In doing so he said at para. [41] of his Opinion as follows:

"On a proper construction of the Asset Purchase Agreement, the Assets sold to the defenders under that agreement, and the reference to goods manufactured or provided by the pursuers derived from the Assets, must be a reference to goods manufactured or sold by them prior to the sale and purchase of the Assets under that Agreement. The manufacture and sale of goods thereafter is, for a period of five months, covered by the Services Agreement. It would be odd, so it seems to me, to find provisions in the Asset Purchase Agreement regulating the position in relation to the services provided by the pursuers under the Services Agreement. Although it is not impossible that provisions of the two Agreements might overlap, it seems to me that since they were at pains to separate the two Agreements it is unlikely that the parties intended there to be any such overlap. In any event, on the ordinary reading of the two sets of provisions, I do not consider that there is any overlap in this respect."

The Lord Ordinary, in sum, held that since the averments were of alleged failures on the handling etc. of claims relating to products manufactured or supplied under the Services Agreement they did not form a relevant basis for a claim under Clause 15.4.

[29] As regards the rest of the defence based on retention which is pled by the reclaimers, by reference to breaches of the Services Agreement, the Lord Ordinary tested these against, inter alia, the following dictum of Lord Shand in Pegler v Northern Agricultural Implement & Foundry Co Ltd (1877) 4 R 435 at page 442:

"I venture to think the sound principle is rather this, that if the defence be founded on an obligation fairly arising out of the contract, and the performance of which is reciprocal to and contemporaneous (viz. exigible or prestable at the same time) with the obligation which is the foundation of the action, then the defence is good."

The Lord Ordinary reached the conclusion that it could be said that the obligation to pay additional consideration in the Acquisition Agreement was contemporaneous with the obligations in the Services Agreement in that it could be said that it did not become payable at any time before the end of the Services Agreement (see para. 43 of the Opinion). That left the Lord Ordinary having to address the question of reciprocity - at para. 44 of his Opinion. In doing so he said: "I do not think it fatal to the defenders' plea of retention that the relevant claims in the Action CA31/07 arise out of obligations under a different contract." Nevertheless, under reference to the way in which he had, at para. 29 of his Opinion, analysed how the two Agreements worked together, he reached the conclusion that there was not the necessary reciprocity to found a plea of retention. "It seems to me", he said, at para. 45 of his Opinion, "that the Services Agreement is a wholly separate stage of the overall transaction from the initial acquisition of the Assets". He noted that the Agreements, if read together, were to operate in stages and that the Services Agreement was intended to be completed well before the exercise of calculating the additional consideration took place. He went on to say:

"The counterpart of the sale of the Assets under the Asset Purchase Agreement is the payment of the Consideration, in the two instalments. The counterpart of the provision of services under the Services Agreement is the payment of the fee for such services."

[30] In their submissions to us, counsel for the reclaimers were at pains to stress that the transaction in question involved among other things the transfer of what was said to be the goodwill which attached to the trademarks which were to be transferred under the Acquisition Agreement. Clause 6.2 of the Acquisition Agreement provides as follows:

"The Vendor agrees to indemnify and keep indemnified the Purchaser against all Losses and Expenses however arising, incurred or suffered by the Purchaser in connection with:

6.2.1 the ownership of the Assets or any of them prior to the Completion Date; or

6.2.2 any Liability (including, without limitation, any defect (or alleged defect) in or affecting (or allegedly affecting) goods supplied or services provided prior to the Completion Date) and, in particular, any claim under any warranty or under the Sale of Goods Acts 1979 or the Sale and Supply of Goods Act 1994."

Warranties provided by the respondents under Clause 8 of the Acquisition Agreement were limited by the provisions of Clause 9 thereof. There was provision in Clause 9.1.3 for account to be taken, in assessing the respondents' liability for breach of warranty of any sums payable under the Services Agreement which showed, it was said, the interaction of the two agreements. Clause 15.4 of the Acquisition Agreement, it was submitted, was meant to cover certain potential claims not specifically addressed under the Services Agreement. The purpose of these provisions was to protect the reclaimers' whole investment under the transaction. Clause 16 of the Acquisition Agreement put it beyond doubt that the two Agreements fell to be taken together as containing the entire transaction between the parties. Clause 22 of the Services Agreement reinforced that point. There were provisions in both Agreements designed to protect the reclaimers from damage to the "brand" during the period up until the end of the Services Agreement. While the bulk of the claim in the other action derived from the Services Agreement provisions, it was the case that, under the Acquisition Agreement, the reclaimers were making claims arising from the provisions contained in Clause 15.4 of that Agreement. Both Agreements, cumulatively, provided for the problem of the value of the assets being diminished by the conduct of the respondents. That the restrictive covenants which were to apply, were to be found not in the Acquisition Agreement, where they would normally be expected to be found, but in the Services Agreement demonstrated how inextricably the two Agreements were linked and that they were inter-dependent. The essence of the claims in the other action, taken together, were that the respondents had damaged the commercial interests in the value of the assets acquired by the reclaimers.

[31] The Lord Ordinary, it was submitted, was wrong in asserting, in the terms he did at para. 29 of his Opinion, that nothing remained to be done under the Acquisition Agreement save for the calculation, in due course, and by reference to subsequent events, of the Additional Consideration. That was an inaccurate description of the true position. The respondents still remained bound to perform certain important obligations. They required to comply with the post-contractual obligations included in the Acquisition Agreement. The "subsequent events" by reference to which the Additional Consideration was to be calculated would be affected by the respondents' performance of the obligations under the Services Agreement. Due performance of the respondents' duties under the Services Agreement was, therefore, part and parcel of the calculation of the Additional Consideration. These submissions were made on the footing that the Lord Ordinary's statement of the position just quoted ignored the connection between the Acquisition Agreement's purpose, that is the acquisition of certain assets, and the purpose of the Services Agreement, that is in ensuring, as it was put, that the acquisition was achieved and done as effectively as possible, having regard to the interests of both parties and to ensure that the reclaimers obtained full value for the assets bought. The Lord Ordinary's approach was, in particular, flawed by virtue of his failure to keep in mind the very objective of the Services Agreement which was three-fold - to ensure (a) an efficient transfer of the assets, (b) continuity of manufacture and (c) preservation of the goodwill. What the respondents did during the services period would carry with it benefits or disadvantages, as the case may be, for both parties. It was submitted that, in terms of the transaction, taken as a whole, the respondents were going to be rewarded by a higher Additional Consideration payment if they performed "well" during the services period and maintained continuity of production. By equal token, the reclaimers were entitled to expect to benefit through the assets being transferred "properly" and a higher turnover being achieved. If the respondents did not perform their duties during the services period, that failure would directly affect the value of the business assets bought and, consequently, would affect the price or consideration that the reclaimers should pay for it. The price of the assets, it was submitted, had intentionally not been determined by reference to any fixed figure at the outset but by reference to a formula producing a further contribution to the respondents. Accordingly, while the Lord Ordinary was, technically speaking, entitled to state that the two Agreements were separate stages in the transaction, they were very much linked and the obligations contained in them were the counterpart of each other.

[32] Counsel for the reclaimers reviewed the relevant authorities in relation to the Scots Law of retention. Before doing so, reference was made to certain authorities to support their contention that the assets sold included the goodwill of the business since that was inherent in what was conveyed by the trademarks. Reference was made in that connection to the Trademark Handbook, para. 101, Haig & Company v Forth Blending Company 1954 S.C. 35 and Reckitt & Colman Products Ltd v Borden Inc & Others (1990) 1 WLR 491 at page 499 per Lord Oliver of Aylmerton.

[33] The focus thereafter in the reclaimers' submissions was to seek support from the authorities for the submission that, as between the obligation in the Acquisition Agreement sued upon in the present action and the obligations relied upon in the other action, arising from the Services Agreement, there was the necessary reciprocity for the law of retention to apply. It was recognised by counsel for the reclaimers, that there was, apparently, no example in the books, or any unreported decided case, where two separately executed contracts of the present kind, albeit executed in the context of a single transaction, had opened up the operation of the law of retention in relation to the obligations contained separately within them. That that is so, is perhaps, not surprising having regard to the fact that the authoritative statement of the principle provided by Professor Gloag on The Law of Contract (2^nd Ed) at page 624 is in the following terms: "As a general rule, it is no excuse for failure of performance that the other party is in default on another contract." Nonetheless, the qualifying words "as a general rule" allowed the reclaimers to advance submissions that the present case is an example of an acceptable exception to it. The main authority which Gloag refers to in support of his "general rule" is the case as Asphaltic Limestone Co v Glasgow Corporation 1907 S.C. 463. In that case the company had two separate contracts with a corporation, each for the paving and maintenance of certain streets. The company had gone into liquidation, and the liquidator had adopted one contract but refused to fulfil the other. Nevertheless as Gloag himself recognised, the principle as enunciated by Lord McLaren in that case would have applied if the position had been that the company, while remaining solvent, had for any reason failed to execute one of their contracts but had performed the other. The principle as stated by Lord McLaren at page 473 was as follows:

"Now, I do not know of any rule of law which requires that a party who has in part performed one of his contracts should be treated as if he had failed in performance merely because he has refused or failed to perform a different and unconnected contractual obligation."

Reference was made to the following further authorities: Fulton Clyde Ltd v J F McCallum & Co Ltd 1960 S.L.T. 253, J W Chafer (Scotland) Ltd v Hope 1963 S.L.T. (Notes) 11 and Barton Distilling (Scotland) Ltd v Barnton Brands Ltd 1993 S.L.T. 1261. From these authorities, it was submitted, on behalf of the reclaimers, that there was nothing objectionable, in principle, to retention being applied to two or more separate contracts where there was the requisite level of mutuality in the obligations undertaken by the parties to those contracts. That, indeed, was as the Lord Ordinary approached matters in the present case. Counsel for the reclaimers then referred to two more recent and authoritative considerations by the courts of the law of retention. The first is the decision of the House of Lords in an English case, Bank of East Asia Limited v Scottish Enterprise 1997 SLT 1213 where the Scots law of retention fell to be considered in relation to a contract. The second of the two cases was Macari v Celtic Football and Athletic Co Ltd 1999 S.C. 628. Both of these cases have things to say about the reciprocity which must exist between the obligations in question, which may mean that the failure by one party of one obligation may allow the other party to withhold performing of an obligation otherwise incumbent upon him. In the first of the two cases, Bank of East Asia Ltd v Scottish Enterprise, Lord Jauncey, in the leading speech, reviewed the law of compensation and retention as they operate in the Law of Scotland. In the first place, his Lordship at page 1215D-F dealt with compensation. This, he said:

"is the term used describing the right to set one claim against another whereby if equal both are extinguished and if not equal the larger claim is extinguished pro tanto (Gloag on Contract (2^nd Ed) 644). It derives from the Act of 1592 c.141 and operates de liquidoi in liquidum. It must be pleaded and it has no application unless the mutual debts are of the same nature and both are liquid in the sense of being presently exigible and of fixed amount......"

His Lordship then went on to note, at p.1215G, that an exception to the strict requirement that both debts must be liquid arises in cases:

"where the illiquid or unascertained claim arises out of the same contract as the debt which is sued for, and where the enforcement of immediate payment would result in enabling the pursuer to obtain satisfaction of his claim under the contract when he has not implemented the obligation of which that claim is the counterpart." (Gloag, op. cit, p. 627)

Lord Jauncey then went on (at p.1216E-F) to adopt the well-known statement of general principle made by Lord Justice Clerk Moncrieff in Turnbull v McLean (1874) 1 R 730 at page 738 which was to the following effect:

"I understand the Law of Scotland, in regard to mutual contracts, to be quite clear - 1^st, that the stipulations on either side are the counterparts and the consideration given for each other; 2d, that a failure to perform any material or substantial part of the contract on the part of one will prevent him from suing the other for performance; and 3d, that where one party has refused or failed to perform his part of the contract in any material respect the other is entitled either to insist for implement, claiming damages for the breach, or to rescind the contract altogether, - except so far as it has been performed."

Having set out the passage, however, and having referred to other authorities, Lord Jauncey went on to set out some important limits to the operation of the principle of retention. In doing so he said, at page 1216 L

".....I do not consider that the authorities warrant so broad a proposition as that any material breach by one party to a contract necessarily disentitles him from enforcing any and every obligation due by the other party."

In applying the general principles enunciated by Lord Justice Clerk Moncrieff in Turnbull v McLean regard must be had to the terms of the contract in question.

[34] In placing this important qualification on the operation of Lord Jauncey bore to follow the dictum of Lord Shand in the case of Pegler cited above. Lord Jauncey then proceeded to work through the implications of that dictum in relation to what Lord Justice Clerk Moncrieff had said in the case of Turnbull v McLean. In so doing his Lordship said at, page 1217H‑K:

"In the light of these cases I turn to consider in a little more detail the three principles enunciated in Turnbull v McLean. The first one is readily applicable to a case where the obligation by A to pay the price is the counterpart of the obligation by B to complete the works or deliver the goods. I do not, however, consider that the Lord Justice Clerk intended to state that each and every obligation by one party to a mutual contract was necessarily and invariably the counterpart of each and every obligation by the other. It must be a matter of circumstances. Thus in a contract to be performed by both sides in stages, the counter obligation and consideration for payment of stage one is the completion of the work for that stage conform to contract. The second principle must, having regard to the first principle, be construed as referring to performance by the other in relation to the part of the contract which the one party has failed to perform, rather than to the whole contract, although in many cases the part will amount to the whole. The third plainly has in contemplation the material part of a contract which the one party has refused to perform and which may be the subject of specific implement. So analysed it becomes apparent that these principles do not produce the result that any claim under a mutual contract can be set against any other claim thereunder howsoever or whensoever such claim may arise."

The working out of this authoritative statement of the law was discussed by the court in the case of Macari. In particular, Lord President Rodger, after having referred to Gloag on Contract, Erskine Institute IV, III 86 and Turnbull v McLean said, with reference to the passage from Lord Jauncey's speech in Bank of East Asia, just cited, as follows (at p 640G):

"This authoritative gloss by Lord Jauncey confirms that the law does not regard each and every obligation by one party as being necessarily and invariably the counterpart of every obligation by the other. One has to have regard to the circumstances. Lord Jauncey deduces from this that a material breach by one party of a particular term of the contract does not of itself mean that the (sic) cannot require the other party to perform any of his obligations under the contract. Rather, the party in breach cannot insist on the other party performing his obligations in relation to the part of the contract of which the first party, is in breach. It is perhaps worth making the point that equally the party not in breach is entitled to withhold performance only for so long as the other party is in breach ... Lord Jauncey does not spell out the circumstances in which one obligation will fall to be regarded as the counterpart of another. Sometimes, of course, the express terms of the contract will regulate the matter. In other cases it depends on the intention of the parties as gleaned from the terms of the contract. Lord McLaren said as much long ago in Siveright v Lightbourne at page 920:

'The question whether the obligations are conditional with respect to one another, so that nonperformance by the one party entitles the other party to withhold performance of his obligation, is always a question of intention to be determined by the terms of the contract itself, and the surrounding circumstances, which often point to implied terms.'" (at pages 604G to 641B).

The Lord President noted that a somewhat similar approach seemed to obtain in law of South Africa. In ESE Financial Services (PTY) Ltd v Cramer 1973 (2) S.A. 808(C) at 809D-E; Corbett J, as he then was, said:

"For reciprocity to exist there must be such a relationship between the obligation by the one party and that due by the other party as to indicate that one was undertaken in exchange for the performance of the other and, in cases where the obligations are not consecutive, vice versa ...".

In Macari, Lord Caplan at page 650D-E stated the law as being:

"The retention of performance must be directed at a failure on the part of the other party to perform the counterpart obligation. Moreover for retention to be available there must be a continuing failure to perform the counterpart obligation. No retention arises in respect of a past breach of contract by the other party."

While the third judge, Lord Marnoch, agreed with both the Lord President and Lord Caplan in the result, he seemed, perhaps, to have taken rather less out of what Lord President Rodger described as Lord Jauncey's "authoritative gloss" than they did. In referring to Bank of East Asia, Lord Marnoch at page 655B said:

"... I do not, myself, find anything in that decision which bears on the more normal situation, such as the present, where all the parties' obligations and counter obligations are, as it were, exigible contemporaneously. In that situation the clear presumption, in my opinion, is that all fall to be construed as inter-dependent and conditional upon each other - Gloag on Contract (2^nd Edn) at 592‑595. This is, of course, only a presumption and, as the author points out towards the end of the passage referred to, it can be overcome by parties making clear their intention that certain obligations and counter obligations can be looked at independently."

Counsel for the reclaimers, in the present case, sought to place some reliance on Lord Marnoch's apparent approach in the passage just cited, and his reference, in particular to a clear presumption that "all (obligations) fall to be construed as inter-dependent and conditional upon each other".

[35] From the authorities, the reclaimers suggested that there were two ways of dealing with how retention fell to be applied in any particular case. The first was starting from the presumption, as per Lord Marnoch's dictum, that all obligations (or at least, all material obligations) are the counterparts of each other and then seeking to identify whether any particular obligation was intended to be free-standing or independent of others. If not, then retention would apply. The second way of approaching matters was simply to identify the obligation which was sought to be enforced and then seek to identify what was its counterpart, if any. If the exact counterpart was not the obligation pled in defence, then retention would not apply. It was the reclaimers' submission that the first approach was to be preferred and fell to be applied in the instant case where the transaction in question was documented in two agreements which operated very much in a unitary way. There were a number of material obligations undertaken by each party. So, the reclaimers were obliged to pay the Consideration, the services fee and what was described as the "Coater fee". They were also obliged to avoid changes in the product which would result in the Additional Consideration being reduced. On the other hand, the material obligations of the respondents included the obligation to execute all the documents required for the transfer of the owned intellectual property rights and to promote the continuity of manufacture. They were to manufacture goods in accordance with quality standards and not to harm the goodwill of the business. There was no good reason to identify the obligation on the part of the reclaimers, to pay the Additional Consideration, as not being the counterpart for the respondents' obligations just referred to. The obligation to pay Additional Consideration was very much interlinked with the obligations on the respondents' part. While the actual transfer of the assets was formally achieved by the Acquisition Agreement, the Services Agreement was there to ensure that, in practical terms, the transfer was achieved as effectively as possible for both parties. The Additional Consideration provisions were, in part, designed to ensure that the purchaser was protected from overpayment for the assets if it turned out that the assets failed to bring in a sufficient level of business, and were designed also to protect the seller from selling the assets at too low a price, if it transpired that the level of sale that the purchaser benefited from was higher than expected. Whatever Additional Consideration fell to be calculated, the reclaimers were entitled, through contractual stipulations, to free themselves from the respondents by their actings undermining the commercial interests that they, the reclaimers, had acquired under the Acquisition Agreement. Breaches by the respondents of both Agreements would be likely to, and did, undermine the ability of the reclaimers freely to use the assets acquired and to turn their investment to their best advantage. All of these considerations pointed to all of the parties' material obligations, in their two Agreements, being the counterpart of the others. Even if one was to address the question by simply seeking to identify the counterpart of the obligation to pay the Additional Consideration, the result would be the same. The parties had signed up to an arrangement whereby what each did over a period of some months was all taken into account as regards the final determination of how much the assets turned out to be worth. The arrangements between the parties were not, as the Lord Ordinary seemed to consider, a contract in stages, as some building contracts, for example, fell to be regarded.

[36] Junior counsel for the reclaimers accepted that the logic of the reclaimers' position thus advanced was, in principle, that the whole transaction could be rescinded if there was a material breach of the Services Agreement but that was subject to the express provisions in the Services Agreement in Clauses 10 and 11 which dealt with termination of that Agreement.

[37] On the question of rescission, senior counsel for the reclaimers maintained that retention may be available in relation to one obligation in respect of a breach of its counterpart even though the contract could not be rescinded because of that breach. This was recognised by Gloag at page 622. The remedy of retention was an equitable one. Senior counsel did, however, submit that rescission of the Acquisition Agreement may be possible because of failure by the respondents under the Services Agreement. These Agreements were so closely interlinked, he said, that they amounted to a single Agreement. If they were two separate Agreements why did the parties include the "entire agreement" provisions in the terms they did?

[38] In addressing the role of Clause 15.4 of the Acquisition Agreement, senior counsel for the reclaimers, contended that it was not to be regarded as merely an ancillary provision. It had an important role in relation to the quantification of the Consideration which was payable for the goodwill. That goodwill would be affected by how customer claims were handled. On a proper construction, Clause 15.4 was capable of covering claims of goods manufactured or services provided throughout the currency of the Agreements. Clause 14.6 of the Services Agreement did not overlap with Clause 15.4. Clause 15.4 was, it was said "addressing the potential problem from a different viewpoint". Even if the argument put forward by the respondents, that Clause 15.4 was to be construed as referring to pre-completion claims, was correct, its breach would still have potential for considerable damage to the investment in the trademarks. Senior counsel for the reclaimers did accept, however, that if Clause 15.4 applied only to claims arising prior to execution of the Acquisition Agreement, then the reclaimers have not, as a matter of relevance, set out such claims, nor had they offered to prove a material breach of Clause 15.4. The position was, however, that there was no difference between 15.4 claims and claims under the Services Agreement and the reclaimers could, in principle, have brought all their claims under reference to Clause 15.4. The reclaimers' pleadings were habile to cover any loss attributable to breaches of Clause 15.4 of the Acquisition Agreement or 16.2(d) of the Services Agreement, with the exception of the indemnity provisions contained in Clause 14.6 which stood apart and alone.

[39] In the summons in the other action it is averred by the reclaimers that there are 19 complaints which had been made by customers relating to the pre-service period and which are covered by the indemnity in Clause 6.2.2 of the Acquisition Agreement. These claims, however, have now been settled. The remaining claims are said to be covered by the indemnity in Clause 14.6 of the Services Agreement. There were still, it was submitted, potential for claims by the reclaimers against the respondents in respect of breaches of Clause 15.4 of the Acquisition Agreement by reason of the way in which the respondents had handled pre-acquisition claims brought by customers.

[40] In reply, counsel for the respondents submitted that the validity of the defence based on retention should be addressed having regard to two principles. The first of these was that, generally speaking, there was no place for the operation of retention when the respective obligations were not contained in a single contract, in the absence of express agreement between the parties that it should operate in relation to separate contracts between them. The second principle was that the authorities made it clear that for the defence to apply, there had to be identification by those relying upon it of obligations which were both reciprocal and contemporaneous. The starting point was that the general rule was that any illiquid claim cannot be set off again a liquid claim. The policy of the law in that respect had been expressed by Lord Migdale in Fulton Clyde Ltd at 254 in adopting the dictum of Lord Chancellor Cranworth in National Exchange Co v Drew (1855) 2 MACQ 103, at page 122, which was to the following effect:

"I think, that not only by the law of England and of Scotland, but by the law of other civilised countries, that cannot be done; the inconvenience of it would be excessive. If a person has an actual liquidated money demand, which he seeks to enforce, the amount undisputed, it would be unjust, or might be unjust to him, to involve him in a question of whether the person who is bound to pay him that liquidated sum may or may not have a right of action against him upon some collateral matter in respect of some damage on account of which he may have a right of action."

That the operation of retention fell to be seen as an exception to the general rule, and that it operated only under strict conditions had been recognised in the speech of Lord Jauncey, under reference to authority, at page 1215D-1216B. Lord Jauncey noted, in particular at page 1216 I-J that the exception to the rule had been said by Lord President Strathclyde in British Motor Body Co Ltd v Thomas Shaw (Dundee) Ltd 1914 S.C. 928 at 926, under reference to the judgment of Lord Benholme in Johnston v Robertson as being:

"based merely on the rule of law of Scotland that one party to a mutual contract, in which there are mutual stipulations, cannot have his claim under the contract satisfied unless he is prepared to satisfy the corresponding contemporaneous claims of the other party to the contract."

[41] Senior counsel for the respondents submitted that the concept of mutuality of contract was of the highest significance in this area of the law. If there was more than one contract there was not mutuality of contract as between the obligations contained therein. Lord Jauncey at page 1216 E in Bank of East Asia had referred to Erskine at III, iii, 86 on the topic of enforcement of stipulations in mutual contracts in a passage, which was to the following effect:

"No party in a mutual contract, where the obligations on the parties are the causes of one another, can demand performance from the other, if he himself either cannot or will not perform the counterpart; for the mutual obligations are considered as conditional".

So first of all, it was submitted, for retention to operate the respective obligations had to be found in the mutual contract. That was not sufficient, however. There had to be reciprocity between the obligations in question. Each and every obligation imposed on one party to a mutual contract was not necessarily and invariably the counterpart of the other's obligations. (See Lord Jauncey at page 1217H-I in Bank of East Asia Ltd).

[42] Even if the Court were not with the respondents on this branch of their argument, in that it did not accept that the fact that there were two contracts necessarily, and by definition, ruled out the operation of retention, the contractual arrangements between the parties, it was submitted, in essence involved a staged contractual transaction, that is, it clearly operated in steps, divided into parts which were the counterpart of each other. Such transactions were specifically addressed by Lord Jauncey in Bank of East Asia Ltd at page 1217I-J where his Lordship said:

"Thus in a contract to be performed by both sides in stages the counter obligation and consideration for payment of stage one is on the completion of the work for that stage conform to contract."

The concept of staged contracts would normally arise in the context of construction contracts as, was the position in the Bank of East Asia case, but was not confined to such contracts. While the purpose of such a contract was the construction of a building for a consideration, this did not mean that any failure in performance of any obligation thereunder could be said to allow the principle of retention to apply. Yet, that it seemed was the logic of the position adopted by the reclaimers in the present case.

[43] That the essence of the matter has to be the mutuality of obligations in question was re-emphasised by the Court in Macari, for example by Lord President Rodger, at page 639D-E and 640I-641A. Gloag on Contract at page 594-595 addressed the topic in terms of a presumption when he said:

"Even when the obligations on each side are exigible at the same time, it is only a general rule that they are mutually conditional. Though from the authorities cited at the beginning of this chapter it is clear that the presumption is that the obligations undertaken by the one party are the counterpart and consideration for each other, it is a presumption merely. The contract may really be a congeries of contracts undertaken at one time, but independent of each other. And though 'it is a general principle that all the material stipulations in a contract forming a unum quid are mutual causes', the fulfilment of one obligation may be dependent on the fulfilment of another, but not necessarily dependent on the fulfilment of all the obligations which the contract may impose."

In the present case, it was submitted, the Additional Consideration was payable on tonnage achieved. It was not made conditional on satisfactory performance of other matters including the obligations contained in the Services Agreement. The transaction in question was executed in two separate contracts. There was no express provision creating pactional retention. The two contracts were intended to work in stages and their functions were distinct even though they might be said to be complementary.

[44] Senior counsel for the respondents then proceeded to review provisions of the two Agreements to support his submissions. In summary, it was said, the provisions of the Acquisition Agreement, when properly construed, established that it was essentially a sale of the relevant trademarks, registered and unregistered. It was not simply a sale of goodwill. The consideration payable was consideration for the sale and transfer to the reclaimers of the trademarks. No doubt the value of the goodwill would vary on how business was run but what was being sold were the trademarks. The Services Agreement was no doubt put in place to support and maintain the value of the trademarks and the goodwill. The provisions of the Acquisition Agreement fell to be fulfilled even if there had been no Services Agreement. The fact that the parties thought it appropriate to include "entire agreement" clauses in both contracts in the terms they did, in fact, argued in favour of there being, in law two separate agreements.

[45] As regards the Services Agreement, Clause 2.1 made it clear that the obligations undertaken by the respondents were in return for the fee specified in the Agreement. Clause 3 provided for payment of this fee on a stage basis. There might be room for retention operating as between the obligation to pay the fee and the obligation to provide the services but no scope for its operation beyond that. Reference was made to Clauses 14.6, 14.7, 15.3 and 16.2(d) as illustrating places where reciprocal obligations within the Services Agreement might be found. On the basis of this analysis of the two contracts there was simply no ground for contending that retention impliedly operated generally as between the obligations, on the one hand to be found in the Acquisition Agreement and on the other hand to be found in the Services Agreement.

[46] Senior Counsel for the respondents then addressed the relevance of the defence in so far as it related to Clause 15.4 of the Acquisition Agreement. This provision, it was submitted, fell to be read along with Clause 6.2.2 of the Acquisition Agreement and was intended by the parties to regulate claims regarding goods supplied or manufactured prior to the date of the Acquisition Agreement. This construction of the provisions was arrived at, it was submitted, by having regard to the fact that the Services Agreement existed and was designed to deal with the handling of customer complaints post-acquisition. The Acquisition Agreement was designed to effect the sale of the trademarks at the time of its execution. The Services Agreement was designed to regulate certain matters thereafter and the Acquisition Agreement was not concerned with what transpired during the currency of the Services Agreement. Support for this view of matters, it was submitted, came from a reading Clause 15 as a whole. It was "historic" in nature.

[47] Even if the court were not with the respondents as to the construction and effect of Clause 15.4 as just described, any obligation arising therefrom was not reciprocal to the obligation to pay Additional Consideration, because the Acquisition Agreement expressly provided that the Consideration and Additional Consideration was payable for the transfer of the assets. Clause 15.4, at best, fell to be regarded as an "ancillary" provision in the Acquisition Agreement. Lastly, even if contrary to all the respondents had to say on this matter, it was considered by the court that there was, in principle, the possibility of retention arising in relation to breach of Clause 15.4, the defences so far as based on such a claim were irrelevant for lack of specification. There was simply no identified loss averred, as being caused by virtue of any breach of Clause 15.4. It was not acceptable to seek to retain the sum of £900,000 without averring the losses that were said to have arisen from any breach of Clause 15.4.

[48] Reverting to the Services Agreement, it was submitted that the necessary reciprocity for retention to operate in respect of any breach of Clause 2 would operate in respect of the obligation contained under Clause 3. Breaches of Clause 5 might allow for the operation of retention in respect of the obligation contained in Clause 3. Reciprocity was expressly recognised between the obligations arising in terms of Section 16.2(d) and the sums payable under Clause 3 by virtue of what was said in Clause 17.1(d). (It should be noted that the first line of Clause 17.1 incorrectly refers to Clause 15.2 rather than 16.2). A proper consideration, therefore, of the Services Agreement's provision established that obligations contained therein had their reciprocal obligation also contained in the Services Agreement. There was no room for looking for reciprocity arising from the Acquisition Agreement.

Decision
[49] As Lord President Rodger observed in Macari at page 639:

"Unquestionably, our law recognises that in certain circumstances a party is entitled to withhold performance of an obligation under a contract when the other party has failed to perform his obligation. The rule is found in many systems, sometimes being referred to as the exceptio non adimpleti contractus ... Although there is therefore no doubt about the existence of the rule, it is considerably harder to define its scope in our law."

At page 640B his Lordship, after referring to certain statements of principle contained in the authorities, said:

"Such general statements may give rise to few problems in the case of simple contracts involving only a limited number of obligations on either side. They can, however, be difficult to apply in practice to situations arising out of complex contracts containing a wide spread of obligations"

Those remarks were, of course, made in the context of the court dealing with a case where there was only one agreement between the parties embodied in one single document. It was a contract of service. The starting point in the present case is to recognise that the parties have deliberately chosen to enter into two separate Agreements, embodied in two separate documents. Those two separate Agreements have different legal descriptions, one is a contract of sale, the other is a contract for services. These nominate contracts carry with them different legal consequences beyond what the parties may themselves have expressly agreed. Not one example was presented to the court of a situation where the courts, in this jurisdiction, or indeed in any other jurisdiction where the principle of retention or its equivalent, applies, have held that because of a perceived connection, however close, between contracts entered into by two parties effecting a business transaction, the law of retention applies as a generality, as between the obligations contained in those separate contracts.

[50] At this point it is, in our view, important to recognise a distinction between an agreement set out in several documents which fall to be read together and, if so read together, constitute one legal contract e.g. of services, and, on the other hand, two or more legal agreements executed between two or more parties which have their different legal consequences and purposes and which are contained in separate documents. The latter situation, to some extent, is one envisaged by Gloag on Contract at page 595 where he states:

"It is clear that two contracts, having no connection with each other except that they are between the same parties and entered into at the same time may be constituted or recorded in one document. In such a case there is no ground for holding that the right to exact performance of one contact is in any way or in any circumstances conditional on performance of the other."

The qualification "having no connection with each other" perhaps prompted the reclaimers in the present case to make the submissions recorded above. They no doubt sought assistance also from the remark, again by Gloag, at page 624 that, "As a general rule, it is no excuse for failure of performance that the other party is in default on another contract" (emphasis added). Nevertheless, the reclaimers were unable to refer us to a case where parties had done what has happened in this case, namely set out in detailed and complex documents, two or more legal agreements with separate different legal consequences, where the right of retention was held to operate as between them. Moreover, it must be noted that when Gloag comes to address specifically the concept of retention he does so as follows:

".....a debt which is admittedly due and payable cannot be withheld on the plea of retention of a claim of damages which does not arise directly out of the same contract (emphasis added)

The point is reinforced by Gloag at p 627 when he writes:

'The right to withhold payment, in these circumstances, is in effect an exception to the rule that an action for a debt admitted to be due and payable is not relevantly met by the defence that the defender has an illiquid or unascertained claim against the pursuer. That rule admits an exception where the illiquid or unascertained claim arises out of the same contract.....'" (emphasis added).

[51] It is, of course, always, as an aspect of freedom of contract, open to parties to agree expressly that the performance of obligations contained in one contract between them will be dependent on performance of obligations in another contract between them, even if the contracts are not executed at the same time or can be said to have any close inter-relationship, apart from the fact of being between the same parties. That is not, however, this case. Where, as here, a person is not seeking to rely on express pactional retention then the legal basis of retention is, perhaps not always entirely clear. Having referred to Lord Jauncey's discussion of the topic in Bank of East Asia, Lord President Rodger at page 640I-641B in the passage cited above, refers to the legal basis, at least in certain cases, being an implied term. It is to be noted that it appears that English law reaches, it seems, similar results as our law does though it does so, as we understand it, by reference, in part at least, to the doctrine of consideration and also having regard to the implied intention of the parties. "The rule has been established by a long series of decisions in modern times that the question whether covenants are to be held dependent or independent of each other is to be determined by the intention and meaning of the parties as it appears on the instrument, and by the application of common sense to each particular case; to which intention, when once discovered, all technical forms of expression must give way" - Tindal, CJ in Stavers v Curling 1836, 3 Bing N.C. 353, 368 cited by Gloag at page 595 (footnote 1) and adopted in Forest v Scottish County Investment Co 1916 S.C. (H.L.) 28, 36 and in Graham v United Turkey Red Co 1922 SC 533, at 554. But, it has to be noted, that in addition to parties expressly providing for the application of retention there is, it seems, in our law a presumption that in a mutual contract it will have a role to play, unless expressly excluded, (see Redpath Dorman Long Ltd v Cummins Engine Co Ltd 1981 S.C. 371). As previously observed, however, it appears, that that presumption has only ever been applied where there is one contract, so Gloag, at page 595 is to the effect that "......there is a general presumption that the reason why the parties have not accorded their agreement in separate documents is that they intended them to be dependent on each other." The approach of the reclaimers, before us, appeared to be that a proper reading of the two Agreements together led to the implication that the parties intended that performance of the obligation to pay the additional consideration was dependent on the fulfilment of the obligations under the Services Agreement and Clause 15.4 of the Acquisition Agreement and that was so because of the obvious interconnection of the matters covered by the two Agreements. In our system, at least, where the matter is not covered by express agreement, what the court is searching for is identification of obligations which might fall to be seen to be mutual. There is, we think, a danger of focusing on the expression "mutuality of contract" rather than on "mutuality of obligation" in this context. Within a single mutual contract, there may be obligations which are mutually dependent upon each other and can truly be described as reciprocal. There may also be within that single contract an obligation, or obligations, in respect of which there is no direct reciprocal counterpart. That is what Lord President Rodger in Macari at page 640G-H took from the speech of Lord Jauncey in Bank of East Asia and what Lord Caplan had to say about the matter at page 650. In a single contract situation, the obligation of an employee to carry out his employer's instruction was not regarded as the counterpart of his employer's implied obligation not to seek to damage the relationship of trust and confidence between the parties. Accordingly, the operation of retention even within a single mutual contract, where not expressly provided for, operates subject to these requirements and qualifications. As has been seen, the reclaimers' position in this chapter of the case, to a very substantial, if not complete, extent, it seemed, was based on the contention that the two Agreements were so intimately connected, when one had regard to overall commercial purpose of the arrangements between them, that the obligation to pay the Additional Consideration under the Acquisition Agreement found its counterpart in the obligations contained in the Services Agreement, breach of which is relied upon in the other commercial action and, to some extent, found its counterpart also in Clause 15.4 of the Acquisition Agreement itself. We do not accept that our law has recognised that it is sufficient for retention to operate as between separate agreements that some kind of commercial inter-connectedness between the agreements' purposes can be identified. The idea of inter-connectedness carries with it some degree of imprecision that could introduce some considerable uncertainty into complex commercial transactions, if that approach was to be followed. It seems to us, in any case, that matters are to be determined by having regard to construing what the intention of the parties was by what they have said, and done, and the fact that they chose to execute their agreement in two distinct legal agreements raises a strong presumption, at the very least, that their intention was that the obligations contained in these two separate agreements were indeed independent and not interdependent. The fact that, as we were told, this was a deliberate decision to bring about certain fiscal advantages, which may not have otherwise arisen had the agreement been constituted in one contract, supports the presumption. In addition, the fact that the two Agreements are, in law, two separate mutual contracts with different legal consequences would argue for the obligations contained in each of them being independent of each other. Applying the law, as set out authoritatively in Bank of East Asia and Macari, it does not appear to us that, on any view, the reciprocal obligation for payment of the Additional Consideration under the Acquisition Agreement was the performance of obligations under the Services Agreement. The reciprocal obligation in relation to the payment of the Additional Consideration arose solely from the Acquisition agreement and constituted the obligation to transfer the assets in question in accordance with that agreement. The reciprocal obligation for the performance of the obligations in the Services Agreement was to be found in the terms of the Services Agreement itself. While it can, no doubt, be said that there was a connection between the obligations contained in both Agreements, in that they both came into existence in the context of the whole transaction between the parties, that could have been said of the respective obligations in the Macari case and in the respective obligations in the South African case, ESC Financial Services (PTY) v Cramer but, as in those cases, their enforcement was not, in our opinion, made dependent one upon the other.

[52] As regards the limited part of the defence which relies on Clause 15.4 of the Acquisition Agreement itself, we are in agreement with the submissions made on behalf of the respondents in that regard. Clause 15.4 is, in our judgement, historic in character and was intended to deal with matters prior to the date of the completion of the Acquisition Agreement, namely 9 June 2005. Thereafter, as regards customer claims in respect of goods and services, matters were to be regulated by the Services Agreement in particular Clauses 14.6 and 14.7. In any event, in our opinion, any Clause 15.4 obligations cannot be said to have as their reciprocal and contemporaneous obligation, the obligation to pay Additional Consideration, under the Acquisition Agreement, following the approach set out in the authorities discussed above. Lastly, on this point, we agree with counsel for the respondents that any element of the defence depended on Clause 15.4 would fall to be regarded as irrelevant, standing the total lack of specification of any loss having arisen because of any breach thereof.

[53] In conclusion, we have previously observed that no case was cited to us where the law of retention was held to operate in circumstances, like the present, where the parties have elected to embody a transaction in two, or more, separate legal agreements whose legal characteristics are different. The Agreements, in the present case, are extremely detailed. They have, no doubt, been drawn up with the assistance of professional draftsmen. There was a real purpose for having the parties' respective obligations kept in separate agreements. That was a revenue purpose. In our view, had the parties intended that the law of retention should operate as between the obligations contained in the agreements, in the manner which the reclaimers submitted before us, a relatively simple clause to that effect could have been embodied in each of the Agreements. That was not done. We have to assume that the failure to do so was deliberate. That points to the intention of the parties at the time of the execution of the Agreements being that retention should not operate as between them. That conclusion is arrived at also by a consideration of the provisions in the Agreements referred to by respondents in their submissions. Accordingly, it appears that the attempt now to assert that the parties' intention was otherwise was something of an afterthought and the court is being invited to provide a shield against the respondents' claim, which shield was not provided for in the Agreement itself. As we have said, with regard to the first line of defence, is not for the court to re-write the parties' contracts. Moreover, we have not been persuaded that there are good reasons to extend the application of the law of retention to a situation like the present, such extension in our opinion being quite contrary to long established authority and being capable of being productive of considerable uncertainty and unintended serious disruption in complex commercial transactions.

[54] For all the foregoing reasons the second line of defence falls to be regarded as irrelevant. In the whole circumstances, we, accordingly refuse the reclaiming motion and adhere to the interlocutor of the Lord Ordinary of 11 September 2008.