Scottish Court of Session Decisions

OUTER HOUSE, COURT OF SESSION [2011] CSOH 45
CA175/09	OPINION OF LORD HODGE in the cause MACINTYRE HOUSE LIMITED Pursuer; against MARITSAN DEVELOPMENTS LIMITED Defender: ­­­­­­­­­­­­­­­­­________________

Pursuer: O'Brien; Biggart Baillie LLP

Defender: Simpson; Semple Fraser LLP

4 March 2011

[1] Maritsan Developments Limited ("Maritsan") is a company which purchased and resold land for development. It collaborated with Macintyre House Limited ("MHL") as MHL worked to identify potential vendors of land for Maritsan and provided consultancy services. MHL and Maritsan enetered into an agreement, which was signed on 15 June and 5 July 2005, to regulate their relationship with each other.

[2] The parties are in dispute about the treatment of VAT due on payments made under the agreement and as to the relevancy of the counterclaim by which Maritsan seeks to rectify the agreement. The parties sought a determination of those issues in a debate, leaving over other disputes for resolution on another date.

The agreement

[3] The agreement, which was entitled "Agreement ... Re: Introductory and Consultancy Fees", was so far as relevant in the following terms. Recital (A) explained Maritsan's business activities. Recital (B) stated that MHL worked with it

"in exchange for payment, to identify Potential Vendors (as defined) who are willing to sell land situated in Scotland to Maritsan by private negotiation for development purposes and in addition as and when required they provide consultancy services to Maritsan in relation to various development projects."

[4] Clause 1 of the agreement contained definitions of the words used in the agreement. It provided so far as relevant:

"'Acquisition Agreement' means a legally binding Agreement giving Maritsan the right to acquire land in Scotland from a potential Vendor; ...

'Development Costs' means the costs outlined in the Schedule;

'Development Project' means a Site owned by a Potential Vendor which is acquired for onward sale by Maritsan which definition shall include the Sites at Whiteshaws, Carluke and Limekiln Burn Farm Road Quarter; ...

'Finance Costs' means all sums of interest, charges or penalties due and payable on money borrowed to finance a Development Project or interest lost on funds used to finance Development Costs

'Net Profits' means the net sale proceeds received by Maritsan (under deduction of the Development Costs) in relation to a Site which has been a Development Project hereunder; ...

'Potential Vendor' means a person, organisation or corporate body introduced to Maritsan by MHL which party owns land in Scotland and in respect of which that party is both willing to contract with Maritsan by private negotiation and not contemporaneously with such negotiations take the property to the open market.

'Sale' means the onward disposal of a Site at arms length to a bona fide third party. ...

'Site' means land being the property of a Potential Vendor acquired by Maritsan with a view to development."

[5] Clause 2 of the agreement was in the following terms:

"2.1 MHL or Maritsan shall identify Development Projects which they shall make available to Maritsan.

2.2 Maritsan undertakes that it shall use all of its reasonable endeavours to ensure that such permissions and consents as shall be required to sell on each Development Project to property developers and builders at the best price are obtained.

2.3 MHL shall provide consultancy services as reasonably required by Maritsan and such services shall in particular relate to the planning process generally. MHL shall make such services available to Maritsan in relation to Development Projects which they introduce."

[6] Clause 3, which was headed "Fees", provided for payments by Maritsan to MHL:

"3.1 Maritsan agrees that it shall remit a sum which is equal to one half of the Net Profits for and in respect of each Development Project to MHL within five working days of the settlement of the Sale. ..."

[7] Clause 4 regulated the payment of VAT and taxes as follows:

"All sums of money payable under this Agreement are, save where the context otherwise requires, expressed exclusive of Value Added Tax but if Value Added Tax shall be due on any payment due this shall be paid provided a valid Value Added Tax invoice in respect of such payment has been issued. Any taxes to be borne in respect of sums received by the parties to this Agreement shall be borne by the recipient which shall indemnify the other party in respect of any such liability."

[8] Clause 7, which was headed "No Partnership", provided that nothing in the Agreement "shall be construed as creating a partnership, joint venture, contract of employment or relationship of principal and agent between the parties."

[9] Clause 8, which is difficult to reconcile with clause 2, stated:

"For the avoidance of doubt (a) there shall be no obligation either on MHL to identify any Development Projects nor on Maritsan to pursue any Development Project so identified, and (b) the consultancy services to be performed by MHL shall be so performed in such a manner and at such time as MHL shall see fit."

[10] Clause 9 provided for termination of the agreement on one month's notice or in the event of breach of contract or in various circumstances of, or akin to, insolvency. Clause 9.2 stated:

"Termination of this Agreement will not affect Maritsan's obligation to make payment to MHL of sums due in respect of Sites already being progressed nor MHL's obligation to carry out consultancy services in respect of such Sites."

[11] Clause 10 was an entire agreement clause and was in the following terms:

"This Agreement, together with the documents referred to in this Agreement, constitutes the whole Agreement and understanding of the parties as to the subject matter of this Agreement, and supersedes all prior representations (other than fraudulent representations), communications, negotiations and understandings concerning the subject matter of this Agreement or the other contract documents and there are no prior or contemporaneous agreements between the parties in respect of this Agreement. No party has relied on any representation or warranty except as expressly set out in this Agreement."

[12] Clause 12, which was headed "Costs", provided for the allocation of costs as follows:

"All costs and legal fees and other expenses, together with all value added tax properly payable thereon, incurred by each party in the negotiation, preparation and completion of this Agreement or any of the matters contemplated hereby shall (except where this Agreement provides otherwise) be borne by the party incurring the same."

For completeness, I note that Clause 1.2.3 provided that unless the context otherwise required "the headings of this Agreement are inserted for convenience only and shall not affect its construction."

[13] The schedule to the agreement defined "Development Costs" as follows:

"1. The purchase price or prices of the Site.

2. All fees, commissions, disbursements, costs, stamp duties and registration fees incurred in connection with the purchase referred to in 1 above.

3. All sums paid to professional consultants and other persons engaged in the provision of services in connection with a Development Project or a Sale.

4. All Sasine and Land Registration Fees and fees paid to solicitors and Counsel for advice properly sought and properly given or proceedings properly taken in connection with the Site.

5. Any sum paid in connection with the removal of trespassers from the property at any time before the Sale as well as any sum paid for any security or surveillance of the Site.

6. The costs of obtaining and thereafter complying with any statutory consent, or with respect to the Site, as a condition of the requisite Planning Permission to any adjoining and neighbouring land.

7. All rates, surcharges, taxes, duties, charges, assessments, impositions and outgoings now or hereafter assessed, charged, levied, imposed upon or payable in respect of the Site or any part thereof.

8. Any further sums which any purchaser on a Sale of the Site shall be properly entitled to deduct or take into account in determining a payment to be made on such Sale.

9. The Finance Costs.

10. Any other sum reasonably and properly incurred in connection with the Development Project and/or the Sale.

11. Value Added Tax on any part of the Development Costs to the extent that the same is not recoverable."

The parties' averments

[14] MHL seeks payment of £249,639.44 which it claims as the balance of fees due under the agreement for the introduction of the site at Whiteshaws, Carluke and for consultancy services in terms of two invoices dated 26 August 2008. Maritsan had paid MHL in two tranches, in June 2006 and June 2007 respectively. Thereafter professional advisers advised MHL that it was liable to pay VAT on its services. The further invoices of 26 August 2008 are thus claims for VAT on the share of "Net Profits" which Maritsan has paid.

[15] The parties accept that in a prior agreement relating to the sale of a site at Braidwood, Carluke, they had operated a joint venture and had shared equally between them the net profits of the transaction. No VAT had been due on MHL's share under such an arrangement. The parties differ as to what they intended when they entered into the agreement which is the subject matter of this action. MHL accepts that it had initially intended that the relationship should be a joint venture but avers that that was not what the parties eventually agreed. Both parties had instructed Brechin Tindal Oatts ("BTO") to draft the agreement as a joint venture agreement. BTO produced a different type of agreement and ceased to act for Maritsan, whom it advised to obtain separate legal advice. The draft agreement was revised at the request of Mr Munro, who controlled Maritsan, but he did not take separate legal advice.

[16] Maritsan avers that the parties intended to create a joint venture and behaved as if they had. The agreement failed to express the common intention of the parties which was that any development project which fell within its scope was to be a joint venture and that the parties would share the net profits equally. As well as making averments, which I discuss below when I consider its submissions, about how clause 3.1 of the Agreement should be construed, Maritsan included in its counterclaim an application for rectification of the agreement in the following terms:

"By

(a)   replacing the title, 'Re: Introductory and Consultancy Fees' on the frontispiece with the title, 'Joint Venture Agreement';

(b)  replacing recital (B) with, 'MHL works with Maritsan to identify Potential Vendors (as defined) who are willing to sell land situated in Scotland by private negotiation for development purposes and in addition as and when required they contribute consultancy services in relation to various development projects';

(c)   in clause 2.3 replacing the word 'provide' with the word 'contribute';

(d)  replacing the heading of clause 3 with the heading, 'Profit Share'; and

(e)   replacing clause 7 with:

'Joint Venture

The parties hereby declare their intention that this Agreement constitutes a joint venture between them in relation to any Development Project that falls within it.'"

The parties' submissions

[17] Mr Simpson for Maritsan divided his submissions into two parts. First, he argued that, if the agreement was not rectified and in order to give it a meaning which was commercially sensible, clause 3.1 should be interpreted in one or other of two ways which he put forward. Secondly, he defended the relevancy of his pleadings in the counterclaim in which he sought rectification of the agreement.

[18] The first interpretation which he advanced was that clause 3.1 properly construed in its context meant that the sum which Maritsan had to remit to MHL was inclusive of VAT. Thus Maritsan would retain one half of the net proceeds and pay the other half to MHL, who would meet any VAT obligation out of its share.

[19] The normal rule in section 19 of the Value Added Tax Act 1994 ("the 1994 Act") was that a sum of money payable under a contract for a supply of goods or services was inclusive of any VAT on it: Hostgilt Ltd v Megahart Ltd [1999] STC 141 and Wynn Realisations Ltd (in administration) v Vogue Holdings Inc. [1999] STC 524. Mr Simpson submitted that the words used in clause 3.1 and the surrounding circumstances meant that the context excluded the rule in the first sentence of clause 4, which otherwise would have disapplied section 19 of the 1994 Act. The relevant factual matrix, of which both parties were aware, included the following. First, the risk of a transaction involving the acquisition and onward sale of a site lay with Maritsan. Secondly, MHL could become entitled to a payment even if it did not provide any consultancy services under clause 2.3. Thirdly, any sale by Maritsan to a third party house builder would be exempt from VAT; thus if it had to pay the VAT due on MHL's services on top of the one half of the net profits, there would be a significantly unequal distribution of the profits in MHL's favour. The parties also knew that the Braidwood development, which had preceded the agreement, had involved the equal sharing of profits. He also submitted that clause 4 was simply a standard contractual term which made sense when there were several payment provisions in a contract but not in this agreement where there was only one clause under which sums were due. That consideration and the wording of clause 12 and paragraph 11 of the schedule suggested that not much thought had gone into the first sentence of clause 4 or the wider agreement.

[20] He submitted that clause 3.1 by specifying that the sum to be remitted was to be one half of the "Net Profits" of each development project strongly suggested that that was the sum to be remitted and that if VAT was due, it was to be paid out of that VAT-inclusive sum.

[21] Mr Simpson's alternative interpretation was that clause 3.1 should be interpreted so that after payment of VAT each of the parties ended up with the same amount of net profits in their hands. This would give effect to the primacy of the equality of shares by sharing between the parties the burden of VAT due on MHL's invoice. It was consistent with the thinking behind paragraph 11 of the schedule which had the effect that irrecoverable VAT on development costs was an expense which both parties met out of their shares. If clause 4 took effect giving rise to an irrecoverable VAT charge on Maritsan, the VAT should be treated in a similar manner to irrecoverable VAT on a "Development Cost", which was shared equally.

[22] Mr O'Brien for MHL submitted that the meaning of the agreement was clear. Clause 3 required Maritsan to remit a sum equal to one half of the "Net Profits" and clause 4 obliged it to pay the VAT on that sum. Nothing in the context of clause 3, which was the only clause which required a sum to be paid, disapplied the general rule laid down by clause 4. Maritsan's first interpretation impermissibly ignored clause 4; its second interpretation sought to create a scheme for which there was no basis in the contract and again failed to give effect to clause 4. In each of the cases which Maritsan cited - Hostgilt Ltd and Wynn Realisations Ltd - the court refused to ignore the terms of the contract.

[23] In attacking the relevancy of the counterclaim for rectification Mr O'Brien confined his submissions to the effect of the rectification if allowed. He recognised that Maritsan's current minute of amendment might cure the complaints which he had raised in his written submissions as to the sufficiency of the specification of the prior agreement which the contract was intended to express.

[24] In short, he submitted that the proposed rectification of the agreement in the counterclaim did not establish a joint venture. Such a venture was a species of partnership: Mair v Wood 1948 SC 83, Lord President Cooper at p.86. An express declaration of partnership was of no effect if the contract as a whole was inconsistent with partnership: Miller on Partnership (2^nd ed.) pp.52-53. Allowing for all the amendments for which Maritsan argued in its application for rectification, the reality of the arrangement between the parties would not be changed. MHL would "contribute" introductory and consultancy services in exchange for payment of a share of the profits from Maritsan's development business. There would be no provision for (a) a capital contribution from MHL, (b) a shared bank account, or (c) MHL to share any losses. Nothing would indicate that MHL could bind the joint venture or that it would be liable for the debts of the joint venture. The only factors pointing towards joint venture would be the existence of a profit share and the declaration of joint venture. But those were not sufficient to create such a venture: Strathearn Gordon Associates v Customs and Excise [1985] VAT TR 79, and Private & Confidential Ltd v HMRC [2009] UKFTT 59 (TC). Mr O'Brien also referred to sections 2 and 3 of the Partnership Act 1890 and Miller on Partnership (2^nd ed.) pp.71-75. The proposed rectification would merely introduce a misdescription. The agreement after rectification would remain a contract for the provision of services by MHL. Accordingly Maritsan had failed to aver a relevant case for the rectification which it sought. In his oral submissions Mr O'Brien added that even if the claim for rectification were strictly relevant, the court should exercise its discretion to refuse the application as it would not alter the outcome of the case.

[25] Mr Simpson responded that Maritsan had confused the rectification of errors of expression on the one hand and the effect of the document as rectified on the other. If the document were to be rectified, it would be for a tax tribunal to decide whether it created a joint venture and therefore whether VAT was due. No decision on that matter was called for from this court. He pointed out that a joint venturer could make a capital contribution in kind or by providing services, as in Mair v Wood. The default provisions of the 1890 Act, which were not inconsistent with the terms of the agreement, would fill the gaps which Maritsan had identified. In particular, sections 5, 9 and 24 respectively provided the power to bind, the liability for partnership debts and the sharing of losses. The production of accounts was implicit in the obligation in clause 3 to remit one half of the net profits and section 44 provided a default regime on the final settlement of accounts. While the attachment of a "joint venture" label to an agreement was not conclusive as to its nature, each case had to be assessed in its particular circumstances.

Discussion

(i) Construing the contract as expressed

[26] There was no dispute between the parties as to the correct approach to the interpretation of commercial contracts and the exclusion of pre-contractual negotiations as an aid to construction. I was referred to Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896, Lord Hoffmann at p.912 and Chartbrook Ltd v Persimmon Homes Ltd [2009] 1 AC 1101.

[27] I accept that the Braidwood contract was a joint venture and that no VAT was charged by MHL in that transaction. But the court is not allowed to look at pre-contractual negotiations to ascertain any intention to replicate that arrangement in interpreting the agreement: Chartbrook (above).

[28] There is no need to reiterate in any detail the principles which govern the interpretation of commercial contracts which judges of this court have summarised in various cases since the decision of the House of Lords in Investors Compensation Scheme Ltd (above). In this case the significant rules are that the court should (i) construe individual provisions of the contract in the context of the whole contract, (ii) apply an objective construction by reference to the meaning which a reasonable third party, who is aware of the commercial context in which the contract occurs, would give to the words which the parties have used, and (iii) adopt a commercially sensible construction, when the court is faced with competing interpretations. Further, the court cannot re-make the contract for the parties on what it considers would be sensible terms or disregard contractual terms. Where parties have included a provision in their contract, the court should strive to give a proper meaning to it: see, for example, Wynn Realisations Ltd (above) Morritt LJ and Clarke LJ at p.529b-e and h-j respectively.

[29] The contract is not easy to interpret and one is left with the feeling that the parties have given insufficient thought to the expression of their intentions. Clause 4 is a strange provision to include in the contract as there is only one provision, namely clause 3.1, which involves one party paying money to the other. A general rule with an exception for context as in sentence 1 of clause 4 makes no sense in this agreement. In response to questions from the bench, counsel agreed that they could not identify any circumstance in which the second sentence of clause 4 could come into play. Indeed, that sentence appeared to make sense in the context of a joint venture but not in a contract for the provision of services for payment.

[30] Clause 4 is not the only provision which puzzles. Clause 2.1, which provides that both Maritsan and MHL are to identify Development Projects, fails to have regard to the definition of "Development Project" which by virtue of the definition of "Potential Vendor" requires that it is MHL which makes the introduction. Clause 8(a) is not obviously consistent with Maritsan's obligations to use all reasonable endeavours in clause 2.2; and it is difficult to reconcile MHL's obligations in clause 2.3 with the relaxed regime envisaged in clause 8(b). It is also hard to reconcile the termination of the contract for breach in clause 9.1 with the continuing obligation on MHL to give consultancy services after termination in clause 9.2.

[31] I am left with the clear impression that clause 4 has been lifted from another contract and inserted into this agreement in a context in which nobody has applied his mind to what the effect of VAT would be. I am not persuaded that the ordinary expectation that parties to a formal document have chosen their words with care is met in this case. But the court cannot reframe a formal contract, even if it is not skilfully drafted. As I have said, I have to consider what a reasonable businessman standing in the shoes of parties would have understood the parties to have meant by the words which they have used in the context of the contract as a whole and having regard to the relevant commercial background.

[32] In doing so, I do not think that Mr Simpson's submission that it was Maritsan who was taking on the greater risk is a significant pointer as to which party was intended to bear the burden of the VAT charge. I can see nothing in the contract which suggests that the parties intended that the profits would be shared unequally because of the incidence of VAT. Neither party would have known in advance whether MHL would have significant input tax to set against its liability to pay output tax. But both parties would have known that on a sale of a site to a house builder Maritsan could not recover any VAT which it had to pay MHL for its services.

[33] In construing the contract as it is now expressed, it is clear that the parties in clause 7 did not want their relationship to be a partnership or joint venture. One can readily see reasons why that might be their wish as it would reduce each party's exposure to liabilities resulting from the acts of the other. It is much more difficult to see why either party would agree to have an unequal sharing of profit because of the possible incidence of irrecoverable VAT on MHL's services.

[34] On the pursuer's construction of the contract MHL would retain 50 per cent of the net profits after it had accounted to HM Revenue and Customs ("HMRC") for VAT and Maritsan would receive only 41.25 per cent. In effect the VAT would be paid out of Martisan's share. Thus if the net profits were, say, £200,000, Maritsan would pay MHL £117,500. After paying HMRC, MHL would have £100,000 while Maritsan had only £82,500. It makes no business sense that the parties should have agreed such an arrangement. While it is always necessary in construing a contract to bear in mind the possibility that one party has made a bad bargain, I am satisfied that the context, of which clause 4 speaks, qualifies the general rule in that clause, as set out below. Thus applying the ill-thought-out clause 4 results in a rejection of the pursuer's construction.

[35] On Mr Simpson's first alternative construction, in which MHL's half share was inclusive of VAT, he informed me that Maritsan would get 50 per cent, MHL 42.55 per cent and HMRC 7.45 per cent of the net profits. Using the same figures as in the previous paragraph Maritsan would get £100,000, MHL £85,100 and HMRC £14,900. That may not be quite as unlikely an intention as the pursuers' position. But it makes little business sense in the context of the contract as a whole which sought the equitable deduction of costs, including irrecoverable VAT on the development costs. Thus I do not consider that the objective interpretation of the parties' stated intention would result in MHL receiving £100,000 inclusive of VAT. It seems to me that clause 4 disapplies section 19 of the 1994 Act, and thus excludes Mr Simpson's first construction, but that the agreement on a proper construction does not require Maritsan to bear the burden of the VAT charge from its share alone.

[36] This is because I construe clause 3.1 in the context of the agreement as a whole as requiring the parties to share the actual net profits equally and the VAT charge on MHL's services to be calculated accordingly. I thus give effect to the rule in clause 4 but qualify it, rather than exclude it, to reflect the intention of the parties which I derive from the agreement as a whole.

[37] In thus regard I recognise Mr O'Brien's point that the agreement contains no express mechanism to support Mr Simpson's second alternative construction. But it does not require a complex mechanism to achieve the intention of the parties which was the sharing of the net profits. I recognise also that "Net Profits" was a defined term and thus had a defined meaning when it was used in clause 3.1. But that is not conclusive where, as here, the court considers that the parties have failed to work out fully the mechanism for giving effect to their agreement in a contract which was defective in a number of respects. In effect Mr Simpson was arguing for the implication of a term into clause 3.1 to achieve the sharing of net profits in the event that MHL needed to charge VAT which Maritsan could not recover. The effect of that term would be that if VAT was due on the charge for MHL's services, the parties would share the burden of that charge and the VAT exclusive sum due to MHL would be its share of the actual net profits after deduction of that charge.

[37] The mechanism to share the burden of any VAT which might be due on MHL's services is straightforward. First, one calculates the "Net Profits" by deducting the "Development Costs" from the net sale proceeds of the site. Secondly, one acknowledges that VAT will be due on the sum payable to MHL as its share of the actual net profits. And, thirdly, one allocates equally between the parties the burden of the VAT to arrive at the share of net profits payable to each party. In effect, if X is the share of each party of the actual net profits one applies the formula: "Net Profits" = 2.175X. Thus using the figures used above, "Net Profits" of £200,000 would be divided by 2.175, giving each party a net share of £91,954 and a VAT charge of £16,092. Using Mr Simpson's figures, the "Net Profits" of £2,853,022.26 would give rise to a sum due to MHL of £1,311,734.37 on which VAT of £229,553.51 would be due, resulting in (a) a payment to MHL of £1,541,287.88 inclusive of VAT and (b) the retention by Maritsan of £1,311,734.38.

(ii) The application for rectification

[38] The question in a debate on the relevancy of the averments which support Maritsan's claim for rectification is whether, if proved, those averments would entitle the defender to the remedy. The legal effect of the contract as rectified is not an issue for the court when considering the question of relevancy. The court is not at this stage called upon to exercise any discretionary power. I am not persuaded that Maritsan's application for rectification must necessarily fail if it were to prove the facts which it has averred in support of that application. It follows that the challenge to the relevancy of the averments in support of the counterclaim fails.

Conclusion

[39] If I am correct in my construction of the agreement, MHL will be entitled to payment of further sums, although not the sums which it has claimed. Maritsan will be entitled to a proof before answer in relation to its counterclaim, which also may need to be adjusted in relation to its conclusions other than the application for rectification. In the circumstances I will have the case put out by order to determine further procedure.