Scottish Court of Session Decisions

EXTRA DIVISION, INNER HOUSE, COURT OF SESSION

[2016] CSIH 56

XA81/15

Lord Menzies

Lord Brodie

Lady Clark of Calton

OPINION OF THE COURT

delivered by LADY CLARK OF CALTON

in the cause

JOHN FRASER TAIT

Pursuer and Respondent;

against

RGM SOLICITORS, a partnership constituted under the laws of Scotland and ROBERT GORDON MARSHALL and SAMUEL HARVEY WADDELL, two of the partners of said firm, as such partners and as individuals

Defenders and Appellants:

Act:  Clark, solicitor advocate, Gilson Gray, LLP, Glasgow

Alt:  R. Dunlop QC;  Clyde & Co

19 July 2016

Summary

[1]        John Fraser Tait, a solicitor, entered into a partnership agreement to carry on the profession of solicitors under the name of RGM Solicitors with effect from 1 July 2007.  He tendered his resignation from said partnership on 12 January 2009 following dispute inter alia about payments due to him in terms of said agreement.  Thereafter, as pursuer, he raised an action in the sheriff court against the partnership RGM Solicitors and two of the partners, Robert Gordon Marshall and Samuel Harvey Waddell as defenders.  The pursuer sought an account and payment of certain sums from the defenders.  The defenders counterclaimed for sums due as a result of the abandonment of a litigation negligently conducted by the pursuer and for payment by the pursuer of the deficit in his capital account. 

[2]        The terms of paragraph 7.1 of the partnership agreement and the construction thereof were crucial to the litigation but the issues in dispute by the parties were not confined to that.

[3]        The sheriff heard evidence in a proof before answer about all the disputed issues.  He decided the issues in favour of the pursuer and assoilzied the pursuer from the craves of the counterclaim as set out in the interlocutor of the sheriff dated 28 November 2014.  By interlocutor dated 17 December 2014, expenses were awarded in favour of the pursuer. 

[4]        The defenders appealed to the Sheriff Principal but on a restricted basis.  The main issue raised in the appeal by the defenders before the Sheriff Principal was the construction of paragraph 7.1 of the partnership agreement.  The Sheriff Principal approved the analysis and approach of the sheriff in his interlocutor of 30 June 2015 and adhered to the interlocutors of the sheriff dated 28 November and 17 December 2014. 

[5]        The defenders appealed to this court.  The appeal focused on the interpretation of clause 7.1 of the partnership agreement and the defenders submitted that both the sheriff and Sheriff Principal had erred in their construction and conclusions about the interpretation and effect of clause 7.1.  The proper construction of clause 7.1 was said to be capable of resolving the only outstanding issues between the parties.

Clause 7 of the partnership agreement

[6]        Clause 7(1) states:

“7.       Profits and losses

7.1       Net profits or net losses (other than profits and losses of a capital nature) shall belong to and be borne by the partners in the following shares:-

Partner shares

Robert Gordon Marshall 50% in respect of all premises except 131 Church Walk, Denny, 40% in respect of the premises at 131 Church Walk, Denny

Samuel Harvey Waddell 50% in respect of all premises except 131 Church Walk, Denny, 40% in respect of the premises at 131 Church Walk, Denny

Thomas Edward Docherty, £38,000 per annum reviewable annually and 20% of the net profit of 131 Church Walk, Denny

John Fraser Tait, £36,000 per annum reviewable annually and 20% of the net profit of the Court Department operated by John Fraser Tait which shall include such works as are deemed by the other partners to be included in the said Court Department….”.

[7]        In clause 1 of the partnership agreement in the definitions and interpretation section, the definition of “net profits” states:

“The profits of the firm (other than profits of a capital nature) in respect of any accounting period before charging taxation but after charging all expenses and outgoings of the firm and the expression ‘net losses’ shall be construed accordingly;”

In clause 5 the definition of “outgoings” states:

“The rent of the premises, the cost of all repairs, alterations, improvements and insurances thereof, the remuneration of all employees of and agents for the firm, all expenses and outgoings incidental to the practice and all losses or damages incurred in carrying on the same shall be paid out of the firm’s money and in case of deficiency by the partners as hereinafter provided”.

Submissions on behalf of the defenders
[8]        Senior counsel invited the court to allow the appeal and to recall the sheriff’s interlocutors dated 28 November and 17 December 2014 to the extent that the interlocutors required to be altered in the event that the grounds of appeal were successful.  He invited the court to put the case out by order to allow parties to address the court about the form of the interlocutor and expenses taking into account the opinion of the court.

[9]        Senior counsel adopted his detailed written submissions.  His main point was both short and simple.  He submitted that clause 7.1 was not ambiguous;  there was only one ordinary and natural meaning to be given to the words agreed by the parties and that meaning favoured the construction relied on by the defenders.  The defenders submitted that the detailed provisions about the shares of the partners set out in the latter part of clause 7.1 were reliant on there being net profits to share.   Where there were no net profits of the firm, as in the present case, the pursuer was not entitled to the specified share detailed in clause 7.1.  Thus the pursuer was not entitled to decree in terms of the first and third pleas in law in the principal action.  Further, as the pursuer had been credited with payments, in a situation where there were no net profits to share, the defenders were entitled to repayment in terms of the second crave of the counterclaim as said payments were only due if there were net profits to share. 

[10]      Counsel invited the court to look in detail at the wording of clause 7 and to recognise that the first three lines which state “net profits or net losses….shall belong to and be borne by the partners in the following shares:” are crucial to the meaning of the clause.  The detailed provision about the partner shares have effect when there are net profits of the firm as defined in the agreement.  In the absence of net profits of the firm there is nothing to share between the partners.  He submitted that this was the beginning and end of the defenders’ position and the matter was as simple as that.  If that is correct the sheriff reached the wrong conclusion about the interpretation of clause 7.1.  The sheriff adopted a mistaken starting point trying to work out how to interpret and apply the various percentages specified under partner shares taking into account the fixed sums which are also specified.  Counsel accepted that the interpretation and application of the part of the clause 7.1 which specifies individual partner shares is not without difficulty but that missed the point.  The issue in this case is not how to distribute the net profits under reference to the provisions about partner shares.  The issue to be determined is whether or not the pursuer is entitled to the sums specified as his share, that is a fixed sum of £36,000 per annum plus 20% of the net profit of the court department.  That share is premised on the provision that there are net profits of the firm to be shared out among the parties.  It is clear from clause 7.1 that this clause is designed to agree and specify shares of net profits or net losses.  Once that is recognised, the pursuer’s interpretation of clause 7(1) which the sheriff accepted is plainly wrong.  On the pursuer’s interpretation, he is entitled to £36,000 per annum and 20% of the net profit of the court department even in a situation where there are no net profits of the firm as defined in the agreement. 

[11]      Turning to the legal framework, counsel submitted that the principles of construction were well established and not in dispute in this case.  Reference was made to Rainy Sky SA v Kookmin Bank [2011] 1 WLR 2900, Global Port Services (Scotland) Limited v Global Energy (Holdings) Limited [2015] CSIH 42 and Arnold v Britton [2015] 2 WLR 1593. 

[12]      If, contrary to the submissions made on behalf of the defenders, the court concluded that the words used by the parties were capable of having more than one potential meaning and that the construction put forward by the pursuer was an alternative meaning, counsel accepted that the construction which should be preferred is that  which is the more commercially sensible.  Reference was made to Rainy Sky SA.  Counsel criticised the sheriff’s reasoning about commercial sense.  The sheriff undervalued the importance and status of becoming a partner in this small solicitors’ partnership.  The pursuer’s income was potentially enhanced, he acquired further powers, status and prospects.

[13]      Counsel also made reference to some authorities about the nature of partnership.  It was not disputed that partnership could take many different forms and that payment might be made in the form of a fixed salary only.  Reference was made to Linley & Banks on Partnership (19^th Edition), paragraphs 5-59 and 10-86.  The parties in the present case could have agreed, for example, that the pursuer be a salaried partner paid without reference to any sharing in profits or liability for losses.  Examples of such arrangements were given under reference to In Re Hill [1934] Ch 623;  Greer L.J. at 630 and Maugham L.J. at 634, and Marsh v Stacey (1963) 107 SJ 512.  The latter case was described as the most similar to the present case albeit it was accepted that in every case the partnership arrangements must depend upon the precise terms of the partnership agreement.  Counsel submitted that it is instructive to note that a problem, similar to the problem in the present case, arose in Marsh as to whether the fixed salary was to be paid regardless of profits or was the fixed salary to be paid only out of profits but given a priority over another partner’s share of profits.  The wording in the Marsh partnership agreement made reference to payment “as a first charge on the profits”.  The dispute was determined by the court on the basis that the salary was to be paid out of the profits with priority given to payment of the fixed salary. 

Submissions on behalf of the pursuer
[14]      The solicitor advocate for the pursuer invited the court to refuse the appeal and adhere to the interlocutors of the sheriff and Sheriff Principal on the basis that the sheriff and Sheriff Principal correctly applied the law.  The primary submission was that clause 7.1 of the agreement was ambiguous and that the clause could be read in the two different ways put forward on behalf of the pursuer and the defenders.  Put shortly, the pursuer contended that the correct construction was that the fixed sum payment of £36,000 and 20% of the court department profits were due to be paid by the defenders regardless of whether there were net profits or net losses of the firm in the relevant period.  The solicitor advocate accepted that in presenting the case to the sheriff and Sheriff Principal, his submission was that clause 7.1 was capable of only one potential meaning and the sheriff accepted that submission in finding for the pursuer. 

The Sheriff Principal in paragraph 34 of his judgment stated:

“…applying the natural and ordinary meaning of the language of clause 7.1 and reading it as a whole, the placing of £36,000 against the pursuer’s name cannot be understood as the allocation of a share in either the profits or losses of the firm…”

The reasoning relied on related to the provisions of the clause which made it clear all of the available shares were allocated before the provision made for the share of the pursuer.

[16]      There was no dispute between the parties about the legal framework within which the court should interpret the partnership agreement.  Reference was made to the development of the law in Rainy Sky SA v Kookmin Bank, Gloag Investments Ltd v Cape Building Products Ltd [2014] CSIH 43 and Arnold v Britton. 

[17]      On behalf of the pursuer it was accepted in the appeal that there were two possible constructions of clause 7(1) of the agreement.  In these circumstances taking into account the legal principles which applied, the court was invited to prefer the construction relied on by the pursuer which is consistent with business common sense and to reject the defenders’ construction.  When the opinion of the sheriff is properly analysed, it is apparent that he considered the natural and ordinary meaning of the words in the agreement;  construed the agreement objectively according to the standards of a reasonable man who is aware of the commercial context;  had regard to all the relevant surrounding circumstances;  and the objective contextual background;  took account of the perspective of both parties;  and having considered the evidence was entitled to prefer the construction put forward by the pursuer which is consistent with business common sense and to reject the defenders’ construction.  This approach was correctly upheld by the Sheriff Principal.  The sheriff, having heard the evidence was in the best position to properly determine the “commercial context” and the “contextual background” against which the agreement required to be construed. 

Decision and reasons
[18]      We did not understand that there was any dispute by the parties about the relevant legal principles of interpretation which should be applied to this agreement.  In particular it was not disputed that:

“…the reliance placed in some cases on commercial common sense and surrounding circumstances (eg in Chartbrook [2009] AC 1101, paras 16-26) should not be invoked to undervalue the importance of the language of the provision which is to be construed.  The exercise of interpreting a provision involves identifying what the parties meant through the eyes of a reasonable reader, and, save perhaps in a very unusual case, that meaning is most obviously to be gleaned from the language of the provision.  Unlike commercial common sense and the surrounding circumstances, the parties have control over the language they use in a contract.  And, again save perhaps in a very unusual case, the parties must have been specifically focussing on the issue covered by the provision when agreeing the wording of that provision”. (Arnold v Britton para.7)

There was also no dispute that a partnership agreement could effectively agree that sums should be paid to a partner, whether designed as salary or not, regardless of the profitability or otherwise of the firm.  The legal entitlement of a partner would depend upon the wording used by the partners in any particular agreement and that wording would require to be construed to consider whether the result was achieved or not.

[19]      The starting point for our consideration is clause 7.1 of the agreement.  In order to understand the opening words “net profits or net losses…shall belong to and be borne by the partners in the following shares:”, it is necessary to refer to the definitions and interpretation section of the agreement in which net profits are defined.  That definition also imports the definition of outgoings which is defined in clause 5.  Before we ask the question what are the respective shares of each partner and in particular the share of the pursuer, the logically prior question which we consider to be important is to identify what is to be shared.  We consider that there is only one answer to that question.  It is the net profits (or net losses) and the net profits are to be identified by reference to the specified definition in the agreement.  It is the net profits of the firm so defined which shall belong to a partner in a specified share in terms of clause 7. 

[20]      If there are net profits then the question would arise as to the meaning to be given to the terms of the partner shares specified in clause 7(1).  We consider that in a situation where the court was required to determine what net profits belong to and are payable to any particular partner in terms of the provisions about partner shares in this agreement, difficulties might arise because of the wording.  Various possibilities were canvassed about how to interpret and give effect to the wording about partner shares and these were problems which appear to be at the forefront of the mind of the sheriff and Sheriff Principal as they grappled with the wording.  But it is the prior question which in our opinion is the important question to decide to resolve the dispute in this case as it has developed.  We consider that the opening words of clause 7.1 could not be clearer.  It is the net profits which shall belong to the partners and thereafter there are specified the following shares.  There may be ambiguity and difficulty in ascertaining what the shares are, but in our opinion there is no ambiguity in determining that whatever is meant, they are shares of the net profits of the firm as defined in the agreement.  In oral submission, the solicitor advocate for the pursuer sought to persuade us that the reference to £36,000 should be considered as an outlay to be deducted before the profits and losses were to be determined.  It was a “salary” to which the pursuer was entitled regardless of profits in terms of his share.  We do not accept that.  Net profits as defined in the agreement include deduction of outgoings which are widely defined.  In any event regardless of how one categorises the £36,000, a partner share in terms of clause 7.1 is a share of net profits and only net profits. 

[21]      We have given careful consideration to the approach adopted by the sheriff.  The sheriff properly recognised in paragraph 10 that the starting point for construction of clause 7.1 is to look at the natural and ordinary meaning.  He does not refer to the wider definition given to net profits in the agreement and does not reflect at all on the first question as to what the partners are to be entitled to share.  The concentration of the sheriff was on the meaning of the latter part of the clause.  His analysis of the natural and ordinary meaning of the words used concentrated exclusively on the difficulties about the meaning of partner shares.  Despite his criticisms in paragraph 14 about clumsy draftsmanship of the partnership agreement, he concluded that the most natural construction of paragraph 7(1), as it relates to the pursuer, was that the pursuer was entitled to receive payment of a fixed sum of £36,000 irrespective of profits (paragraph 15).  The sheriff then considered in the context of the facts what is the most commercial construction and concluded that supported the only natural construction which he found.

[22]      The Sheriff Principal in paragraph 32 made reference to the beginning of clause 7.1 and stated that:  “… interaction with the wording which follows falls far short of creating a clause whose terms can be said to be clear and unambiguous”.  In his opinion attempts to legitimise their construction by the defenders simply gave rise to more questions than answers.  The Sheriff Principal also focused his attention on the difficulties of the wording about the partnership shares but he did not address in detail the question of what it was the parties agreed to share. 

[23]      In our opinion this is a case in which the meaning is clear about the critical issue.  There is no ambiguity and there can only be one potential meaning.  There is no need therefore to explore commercial common sense and the surrounding circumstances.  The meaning is plain from the language of the provision used in the context of the agreement.

[24]      At a late stage, an issue was raised by the pursuer as to whether or not as a matter of fact a net loss was suffered by the firm.   It appears to us that was an assumption on which the litigation was conducted but in any event there did not appear to be any evidence before the sheriff that the firm had in fact made a net profit during the relevant accounting period 2008 to 2009.  On the pursuer’s interpretation of clause 7(1) the factual issue of net profits or net loss of the firm is irrelevant because the pursuer contended that he is entitled to the payment of his specified share regardless of any profits made by the firm.  It was not disputed by the parties that if there were net profits of the firm to share, the pursuer would be entitled to a share thereof.  There might be dispute about how such a share would be calculated if the profits, for example, were insufficient to cover a minimum of the fixed sums specified.  Various solutions to that were discussed in the course of submissions but we do not require to resolve such questions.  We have concluded that the pursuer could only prove an entitlement to payment of his share if there were net profits of the firm.  In order for the pursuer to succeed therefore, the pursuer would bear the onus of proving that there were net profits for the relevant period. 

[25]      We have not dealt separately with the appeal insofar as it relates to that part of the counterclaim in which the defenders sought repayment of the deficit in the capital account of the pursuer.  We are of the opinion that if the pursuer’s construction of clause 7(1), as we have found it to be, is wrong and the pursuer therefore was not entitled to payment of his share in terms of clause 7(1), this would result in the defenders being entitled to repayment of any payments made to the pursuer as “drawings” for the period 1 May 2008 to 30 April 2009.  We note the terms of the defenders’ second plea in law in the counterclaim and there requires to be some clarification of the sum counterclaimed.

[26]      For these reasons we allow the appeal.  We appoint the case to call by order to allow parties to address us about the outstanding issue, the terms of the interlocutor and expenses.