Scottish Court of Session Decisions

OUTER HOUSE, COURT OF SESSION

[2015] CSOH 6

CA150/14

OPINION OF LORD DOHERTY

In the cause

PARK’S OF HAMILTON (HOLDINGS) LIMITED

Pursuer;

against

HOLMES MACKILLOP LLP

Defender:

Pursuer:  Sandison QC;  Brodies LLP

Defender:  McBrearty QC;  CMS Cameron McKenna LLP

21 January 2015

Introduction
[1]        In this commercial action the pursuer seeks damages from the defender, a firm of solicitors, in respect of losses said to have been caused through the professional negligence of one of the partners of the firm.  At the material times the pursuer was a client of the defender.

[2]        On 22 December 2006 the pursuer entered into a Share Purchase Agreement (“the Agreement”) (6/1 of process) with Norman James Henry, Mrs Diane Christine Clark and the Henry Grandchildren’s Trust (“the Vendors”) in terms of which it acquired the entire issued share capital of Henry Brothers (Holdings) Limited (“the Company”), a company engaged in the motor trade.  On the same date, and pursuant to the Agreement, the pursuer, Mr Henry and Mrs Clark also executed a Taxation Undertaking (7/1 of process).  During the negotiation of the terms of the Agreement and the Taxation Undertaking, and thereafter, the defender acted as the pursuer’s solicitors.

[3]        A subsidiary of the Company, Henry Brothers (Glasgow) Limited (“the Subsidiary”), had received a VAT refund from HMRC in about 2004.  At the time of execution of the Agreement the Company and the Subsidiary were in dispute with HMRC as to whether the Subsidiary was liable to pay corporation tax on the refund.  The accounts of the Company for the pre‑acquisition period had contained a provision for £267,019 (“the VAT Dispute Amount”) in respect of the potential corporation tax liability of the Subsidiary.  The Vendors believed that such provision had been over‑cautious.

[4]        The Agreement provided (clause 4.1) that the consideration for the purchase of the shares should be the payment in respect of goodwill and a further amount equal to the Net Asset Value (the aggregate sum of the values of the assets of the Company and the Subsidiary less the aggregate of the amount of the liabilities and provisions of the Company and the Subsidiary).

[5]        In light of the dispute as to corporation tax liability for the VAT Dispute Amount clauses 8.1 to 8.4 of the Agreement provided as follows:

“8        VAT Dispute Amount

8.1       The Vendors and the Purchaser agree that the amount of the provision made in the Accounts in respect of the corporation tax arising from receipt of a VAT Refund (‘the Refund’) together with statutory interest in 2003/04 (being £267,019) (‘the VAT Dispute Amount’)) (sic) will not be included as a liability (or be otherwise provided for) in the Completion Accounts for the purposes of determining the Net Asset Value in accordance with Clause 4 and Part 8 of the Schedule.

8.2       Norman James Henry (‘Mr Henry’) agrees and undertakes to indemnify, free and relieve the Purchaser (or the Subsidiary at the direction of the Purchaser) in respect of the amount of any liability incurred by the Purchaser or the Subsidiary, as appropriate, in the event that all or any part of the VAT Dispute Amount is finally and judicially determined to be due by the Subsidiary to HM Revenue and Customs (‘HMRC’), subject to the following conditions:-

8.2.1     The Purchaser, the Company or the Subsidiary (as applicable) actually makes payment of the VAT Dispute Amount to HMRC (‘the VAT Payment’);

8.2.2     The VAT Payment made pursuant to Clause 8.2.1 is evidenced by vouching acceptable to Mr Henry acting reasonably;  and

8.2.3     The VAT Payment is made on or before 6 years from the Completion Date.

8.3       In the event that HMRC indicates to the Company or to the Subsidiary that it intends to seek the VAT Payment, the Purchaser shall so advise Mr Henry.  Mr Henry shall then be entitled (subject to his meeting all third party costs including those of chartered or tax accountants engaged for the purposes) to require the Company or the Subsidiary to take all steps as Mr Henry in his discretion shall require to defend any claim or assessment made by HMRC in relation to the VAT Dispute Amount.  In that regard the Company and the Subsidiary will make available all relevant books and records to Mr Henry and his advisers and Mr Henry shall also be entitled to consult with the Financial Controller.

8.4       The Purchaser and the Vendors acknowledge that in relation to the VAT Dispute there is a possibility of a further amount becoming payable by HMRC for compound interest on the Refund (‘the Additional Interest’). The Purchaser agrees that in the event that the Company or the Subsidiary receives an amount in respect of the Additional Interest within 6 years of the Completion Date, the Purchaser shall pay to the Vendors by way of additional consideration an amount equal to the Additional Interest (net of tax and the external third party costs referable to the pursuit of a claim for Additional Interest incurred by the Company and/or the Subsidiary in so far as not already recovered from Mr Henry) within 10 Business Days of receipt by the Purchaser or the Company or Subsidiary (as appropriate) of the Additional Interest.”

The “Vendors” were Mr Henry and the other sellers; the “Purchaser” was the pursuer.

[6]        In about April 2012 the pursuer made enquiries of the defender’s Mr J Stuart McNeill.  The pursuer avers that it asked what the time limit was for enforcing the indemnity in clause 8 and was advised that it was 7 years after the Completion Date.  The defender denies that an enquiry in precisely those terms was made, but it admits that Mr McNeill was in breach of a duty to the pursuer to ascertain the precise nature of the enquiry as to time limits which was being made by the pursuer.  The pursuer avers that had Mr McNeill advised it properly in April 2012 it would have made the VAT Payment to HMRC before 22 December 2012, and would thus have maintained its right to be indemnified by Mr Henry in terms of clause 8.  The defender disputes that.  It maintains that on a proper construction of clause 8 it was a condition of the indemnity that the VAT Dispute Amount was finally and judicially determined to be due to HMRC on or before 6 years from the Completion Date; that was not done here; and that it would not have been done even if the defender had given appropriate advice.  The pursuer disagrees with the defender’s construction.  Its position is that judicial determination need not be within the 6 year period provided the VAT Payment was made within that period.  

[7]        The issue of the proper construction of clause 8 came before the court for determination at a Debate on the Commercial Roll.  It was common ground that if the defender’s construction is correct the pursuer’s averments are irrelevant and the action should be dismissed;  but that if the pursuer’s construction is correct the defender’s averments setting out its construction (in the fifth to eighth sentences of Answer 10) are irrelevant and ought not to be admitted to probation.

Submissions for the defender
[8]        Mr McBrearty submitted that on a proper interpretation of clause 8 the pursuer would have been entitled to enforce the indemnity only if final judicial determination of liability to HMRC and the making of the VAT Payment to HMRC both took place within 6 years of the Completion Date.

[9]        The proper approach to the construction of commercial contracts was set out in Rainy Sky SA v Kookmin Bank [2011] 1 WLR 2900, per Lord Clarke of Stone-cum-Ebony at paragraphs 14, 21 and 23‑30; in Multi‑Link Leisure Developments Ltd v North Lanarkshire Council 2011 SC (UKSC) 53, per Lord Hope of Craighead at paragraphs 20‑23, per Lord Rodger of Earlsferry at paragraph 26, per Lord Clarke at paragraph 45; and in Grove Investments Ltd v Cape Building Products Ltd [2014] CSIH 43, in the Opinion of the Court at paragraphs 9‑11.  For present purposes the four most important propositions which emerged from these cases were:

(i)         The aim of the court in construing a commercial contract is to ascertain objectively the intention of the parties.  That involves consideration of the language used and ascertaining what a reasonable person with all the background knowledge reasonably available would have understood the parties to mean.

(ii)        Where unambiguous language is used the court will give effect to it.

(iii)       Where a term of a contract is open to more than one interpretation it is generally appropriate to adopt the interpretation which is most consistent with business common sense.

(iv)       A contract should normally be construed in such a way as to avoid arbitrary and unpredictable burdens or impositions or benefits, according to what would be the expectations of reasonable parties in the contractual context.

[10]      On an ordinary reading of clause 8.2 the conditions at 8.2.1, 8.2.2 and 8.2.3 applied to the VAT Dispute Amount as finally and judicially determined.  Final determination had to precede payment.  Both had to take place within the 6 years period.  There was nothing remarkable or absurd in the notion that liability to indemnify had to arise within the 6 year period.

[11]      Mr McBrearty acknowledged that if his construction was correct the time limits in clause 8 were of a different nature from the time limits in clause 7; and from the time limits in clause 7 of the Taxation Undertaking.  He did not shrink from that.  There was no reason to think that parties would have considered that the approach to time limits which had been adopted in relation to breach of warranties was apt in relation to the VAT Dispute Amount.  The same observation applied to the approach to time limits taken in the Tax Undertaking.

[12]      Mr McBrearty relied upon the terms of clause 8.4 as tending to indicate that his construction of clause 8.2 was correct.  He described clause 8.4 as “the counterpart” of clause 8.2.  If HMRC paid Additional Interest on the VAT Refund to the Company or the Subsidiary within 6 years of the Completion Date the Purchaser was to pay additional consideration to the Vendors.  A payment of Additional Interest after the expiry of the 6 year period would not give rise to liability to pay additional consideration. That showed that within at least this part of clause 8 the contracting parties had viewed a 6 year cut‑off point as being sensible and reasonable.  That was a conclusion which ought to be drawn whether or not clause 8.4 fell to be regarded as the counterpart of clause 8.2.

[13]      Mr McBrearty accepted that the language of clause 8.2 was capable of bearing the construction which the pursuer contended for.  He maintained, however, that the defender’s construction was the more natural reading;  and that it was more consistent with business common sense than the pursuer’s construction.  The contracting parties would have wanted to know on the expiry of the 6 year period whether Mr Henry was obliged to indemnify the Purchaser.  The defender’s construction had the advantage of certainty.  On the pursuer’s construction the obligation to indemnify could be kept alive by making a without prejudice payment to HMRC within the 6 year period, and with there then being no time‑limit for final judicial determination.

Submissions for the pursuer
[14]      While, like Mr McBrearty, Mr Sandison accepted that the language used in clause 8.2 was capable of bearing either of the mooted constructions, he submitted that the construction the pursuer contended for was the more natural reading.  The obligation to indemnify had not been conditional upon there having been a final judicial determination of liability to corporation tax before the expiry of the 6 year period.  The making of the VAT Payment was the only condition which had to be satisfied on or before the expiry of the 6 year period.

[15]      If the contracting parties had intended to require that liability to corporation tax should have been finally judicially determined by the expiry of the 6 year period it would have been very easy for them to have said so.  They had not done that.  On the contrary, the 6 year temporal limitation had been inserted only in clause 8.2.3.  It had been expressly linked to making the VAT Payment, and not to anything else.

[16]      It was notable that no time limits for final judicial determination of a claim had

been provided for in the provisions of the Agreement relating to warranties and other undertakings.  The time limits were for giving notice of claims to the Vendors and for raising actions against them.  Similarly, in relation to enforcement of the undertakings given in the Taxation Undertaking, the time limits were for giving notice of a claim and for raising proceedings in relation to the claim.  If the defender’s contended construction was correct clause 8.2 would provide the sole instance in the Agreement or the Taxation Undertaking where there was a “drop dead date” which required final judicial determination to occur before it.

[17]      Clause 8.4 was not the counterpart of clause 8.2.  Unlike clause 8.2 it did not relate to the payment of corporation tax.  It dealt with an entirely different subject-matter, viz the possibility of additional compound interest being paid by HMRC in respect of the VAT Refund which had already been made (two years prior to the Agreement).

[18]      There was no good reason why the parties to the Agreement, as sensible business persons, would have wished to have provided (and that only by implication) a different and ‑ from Mr Henry’s point of view - much more beneficent regime for the vindication of a claim under clause 8.2 than for vindication of analogous claims.  The general purpose of providing time limits for the enforcement of warranties and undertakings in a share purchase agreement was to enable the parties to know by a particular point in time whether there remained any outstanding issue from the transaction in respect of which they might require to make provision.  But in relation to the VAT Dispute Amount the parties knew at the outset that there was an extant claim and a potential liability.  So instead of providing for notice of a claim and litigation within specified periods they had agreed what was in effect a functional equivalent - that payment to HMRC had to be made within a certain time.  It would have made no commercial sense to provide that the indemnity could only be enforced if within 6 years of the Completion Date all or part of the VAT Dispute Amount was finally and judicially determined to be due to HMRC.  The occurrence of final judicial determination was, to some extent, an arbitrary matter.  It was not within the control of the pursuer, the Company and the Subsidiary.  If the defender’s construction was correct there would be an incentive for Mr Henry to exercise his clause 8.3 rights in order to postpone or delay the occurrence of final judicial determination.  The parties would have been well aware that it was not uncommon for taxpayers to make without prejudice payments to HMRC which could later be recovered in the event that judicial determination was in their favour.

Decision and reasons
[19]      I find it convenient to begin with some preliminary observations on clause 8.

[20]      The clause dealt with two particular matters, both of which related to the VAT Refund which HMRC had made to the Subsidiary.  First, and principally, there was an ongoing dispute with HMRC as to whether corporation tax was due by the Subsidiary in respect of the VAT Refund and interest.  Second, there was an awareness that HMRC might be obliged to make a payment to the Subsidiary of Additional Interest in respect of the Refund.  In terms of clause 8.2 Mr Henry undertook a contingent obligation to indemnify the pursuer or the Subsidiary.  That obligation was subject to four suspensive conditions, viz that all or part of the VAT Dispute Amount was finally and judicially determined to be due by the Subsidiary to HMRC; and the conditions in 8.2.1, 8.2.2 and 8.2.3.  Clause 8.3 entitled Mr Henry “to require the Company or the Subsidiary to take all steps as Mr Henry in his discretion shall require to defend any claim or assessment”.  The grant of that right formed part of the quid pro quo for the assumption of the contingent obligation to indemnify.  In such circumstances clause 8.3 ought not to be construed as to entitling Mr Henry to require the Company or the Subsidiary to take steps intended to illegitimately prevent or obstruct the fulfilment of the suspensive conditions (cf. Gloag, The Law of Contract (2^nd ed.), pages 276‑7).

[21]      Both counsel accepted that in the event that only part of the VAT Dispute Amount was finally and judicially determined to be due, parties could not have intended that liability to indemnify should be conditional upon payment to HMRC of the whole VAT Dispute Amount being made.  I agree with counsel that a construction of clause 8.2.1 which required that would be absurd.  The words “VAT Dispute Amount” in clause 8.2.1 ought not to be read as meaning £267,019 (as they do in clause 8.1) in every case.  Once clause 8.2 is read as a whole, it becomes clear that in the context of clause 8.2.1 the words “VAT Dispute Amount” must mean a sum equal to £267,019 or such lesser sum as may be found to be due to HMRC.  It is the making payment of that sum which is the VAT Payment.

[22]      Both counsel also accepted that each of the rival constructions of clause 8.2 was a possible construction:  but each maintained that his construction was the more natural one.  It follows that, if I agree that each construction is one which the language used can bear, I require to consider the consequences of each construction, and which construction accords better with commercial common sense.

[23]      I agree with Mr Sandison that the construction the pursuer contends for is the more natural reading of clause 8.2.  Clause 8.2.3 requires that the VAT Payment is made on or before 6 years from the Completion Date.  As a matter of ordinary language it does not explicitly require that final and judicial determination of the liability to HMRC must take place within that period.  For such a requirement to be read into clause 8.2 “VAT Payment” would require to be construed as meaning only a payment made after final judicial determination of liability.  As already discussed, in terms of clause 8.2.1 it is a condition of liability to indemnify that payment has been made of a sum equal to £267,019 or such lesser sum as may be found to be due to HMRC.  That is the VAT Payment.  It does not follow that such payments may only be made after final judicial determination of liability.  I do not think it is either necessary or natural to read the expression in that way.  Payments under reservation of liability are frequently made, for a variety of reasons.

[24]      The defender’s reading of clause 8.2 is not the natural or ordinary reading of the words used.  However I agree with counsel that the words used cannot be said to be incapable of having the meaning which the defender suggests.  The pursuer’s construction, while the more obvious construction, is not so clear and unambiguous as to be the only possible meaning of the clause.

[25]      In Rainy Sky SA v Kookmin Bank, supra, Lord Clarke observed:

“21  The language used by the parties will often have more than one potential meaning.  I would accept the submission made on behalf of the appellants that the exercise of construction is essentially one unitary exercise in which the court must consider the language used and ascertain what a reasonable person, that is a person who has all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract, would have understood the parties to have meant.  In doing so, the court must have regard to all the relevant surrounding circumstances.  If there are two possible constructions, the court is entitled to prefer the construction which is consistent with business common sense and to reject the other.

…

30  ... As stated in a little more detail in para 21 above, [the correct approach] is in essence that, where a term of a contract is open to more than one interpretation, it is generally appropriate to adopt the interpretation which is most consistent with business common sense…”

[26]      I turn first to the remainder of the Agreement and to its context.  Clause 8 of the Agreement formed part of a suite of obligations undertaken by the respective parties - in the Agreement itself and in the related Tax Undertaking. Mr McBrearty was unable to point to a single further instance where the parties had provided that final and judicial determination of a liability had to occur within a stated time limit.  Not only was such provision absent in the terms relating to claims for breach of warranties, but it was also absent in the case of claims relating to other undertakings (including claims under the Tax Undertaking which might be regarded as being more analogous to the present claim than a claim for breach of warranty).  The absence of any such provision strikes me as unsurprising.  Under the general law relating to limitation the normal requirement is for a claim to be made within a limitation period, not that the claim be finally and judicially determined within that period.  The pursuer’s construction accords with the approach of the general law relating to limitation; the defender’s does not.

[27]      Mr McBrearty placed reliance on the terms of clause 8.4.  He did not suggest that it governed the operation of the indemnity.  It is plain that it does not do so.  It is also readily apparent that clauses 8.1 to 8.3 on the one hand, and clause 8.4 on the other, deal with distinct and different obligations.  Clauses 8.1 to 8.3 relate to the grant of an indemnity by Mr Henry in respect of liability for corporation tax on the VAT Dispute Amount.  Clause 8.4 makes provision for the pursuer becoming liable to pay additional consideration to the Vendors in the event that within 6 years of the Completion Date HMRC pays Additional Interest on the VAT Refund to the Company or the Subsidiary.  Mr McBrearty’s main submission in relation to clause 8.4 was that it showed that the parties had considered that a cut-off point of 6 years for enforcement of an obligation was reasonable.  That appears to be so in relation to the obligation to pay additional consideration, but non constat they meant that the obligation to indemnify should only be enforceable if liability for corporation tax was finally and judicially determined within the same period.  If they had so meant they could very easily have said so (cf. Multi-Link Leisure Developments Ltd v North Lanarkshire Council, supra, per Lord Hope at paragraph 16, per Baroness Hale of Richmond at paragraph 43).  What was required within the 6 year period in terms of clause 8.4 was not final and judicial determination of liability, but the payment of Additional Interest by HMRC to the Company or the Subsidiary.  Similarly, with clause 8.2 what was required was payment (but in this case to HMRC).  With none of the provisions of the Agreement or the Taxation Undertaking - clause 8.4, clause 8.2, or any other - did final and judicial determination of liability have to occur within the applicable time limit.

[28]      What then of the consequences of the rival constructions?  Mr McBrearty prays in aid the desideratum of certainty.  On his construction Mr Henry knows where he stands at the latest 6 years after the Completion Date.  On that date, if there has been no final and judicial determination of liability to HMRC, the contingent obligation to indemnify flies off.  By contrast, on the pursuer’s construction there would be no certainty on the expiry of the 6 year period.  If the pursuer had made a without prejudice payment timeously there would be no further time limit within which final judicial determination had to take place.  Mr Henry could be left with the claim hanging over him for an indeterminate period.

[29]      I am not satisfied that certainty would have been viewed by a reasonable businessman, in possession of all the relevant facts at the time of contracting, as being the paramount consideration.

[30]      The shared aim of the Agreement was that the shares should be sold for a consideration which reflected the value of goodwill and the Net Asset Value of the Company and the Subsidiary.  No provision had been made in the Net Asset Value for the Subsidiary being liable for the VAT Dispute Amount.  If the Subsidiary was liable the consideration paid by the pursuer would have been greater than it ought to have been.  In those circumstances the parties agreed that Mr Henry should indemnify the pursuer in respect of the liability.  In relation to all this there can be no dispute.  The dispute concerns the meaning to be attributed to the temporal limitation in clause 8.2.

[31]      The defender’s construction involves imputing to the parties a shared intention that Mr Henry should have no obligation to indemnify where liability for the VAT Dispute Amount is finally and judicially determined to be due on a date later than 6 years after the Completion Date.  In my opinion that is an improbable commercial result.  It is not what reasonable commercial men, apprised of the facts, would have been likely to agree to.  It would open the way to results which they would regard as being arbitrary and unpredictable; and which would place an unfair risk on the pursuer and confer a corresponding windfall benefit on Mr Henry.  Reasonable businessmen would have been aware that it is not uncommon for taxpayers to make payment to HMRC on a without prejudice basis (ie on the basis that they continued to insist on their rights to maintain that tax was not due) pending determination of a dispute on liability - often with a view to preventing the incurring further interest charges, penalties or the like.  They would also have been aware that other considerations might well make it prudent for the pursuer to make payment to HMRC before final judicial determination of liability - especially if Mr Henry elected to exercise the rights conferred on him by clause 8.2.3 and/or (for that reason or any other reason) there seemed to be a real prospect that that determination would not take place within 6 years of the Completion Date.  Reasonable businessmen would appreciate that achieving final and judicial determination of liability to HMRC would depend on matters outwith the pursuer’s control.  They would baulk at the notion that the right to indemnity should be lost because an appeals process took more than the 6 year period to be exhausted (eg because successive appeals were taken by HMRC).  They would demur from the proposition that that was fair or business-like.  As Lord Steyn has observed extra judicially (“Contract Law:  Fulfilling the reasonable expectations of reasonable men” 113 LQR 433, at 441)(approved by Lord Clarke in Rainy Sky SA v Kookmin Bank, supra, at paragraph 25):

“… [I]n the event of doubt, the working assumption will be that a fair construction best matches the reasonable expectations of the parties.”

The pursuer’s construction avoids the obvious risk of injustice which is inherent in the defender’s construction.  It also appears to me to be more consonant with the general law relating to limitation.

[32]      The defender’s claim that the pursuer’s construction would be liable to result in a claim hanging over Mr Henry indefinitely does not appear to me to deserve much weight.  The pursuer would be unlikely to make a payment on a without prejudice basis unless it considered there was a real prospect of liability being established. On the pursuer’s construction payment (whether without prejudice or unreserved) required to be made within 6 years.  Where a without prejudice payment was made timeously it would be in the pursuer’s interest to obtain a final judicial decision as soon as possible;  and Mr Henry could use the power in clause 8.3 to seek to achieve the same end.

[33]      It might be said that my observations in paragraph 30 (apart from the final sentence) about clause 8.2 may be applied mutatis mutandis in the case of clause 8.4 and the additional consideration, yet the parties were content with a period of 6 years after the Completion Date for the receipt of the Additional Interest which was the prerequisite of the liability for payment of additional consideration.  That is of course true.  However, significant differences are that clause 8.4 is in clear and unambiguous terms; relatively speaking, it is a provision of lesser importance and of a more subordinate and ancillary nature than clauses 8.1 to 8.3; and the right to additional consideration does not depend upon a final judicial determination within the 6 year period (and does not have the problems associated with such dependence).

[34]      I conclude therefore that the pursuer’s construction is a more natural reading of clause 8.2 in the context of the Agreement as a whole and the other surrounding circumstances than the defender’s construction.  In the whole circumstances, including consideration of the consequences of each construction, the pursuer’s construction also seems to me to be more in accordance with business common sense.  A reasonable businessman, informed as to the facts, would have understood clause 8.2 to mean what the pursuer says it means.

Disposal
[35]      The defender’s averments in the fifth to eighth sentences of Answer 10 are irrelevant and ought not to be admitted to probation. I understood parties to be in agreement that in that event a proof before answer on the parties’ remaining averments would be required, but I will put the case out by order to enable discussion as to the appropriate further procedure and to deal with the expenses of the Debate.