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Cite as: [2008] ScotSC 10

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CA251/05

JUDGMENT

SHERIFF PRINCIPAL

JAMES A TAYLOR

in the cause

John Forster

PURSUER/APPELLANT

against

Messrs Ferguson & Forster & Others

DEFENDER/RESPONDENTS

GLASGOW, February 2008.

The Sheriff Principal, having resumed consideration of the cause, Allows the appeal; Recalls the interlocutors of 17 March 2006, 4 April 2006, 3 May 2006, 29 November 2006 and 4 December 2006; Sustains the pursuer's first plea-in-law to the extent of excluding from probation the defenders' averments in answer two from the third last line on page 4 of the closed record (No 13 of process) "The individual defenders have been given preliminary advice..." to the end of answer two; in answer three on page 7 of the closed record from the words "He was, in any event, in material breach of the partnership agreement..." to "...as a result of the pursuer's fraudulent conduct and the claims arising therefrom." on the seventh last line on page 7; Repels the defenders' third plea in law; on the pursuer/appellant's unopposed motion, Certifies the appeal procedure as suitable for the employment of junior counsel; on joint motion, Reserves meantime the question of expenses.

NOTE:-

[1] The pursuer is the former partner in a firm of solicitors in Stranraer. The defenders are the firm and his former partners. The case was remitted from Stranraer Sheriff Court to Glasgow Sheriff Court in order that the commercial procedures available in this court could be adopted. The pursuer admits that he fraudulently dealt with clients' funds and that he overcharged clients. He acknowledges that he was in breach of the fiduciary duty he owed to his partners. Accordingly there was no dispute that the pursuer was in breach of the partnership agreement. He had little option but to make such admissions as he was convicted and imprisoned for his activities. Mr Hennessy, solicitor for the defenders, informed me that following the uncovering of the pursuer's actings, the pursuer resigned from the partnership, left the firm and made over the whole assets of the firm to the defenders, the remaining partners. I was informed in the course of the appeal that the resignation was in writing but the letter was not in process. The pleadings had not been fully developed as parties had sought a finding on whether the defence of mutuality of contract was relevant. Since the debate before the learned sheriff there had been a change in the pursuer's legal representation with new solicitors and counsel. The foregoing narrative was accepted to be correct save only for the concept of the pursuer being said to have "made over the whole assets of the firm to the defenders". Nothing turned on this reservation. The pursuer in this action sues his former partners for payment of a pension. The defenders resisted the action relying on, inter alia, the principle of mutuality of contract. The learned sheriff found for the defenders. The pursuer appealed.

[2] Clauses 12 and 15 of the partnership agreement are in the following terms:-

"TWELVE If any Partner shall

(a) become apparently insolvent or enter into any composition or arrangement with or for the benefit of his creditors generally;

(b) commit any act of gross professional misconduct;

(d) grossly neglect the Partnership business;

(e) fail to account for and pay over or refund any monies for which he is accountable to the Partnership within seven days of being requested to do so by any Partner'

(f) act in any respect contrary to the provision of this Agreement (not being a trivial nature) or to good faith between the Partners;

then in any of these events, the other Partners may expel the Partner concerned with effect from such date as they shall specify in a written notice given by the other partners or such Partners and the partner so expelled shall be deemed to have retired from the Partnership on such date. Save that in the event of any matter alleged under sub paragraph (f) or (g) hereof the other Partners shall first give the offending Partner notice requiring him to rectify any matter capable or rectification and/or that any such conduct may lead to notice being given under this clause and the other Partner shall only be entitled to give such notice in the event of the offending Partner failing to comply with any such notice to rectify any matter capable of rectification and/or repeating the alleged act or other act of a similar nature.

FIFTEEN Each Partner shall (sic):-

(a) The death or retirement of any Partner shall not necessarily determine the Partnership among the others.

(b) On the death or retirement of any of the Second, Third or Fourth Partners the First Partner shall have the option to acquire that deceased or retiring Partner's interest in the Partnership for a consideration equal to his interest at the date of death or retirement as determined by the accounts drawn to that date. The foresaid option shall be exercise by the First Partner within three months from the date of death or retiral.

(c) On the death or retirement of the First Partner each of the Second, Third and Fourth Partners shall have the option, to be exercised in writing within three months from the date of death or retirement of the First Partner, to acquire his interest in the Partnership in accordance with a set of accounts to be drawn as at the date of death or retirement incorporating.

(i) Any heritable property at the then open market value with vacant possession.

(ii) The goodwill and work in progress at a combined value which will be a sum equal to one third of the annual gross fee income of the firm for the three preceding years.

(iii) The whole other assets of the firm including all furniture, fixtures, equipment, stationery, text books at their net value on a written down value for tax purposes.

(d) In the event of the option contained in paragraph 16 c. (sic) hereof not being exercised as to the entirety of the first partners interest in the Partnership the Partnership shall be wound up. In that event the First Partner or his Executors heirs and Assignees shall have the right to acquire the practice as if the Second, Third and Fourth Partners had retired and the First Partner had exercised his option to acquire their share as hereinbefore provided.

(e) On the death or retirement of the First Partner he or if he shall have died his personal Representative, may elect to receive in lieu of any sum due to him or his estate in respect of the goodwill and work in progress of the Partnership a Pension for the period of 10 years, payable to him or if he had died to his wife or representative equal to one quarter of the First Partners average income calculated on the previous three years gross income.

(f) Any valuation for the purposes of this paragraph shall be agreed between a Valuer appointed by the Partners and in default of agreement shall be fixed by a Valuer nominated by the President for the time being from the Law Society of Scotland. The cost of any such Valuation shall be an expense of the Partnership."

[3] Mr Bartos, Advocate, for the pursuer/appellant, submitted that there were four legal propositions which underpinned the pursuer's position:

1) Retention of performance of an obligation due under a contract was only available as a temporary defence in order to compel the performance by the pursuer of an obligation due but not being performed by the pursuer which is reciprocal to the one which the defenders are refraining from performing.

2) The obligations of parties to a contract are presumed to be reciprocal unless parties show the intention to the contrary in a contract.

3) The defence of retention is available only if the pursuer is continuing to fail to perform the reciprocal obligation. It is not available in order to compel performance of an obligation which has been breached on a one-off occasion and which breach can no longer be purged.

4) Where a person is entitled to exercise a defence of retention of performance he loses that entitlement where he subsequently seeks to rely on the contract.

[4] Support for the first and third propositions was said to be found in Erskine, Book III, Title iii at paragraph 86. I was effectively taken through Lord President Rodger's opinion in Macari v Celtic Football & Athletic Club 1999 SC 628. Counsel took what was said at page 640H as support for the proposition that before a party can withhold performance the breach said to entitle such a withholding of performance must be capable of being purged. Lord Caplan's opinion at 650D was used to support the foregoing and to add a further gloss to the effect that no retention arises in respect of a past breach of contract. In other words, since the breach by the pursuer was completed and in the past the defenders could not withhold performance of their obligation to pay the pension. It was suggested that Lord Marnoch at page 654H had taken a slightly different approach particularly where at 655D he suggests that the obligation to maintain trust and confidence was so basic and all pervading that such a breach struck at the very root of the contractual relationship. All this was said to be properly explained in the South African case of B K Tooling v Scope Precision Engineering 1979 (1) SA 391(a). I was taken through the report for the purpose of explaining the derivation of the defence of retention. It was submitted that the passage at 415 to 416 supported the view that retention was a form of quasi security to ensure that the other party carried out the obligation presently not being carried out. The passages at pages 417 and 418 were said to support the proposition that one could plead non-implement by the seller not as a bar to the action but as a bar to judgement. Continuing in this theme I was referred to ESE Financial Services v Cramer 1973 (2) SA 808(c). I was briefly referred to Bank of East Asia 1997 SLT 1213 at 1218 and in particular the speech of Lord Jauncey where he said "It follows that retention may be operated against corresponding obligations prestable but unfulfilled, but has no relevance to obligations duly performed."

[5] In support of the second proposition which I set out earlier I was referred to Lord Rodger at 640G to 641D; Lord Caplan at 650D and Lord Marnoch at 655C. It was suggested that Turnbull v McLean (1874) 1R 730 was "sometimes misunderstood".

[6] For the fourth proposition I was again referred to Macari and in particular to Lord President Rodger in Macari at 641E-H and 642B, Lord Caplan at 650E and Lord Marnoch at 655E. I was also referred to Hoult v Turpie 2004 SLT 308 at 313L. It was submitted that it would be an odd result if any act contrary to good faith resulting in no loss to the partnership could result in the partner not being able to obtain either his share of the capital of the firm or his pension entitlement.

[7] Mr Hennessy for the defenders submitted that a partnership is a relationship in which the parties owe fiduciary duties to each other. These duties exist even before the partnership is commenced, continue during its subsistence and even after its termination. The pursuer had breached that duty. It was a material breach which went to the root of the contract and subsisted throughout the contract. Where a partner is in breach of the contract in such a manner the remaining partners are entitled to withhold performance of any terms of the partnership contract. The principle of mutuality applies in the circumstances of this case to prevent the pursuer having any claim based upon its terms. The pursuer was engaged in fraudulent activities throughout the period of the partnership which he concealed from his partners and others. These were for his own personal gain. They included conduct which increased the profits of the firm for his own benefit. The present claim is for payment of a pension which is based upon these fraudulent profits. He referred me to Bank of East Asia, Macari and Hoult v Turpie.

[8] I have come to the view that this appeal must be allowed. The decisions in Bank of East Asia and Macari are binding upon me. In Bank of East Asia Lord Jauncey, after carefully reviewing the authorities stated:-

"My Lords, I do not consider that the authority wasn't so broad a proposition as that any material breach by one party to a contract necessarily disentitles him from enforcing any and every obligation due to the other party. In applying the general principles enunciated by Lord Justice-Clerk Moncrieff in Turnbull v McLean regard must be had to the terms of the contract in question."

After considering the speech of Lord Jauncey, Lord President Rodger in Macari said:-

"This authoritative gloss by Lord Jauncey confirms that the law does not regard each and every obligation by one party as being necessarily and invariably the counterpart of every obligation by others. One has to have regard to the circumstances. Lord Jauncey deduces from this that a material breach by one party of a particular term of a contract does not of itself mean that he cannot require the other to perform any of his obligations under his contract. Rather, the party in breach cannot insist on the other party performing his obligations in relation to the part of the contract of which the first party is in breach."

Lord Caplan put it thus:-

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

I am not convinced that Lord Marnoch was saying anything different from that said by Lord President Rodger and Lord Caplan when at page 655 he said that in the normal situation "all the parties' obligations and counter obligations are, as it were, exigible contemporaneously...This is, of course, only a presumption and,...it can be overcome by parties making clear their intention that certain obligations and counter obligations can be looked at independently."

In Hoult v Turpie Lord Drummond-Young acknowledges the principle set out by Lord Jauncey in his speech when he says at paragraph 8 on page 312:-

"The submissions made by counsel on either side raise an important issue relating to the principle of mutuality of contractual obligations: the nature and significance of the requirement that, for the principle to operate, the obligations in question must be the counterparts of each other. The existence of such a requirement is clear; indeed, it is inherent in the very notion of mutuality. The dispute between the parties centres rather on the extent to which the individual obligations on one side of a contract are to be regarded as the counterparts of the individual obligations on the other."

In paragraph 9, Lord Drummond-Young goes on to say:-

"I am of opinion that the principle of mutuality should not be interpreted in a way that substantially curtails the availability of the defence of retention. That applies in particular to the requirement that the obligations should be counterparts of each other; that requirement should not be used in an artificial manner which breaks up the essential unity of a contract.

[9] There can now be little doubt that under Scots law before one party to a contract can withhold performance of an obligation incumbent upon that party on the grounds that the other party has failed to perform an obligation incumbent upon it under the contract, the two obligations must be the counterpart of each other. The question then becomes one of interpretation of the contract. As Lord Rodger puts it in Macari at page 640I:-

"Lord Jauncey does not spell out the circumstances in which one obligation will fall to be regarded as the counterpart of another. Sometimes of course the express terms of the contract will regulate the matter. In other cases it depends on the intention of the parties as gleaned from the terms of the contract."

[10] In a simple case of a property owner instructing a tradesman to carry out a single piece of work the position is very clear: until such time as the tradesman has performed his obligations and completed the work the property owner is under no obligation to make payment of the contract price agreed to by the parties for the work to be done. We are here dealing with a contract of partnership which is more complex. In essence the question to which the parties wished an answer is:- "Is the contractual obligation undertaken by the defenders to pay to the pursuer a pension the counterpart of the obligation of the pursuer not to defraud clients and not to breach the fiduciary duty owed to his partners?" The contract might be thought to be weighted in favour of the pursuer. However it is not for the court to re-write the obligations which the parties respectively undertook. Clause 15 deals with retirement. Clause 15(c) provides that on the pursuer's retirement the remaining partners can opt to acquire the pursuer's interest in the partnership. That interest is said to include inter alia the goodwill and work in progress of the firm. Clause 15(e) gives to the pursuer upon retirement the right to elect to receive, instead of a lump sum representing goodwill and work in progress, a pension calculated by reference to a formula. Clause 12 provides that if any partner performs a variety of acts, including acting in such a way as to bring his name or the name of the partnership into disrepute or acting in any respect contrary to good faith between the partners, then that partner may be expelled. The clause goes on to say that "The partner so expelled shall be deemed to have retired from the partnership on such date." Thus if a partner brings the firm's name into disrepute and is expelled that is deemed by the agreement to be the equivalent of a retiral from the firm. As has been seen a retiral entitles the retiring partner, at his option, to payment of a pension instead of a lump sum representing goodwill and work in progress. I accept that in this case the defenders did not expel the pursuer which they would have been entitled to do. The pursuer beat them to it and resigned albeit not in accordance with Clause 13. Clause 13 required that the retiring partner should give not less than six months notice in writing. The pursuer retired with immediate effect. A consideration of the foregoing gives an insight into what was in the minds of the parties at the time they entered into the contract. Notwithstanding expulsion, perhaps for breaching the duty of good faith to his partners, a partner was entitled to receive the balance on his capital account. Conforming to the criteria set out in Clause 12 was not considered by the signatories to the contract to be a counterpart of being entitled to payment of one's capital. I agree with Mr Bartos that this is a very powerful indicator that in relation to this particular contract the actings of the pursuer, reprehensible though they were, do not entitle the defenders, per se, to withhold payment to the pursuer of what would otherwise be due to him from his capital account. The parties would appear not to have intended that acting in good faith was a counterpart obligation to being paid one's capital upon being expelled from the firm. In coming to this position I am mindful of the obiter remarks of Lord Drummond-Young in Hoult, regarding the "essential unity of a contract." There is a limit to how far one can take this concept and at the same time follow the binding decisions of Bank of East Asia and Macari. When one is dealing with a contract extending to eight pages, as the partnership agreement does, it seems to me almost inevitable that some obligations will not be the counterpart of others. For example Clause 11(j) provides that no parties may incur any capital expenditure in respect of the partnership in excess of £1,000. If a partner breached that clause by incurring capital expenditure in excess of this sum he will be in breach of the partnership agreement. I doubt if anybody would seriously suggest that such a breach would entitle the other partners to withhold payment of that partner's share of the profits as provided for in Clause 3, should the firm have received value for the expenditure. If the actings of the pursuer have not in any way damaged the financial position of the firm there does not seem any good reason why the remaining partners should receive a windfall represented by the pursuer's capital. The fact that the contract provides that the capital can be received in instalments as a pension is irrelevant. In the context of a contract of employment the duty of good faith owed by the employer to the employee has been said on many occasions to go to the heart of the employer/employee relationship. In the context of a partnership agreement I am of the view that a breach by one partner of the fiduciary duty owed to the other partners also goes to the heart of the contract. Such a breach might entitle the other partners to expel the partner in breach. Indeed that is what the partnership agreement provided in this case. However it does not follow that the expelled partner is not entitled to receive the balance at credit of his capital account.

[10] The court is being asked at this stage to answer a narrow question. It may be that the pleadings will be developed and that the defenders will plead a case that the actings of the pursuer did have an adverse financial impact upon the firm. Should that be the case I did not understand it to be disputed that the defenders would be entitled to compensate any financial loss sustained by the firm as a consequence of the pursuer's actings against any sums due to the pursuer. I do not consider there to be force in Mr Hennessy's submission that the pursuer was not entitled to payment of his capital because his capital account was inflated by virtue of his actings. By overcharging clients there can be little doubt that the profits of the firm will have been inflated. That will probably have fed through to the pursuer's capital account. The defenders, as partners in the firm, will probably also have benefited from the pursuer's actings even if "salaried partner" is a means of describing their status. I can see that there might be some force in this argument if those clients who had been overcharged now sought repetition of the sums paid in excess of what they should have been charged. There is no suggestion that this happened. I do not think the defenders nor the court, can look behind the figures in the firm's accounts.

[11] I should record that there was no submission made that by having "made over" his entitlement to the assets of the firm to the defenders, the pursuer had donated the sum at credit of his capital account to the defenders. In any event I could not have dealt with such a discussion as Mr Bartos reserved his position on whether the pursuer had "made over" his entitlement to the assets of the firm to the defenders.

[12] I had the benefit of being very well addressed by the representatives of both parties. In that respect I had a considerable advantage over the position in which the learned sheriff found himself.