Scottish High Court of Justiciary Decisons

A.E.T.C. LTD v. IAN STEEL AND OTHERS [2001] ScotHC 85 (10th August, 2001)

[1] By Share Sale and Purchase Agreement dated 27 February 1998 ("the Agreement") the pursuers purchased from the defenders and Clydesdale Bank Equity Limited the entire issued share capital of Baronshire Engineering Limited ("the company"). The first defender was managing director of the company, and the second and third defenders were also directors.

[2] In the Agreement the defenders granted certain warranties in favour of the pursuers. In this action the pursuers aver breach of warranty on the part of the defenders and claim damages in respect of loss which they allege that they have suffered as a result.

[3] The defenders plead that the pursuers' averments are irrelevant and lacking in specification. Their complaints of lack of specification were not resolved in the course of adjustment of the pleadings, and the case was ultimately appointed to debate. The points to be argued were formulated in a Note of Argument for the defenders.

[4] Clause 5.1 of the Agreement provided:

The "Completion Date" was 27 February 1998. It is averred by the pursuers that the truth and accuracy of the particular warranties on which they found were not qualified in the Disclosure Letter.

[5] The first of the two warranties founded on by the pursuers was set out in Clause 5.11 of Part 3 of the Schedule to the Agreement. It was in the following terms:

[6] The second warranty founded on was set out in Clause 9.2 of Part 3 of the Schedule. It was in the following terms:

In connection with that warranty it is necessary to bear in mind the terms of Clause 1.6 of the Agreement which provided:

[7] In article 3 of the condescendence the pursuers aver:

[8] Mr Marney for the defenders identified that the pursuers' case under Clause 9.2 was in two parts. It was said first that the defenders had actual knowledge at the completion date that there was an excessive level of stock. Secondly, it was said that any director exercising due diligence at about that time would have become aware of the excess level of stock. It was the first part of the case that was, in Mr Marney's submission, lacking in specification. Mr Marney made three points. First, he said, there was no sufficient specification of when the event in question - the raising of concerns by the auditors - took place. The defenders were left with no notice of when in the year mentioned the point was raised. Secondly, he said, there was no specification of who were the persons involved, on the part of the auditors or among the defenders. There was no specification of how the point was communicated - at a meeting, on the telephone or by letter or memorandum. No mention was made in the pleadings of any document. Thirdly, Mr Marney submitted that there was no specification of the terms in which the auditors expressed their concern. Not every expression of concern about slow moving stock or the realisability of stock was apt to bring home to the defenders knowledge that there was over £30,000 of excess stock, and thus that the warranty was untrue. On the basis of those submissions, Mr Marney invited me to exclude from probation the part of the averments quoted in paragraph [7] above that I have highlighted in bold.

[9] Mr Webster for the pursuers submitted that the averments of actual knowledge on the part of the defenders of the fact that the company held an excessive level of stock were sufficiently specific. So far as timing was concerned, granted that the defenders were at the material time the directors of the company, adequate notice was given by the averment that the auditors raised their concerns with them "[in] 1997 ... while preparing the annual accounts for the financial year ending 1996". The averment that the concerns were raised "with the directors" called for no further elaboration. Nor, in the context, was there any need for identification of the person from the auditors who had raised the point. Mr Webster explained that he was not at present in a position to give further specification of the averments on this matter. The pursuers' present accountants, PriceWaterhouseCoopers, had had access to BDO Stoy Hayward's working papers in the past, and the basis for the assertion had been noted in those papers, but the papers were now back in the hands of the former auditors. If further specification required to be given, the pursuers would require to recover the working papers by commission and diligence. Mr Webster tendered a specification of documents in terms of which he ultimately moved at the bar for commission and diligence.

[10] Turning to the other aspect of Mr Marney's submissions, Mr Webster submitted that on a fair reading of the pursuers' pleadings it was a reasonable inference that the concern raised by the auditors was of such a nature as to alert the defenders to the excess level of stock. The averment was, in any event, also relevant as providing the context for the later averments about failure to exercise due diligence. Even if the point raised by the auditors was not enough by itself to bring home to the defenders knowledge that the warranty was untrue, it was a relevant consideration to be taken into account in judging what steps should have been taken by the defenders in the exercise of due diligence.

[11] Of the three points taken by Mr Marney, there is in my opinion no real substance in the first two. Given that the defenders were at the material time the directors of the company, I am of opinion that the time at which the point was raised by the auditors is adequately identified by reference to the period of preparation of the annual accounts in the year specified. The averment that the point was raised with "the defenders" in my view calls for no further specification. There is, likewise, no need, in my view, as a matter of fair notice to the defenders, to name the representative of the auditors who raised the point. Nor do I regard the absence of specification of the form in which the point was communicated, taken by itself, as critical. I would, however, be inclined to take the question of the form in which the concern was expressed along with the point about the terms in which it was expressed (see paragraph [12] below).

[12] In my view there is force in Mr Marney's third criticism of the averments of actual knowledge of breach of the Clause 9.2 warranty. The warranty is very specifically that (save for stock with a book value of £30,000) the defenders did not consider that the company's stock of raw materials and finished goods would exceed its requirements over the next two years. The averment of breach of warranty is that the company's stock in fact did exceed its requirement over the next two years by £255,000. To support the case of actual knowledge, the pursuers, in my opinion, require to make averments of circumstances which support the inference that the defenders were aware that there was such excess stock. The assertion that the auditors raised "concerns regarding slow moving stock and the likely realisability of the stock held by the company" may or may not support the relevant inference. Whether they meant to say, or did convey, that there was more stock than was required for the next two years, by a margin or more than £30,000, is not evident from the averments. In my opinion as a matter of fair notice of the case against them the defenders are entitled to better specification of the terms in which the auditors' concerns were expressed. That is, in my view, particularly so if, as appeared to emerge from Mr Webster's submissions, there is documentary material in existence that encapsulates the point raised by the auditors.

[13] In the circumstances, because of the inadequacy of the specification of precisely how the auditors' concerns were expressed, I would not be minded to admit the averments highlighted in bold in paragraph [7] above to probation as they stand. On the other hand, when it appears that means are available to make the averment more specific by recovering the auditors' working papers, I would be reluctant to deny the pursuers the opportunity of following that course. It is, of course, regrettable that they have not taken formal steps to recover the documents before now. I am not, however, prepared to grant the motion for commission and diligence that Mr Webster made at the bar in the course of the debate. Mr Marney had not had a proper opportunity of considering the terms of the specification of documents, but he did submit that the substantive call was too widely expressed. It sought excerpts from the auditors' papers "showing or tending to show (a) the extent of stock, including raw materials and finished goods, held by [the] company at any time; and (b) representations made by [the auditors] to the company regarding the same". In my view Mr Marney's objection to the width of the call was well founded. My provisional view is that it requires to be restricted to the relevant time, and ought to be more closely tied to the averment about the auditors' concerns by seeking documents showing or tending to show the terms in which those concerns were expressed to the defenders. In the circumstances the course which I propose to take, in regard to this aspect of the case, is to put it out By Order to give the pursuers the opportunity (i) to renew the motion for commission and diligence by reference to a more precisely drafted specification of documents, and (ii) to consider whether they are able and wish to make a motion for leave to amend to improve the specification of the averments which I would not admit to probation in their present form.

[14] In article 3 of the condescendence the pursuers further aver:

[15] Mr Marney began his submission in relation to this aspect of the case by identifying that the case made by the pursuers was that the Clause 5.11 warrant was broken in respect that the B16 valve, in the respect specified, did not comply with the representations made about it in the company's sales literature, and that the defenders had actual knowledge of that fact. The pursuers' averments of knowledge were lacking in specification. Mr Marney made three points. The first concerned the averments about United Distillers. The second concerned the averments about the issue of credit notes. The third concerned the averments of four instances of "subsequent" bearing failure.

[16] Mr Marney's first submission was that there was nothing in the averments about the repeated failures of valves complained of by United Distillers to suggest that those failures were the consequence of inability on the part of the valves to operate at the temperatures and pressures mentioned in the company's literature. Those complaints therefore were not apt to bring home to the defenders knowledge that the representation about the temperatures and pressures at which the B16 valve could operate was untrue. Further, the averment about the United Distillers complaint could not be regarded as a specific instance of the allegation, made in the preceding sentence, that the company had had to replace valves and bearings - United Distillers were said to have declined to place further orders, not to have had valves replaced. The preceding averment about replacement was therefore lacking in specification.

[17] Secondly, Mr Marney submitted that that there was nothing in the averments about sales and credit notes to suggest that the credit notes had been issued in respect of B16 valves which were defective in the respect founded on. An inspecific averment about the issue of credit notes could not bring home to the defenders knowledge that the B16 valves were disconform to the representations the company had made about them in the particular respect founded upon.

[18] Thirdly, the averments in the passage following the word "Subsequently" were lacking in specification in two respects. First, it was not clear to what date the word "subsequently" referred. To be relevant the averments about failed valves would require to relate to failures occurring before the completion date, but as a matter of syntax "Subsequently", appearing where it did, meant "after 31 March 1998", i.e. some time after the completion date. Failures which came to light after the completion date could not contribute to the defenders' knowledge at the completion date that the B16 valves did not perform as they were represented to do. Secondly, it was not clear on the face of the averments that the failures referred to were failures attributable to the inability of the valves to operate at the temperatures and pressures mentioned in the literature.

[19] If, as Mr Marney submitted should happen, those three passages of averment were excluded from probation, the result was that there were no relevant averments of breach of the warranty contained in Clause 5.11. The whole passage of averment quoted in paragraph [14] above should therefore be excluded from probation.

[20] Mr Webster submitted that the averments of knowledge founded on in connection with the Clause 5.11 case were to be construed in the context of the clear averments of the way in which the B16 valves did not correspond to the claims made about them in the company's literature. The former averments, he stressed, were averments from which the pursuers sought to have the inference drawn that the defenders had actual knowledge that the B16 valve did not perform as the company had claimed it did. He accepted that the averments about United Distillers did not specify that the failures of which that company complained were the result of the inability of the B16 to operate at the temperature claimed in the company's literature. He indicated that he was not in a position to make a more specific averment to that effect. Nevertheless he submitted that the averment of the failures complained of by United Distillers should be construed in light of the earlier averments as an instance of that type of failure. Mr Webster also accepted that the averments about the credit notes were not specifically averments of failure of the sort founded on. He also accepted that, on one view, the averments about the four "subsequent" failures related to the period after the completion date. His submission was, however, that if there were a large number of credit notes issued before the completion date, and if there were evidence of failures of the relevant sort after the completion date, the latter line of evidence might justify regarding the evidence of credit notes as probably relating to the relevant sort of failure.

[21] In my opinion, the averments about the complaint from United Distillers cannot be construed as supporting the inference that the defenders knew at the completion date that the B16 valve could not perform as the company's literature had claimed. Repeated failures of B16 valves are not necessarily repeated failures of the particular sort founded upon. If, as Mr Webster confirmed, he is not in a position positively to aver that those failures were of the relevant sort, I do not see how he can claim that the inspecific averment ought to be construed as if it were in that respect specific. Likewise, I do not consider that the averment that credit notes were issued can, so long as it wholly fails to identify the reason for the issue of the credit notes, be treated as if it were a specific averment that the reason was the relevant one. As a matter of syntax, the word "Subsequently" introducing the averments about the four specific cases of failure means "after 27 March 1998". The averments therefore relate to a period after the completion date. They therefore cannot have a direct bearing on the defenders' knowledge at the completion date. I accept the theoretical possibility that averments of the prevalence of post-completion failures of a particular sort might cast light on the likely nature of unattributed pre-completion failures, but I do not consider that that approach to the averments about credit notes and post-completion failures of an unspecified sort gives the defenders the fair notice of the case against them to which they are entitled. It is, in my view, for the pursuers to make specific averments of circumstances which support the inference that the defenders knew at the completion date that the B16 valve did not perform as the company's literature claimed in the particular respect founded upon. None of the three considerations set out in the pursuers' pleadings, and attacked as inspecific by Mr Marney, in my opinion provides such support. If the passages which Mr Marney attacked are excluded from probation, all that is left is the averment that the first defender was aware that the company had had to replace B16 valves and acetal bearings. That averment is itself, in my opinion, lacking in fair specification. In the result, therefore, I do not consider that the averments in support of the Clause 5.11 case are sufficiently specific to be admitted to probation. I am therefore minded to exclude them from probation, unless Mr Webster is able to persuade me, when the case is put out By Order, that time for amendment should be allowed.

[22] In the pursuers' averments of loss in article 4 of the condescendence the following passage appears:

[23] Mr Marney submitted that the averments about sales to the US market after completion were irrelevant. The clause 5.11 warranty was that as at the completion date "the company has not knowingly sold or supplied products which ... do not comply in any material respect with any ... representations ... made by it". It was concerned to protect the pursuers from claims arising out of pre-completion sales or supplies. Loss arising from post-completion sales could not be loss resulting from breach of that warranty. Further, there was no fair notice of the identity of the customers who returned failed valves, or of the nature of the failures that led to such returns. In these circumstances Mr Marney sought to have excluded from probation the averments quoted in paragraph [22] above.

[24] Mr Webster submitted that, even if what Mr Marney said was sound, it did not justify excluding from probation the whole of the passage in question. Only the first two sentences and the third last sentence related to the US market. Moreover, it was not clear that the third last sentence related to the network of distributors set up in 1999.

[25] In my opinion Mr Marney was correct in his submission that losses arising from post-completion sales or supplies are not losses recoverable in a claim for breach of the clause 5.11 warranty. I do no consider that the later reference to the US market can be divorced, as Mr Webster suggested it should, from the averment about the network of distributors set up in 1999. On the other hand, I accept Mr Webster's submission that Mr Marney's motion to exclude the whole passage quoted in paragraph [22] above from probation was too sweeping. I would be minded to exclude from probation the passages which I have highlighted in bold in paragraph [22].

[26] As I have set out in paragraphs [13], [21] and [25] above, I would be minded to exclude from probation (a) the averments highlighted in bold in paragraph [7], (b) the whole of the averments quoted in paragraph [14], and (c) the averments highlighted in bold in paragraph [22], at least if they remain in their present form. For the reasons given in paragraph [13], however, I shall first put the case out By Order to enable the pursuers to consider their position and move such motions for commission and diligence and for leave to amend as they think fit. I shall reserve the question of the expenses of the debate.