1. This
appeal raises a point of principle about the extent of the liability of a
vendor of shares who gives a limited warranty as to the preparation of a profit
forecast upon which the purchaser relies.
2. The
vendor was a subsidiary of a listed New Zealand company called Lion Nathan
Limited, which guaranteed the vendor's obligations. In the contract, Lion
Nathan Limited is called "the Guarantor" but for present purposes it will be
convenient to call it "the vendor". By a contract dated 13th May 1989 the
vendor agreed to sell the entire issued share capital of Oasis Industries
Limited ("Oasis") to a substantial Australian company called C.C. Bottlers
Limited ("the purchaser"). The price was NZ$250 million, subject to
adjustment. Oasis carried on business bottling
3. The
contract was negotiated with some haste and secrecy because neither party
wanted other players in the soft drinks market to know that Oasis was being
sold. This meant that the purchaser could not be given access to the company's
books and had to rely upon the information provided by the vendor. The price
was calculated by applying a multiple of 20 to the vendor's forecast of the
expected profits after tax in the company's 1988-89 year of account, which ran
from 1st September 1988 to 2nd September 1989. The vendor was willing to
warrant the accuracy of its forecast up to the date of completion, which was
fixed for 3rd July 1989. The contract provided for an adjustment of the price
to reflect any shortfall in the forecast profit up to that date. But because
thereafter the company was expected to be under the control of the purchaser,
the vendor was willing to offer only a more limited warranty in respect of the
earnings during the remaining two months or so of the financial year. It
supplied a Projected Revenue Statement ("PRS") which forecast that the
company's earnings before interest and tax ("EBIT") during that period would be
$2.223m. There was no provision for adjustment of the price by reference to
this forecast but Schedule 4, paragraph 32 of the contract contained a warranty
in the following terms:-
4. In
the event, there was a substantial shortfall in earnings over the whole of the
financial year. This led, in accordance with the contract, to an adjustment of
the price by reference to the shortfall in respect of the first ten months. As
to these figures, there is no dispute. The action arises out of the forecast
of $2.223m for the last two months. The actual earnings during that period are
agreed to have been $1.233m.
5. Blanchard
J. held that there had been a breach of warranty. He found that the forecast
had not been calculated on a proper basis and that on then current trends and
performance the forecast results were not reasonably achievable. The Court of
Appeal upheld the judge's finding on liability and there is no appeal against
that decision. The issue is over the measure of damages.
6. The
judge construed paragraph 32 to mean, putting the matter very shortly, that the
vendor warranted that reasonable care had been taken in the preparation of the
forecast. He said that the requirement that the forecast should be "on a
proper basis" meant that it had to be one which -
8. The
Court of Appeal agreed with the judge's view that the first part of the
warranty was concerned solely with the way in which the forecast had been made.
But they said that the second part, warranting that the forecast results were
achievable, was the equivalent of the warranty as to quality. It was a
warranty that Oasis was a company reasonably capable of achieving earnings of
$2.223 in the period in question.
9. This
difference over construction has an important effect on the way in which
damages are calculated. In the case of a warranty as to the quality of the
goods, the purchaser is
prima
facie
entitled to the difference between what the goods as warranted would have been
worth and what they were actually worth. If the vendor had warranted that the
earnings in the last two months would be $2.223m, there would have been an
analogy with a warranty of quality and the damages would
prima
facie
have been the difference between what the shares would have been worth if the
earnings had been in accordance with the warranty and what they were actually
worth. The Court of Appeal was saying that although the vendor had not
warranted that the earnings would be $2.223m, he had effectively warranted that
the company could be valued on the assumption that they would be in the region
of $2.223m. As the region would be a range above and below the figure of
$2.223m, the reasonable buyer would value such a company, as the actual
purchaser had
10. On
the other hand, if one construes paragraph 32 as a warranty that reasonable
care has been taken in the preparation of the forecast, there is no analogy
with a warranty of quality. The forecast, though prepared with reasonable
care, may on account of unknown or unforeseeable factors turn out to be
substantially inaccurate. It therefore does not warrant that the company has
any particular quality. The
prima
facie
rule for breach of a warranty of quality of goods cannot be applied. One must
therefore return to the general principle of which that rule is only one
example, namely that damages for breach of contract are intended to put the
plaintiff in the position in which he would have been if the defendant had
complied with the terms of the contract. In this case the vendor represented
to the purchaser that $2.223m was a figure upon which he could rely in
calculating the price. The figure was in fact used in the calculation of the
price. If the vendor had made a forecast in accordance with the terms of the
warranty, he would have produced a lower figure and the price would have been
correspondingly lower. The damages are therefore the difference between the
price agreed on the assumption of NZ$2.223m earnings and what the price would
have been, using the same method of calculation, if the forecast had been
properly made.
11. This
was the principle applied by Blanchard J. and accepted by the Court of Appeal
as correct in respect of the first part of the warranty. But their Lordships
think, with respect to the Court of Appeal, that the judge was also right in
construing the second half as having the same meaning as the first, namely that
reasonable care had been taken in the preparation of the forecast. The
construction given to the second half by the Court of Appeal amounts in
substance to a warranty that for the purposes of calculating the value of the
company, it could be assumed that the forecast would be correct. Their
Lordships think that this is exactly the form of warranty which the vendor did
not wish to give. They therefore agree with the judge that the crucial
question in this case is the ascertainment of what a properly prepared forecast
would have been.
12. The
judge decided that a properly prepared forecast would have been $1.6m. He
assessed the damages by making a deduction for tax and calculating what the
price would have been if the agreed multiple of 20 had been applied to the
resulting figure. The Court of Appeal held that the figure of $1.6m was too
high and that a
13. The
judge heard a great deal of expert and other evidence in the course of a trial
which lasted 25 days. Their Lordships therefore accept that his finding should
not be disturbed unless it can be shown to be founded upon some error of
principle.
14. In
order to see the principle upon which the judge chose the figure of $1.6m, it
is necessary to summarise and quote from his careful and detailed judgment. In
dealing with the question of liability, he found that the forecast was not, as
one would have expected, based upon induction from the information available at
the time it was made. Instead, it started from the desired result, namely to
produce a forecast which, together with the results and projections for the
rest of the year, would justify a price of $250 million. The forecasts of
expected sales volumes, discounts and expenses were made to yield that result.
In some cases this was done without attempting to obtain information which was
available and would have shown that the assumptions necessary to support the
forecast were unsustainable. In other cases, it was done in the teeth of such
information. Their Lordships quote, with some annotation, the judge's summary
of his conclusions:-
15. So
much for the findings as to why the forecast failed to comply with the
warranty. They plainly show a radical departure from acceptable methods of
forecasting. The judge's reasoning on the assessment of damages is contained
in the following passage:-
16. What
did the judge mean by saying "highest tolerable forecast" and "the relevant
side of the ballpark"? Their Lordships think that the concept of the ballpark
refers back to the passage quoted earlier in which the judge construed the word
"achievable" in paragraph 32 as meaning that the actual figure would be "in the
same ballpark", followed by the reference to the Adelaide Oval, which their
Lordships understand to be a relatively small cricket ground. The concept
which the judge seems to have had in mind is the range of deviation from the
mean which is a necessary element in any forecast. A forecaster who predicts
that profits in a given period will be, say, $2.223 million, is not doing
anything so silly as to say that in his opinion the profits will be precisely
that figure. He is saying that $2.223 million is in his opinion the most
probable outcome, but that figures slightly higher or lower are almost equally
probable and that on either side of them there is a range of possible figures
which become increasingly less probable as they deviate from the mean. The
forecaster, if asked, should be able to supplement the bald figure with a
statement of the limits of deviation to which confidence can be attached. In
some cases, the information which he has may enable him to say that the
probability of deviation outside fairly narrow limits is very small. In other
cases, the possibility of the outcome being affected by unknown or
unforeseeable factors may be much greater and the limits of foreseeable
deviation therefore much wider. The same is true of a valuation of property,
which is no more than an estimate of what a property would fetch on a given
date, based upon induction from information about what similar property has
fetched.
17. Their
Lordships therefore understand the judge to mean that if the vendor had taken
reasonable care in the preparation of his
18. Their
Lordships can for the moment postpone consideration of this question because in
their opinion the judge's use in this context of the concept of reasonable
foreseeable deviation was in itself erroneous. As has been said, a forecast is
always the forecaster's estimate of the most probable outcome, the mean figure
within the range of foreseeable deviation. The judge appears to have assumed
that if a figure would have been within the range of foreseeable deviation from
the mean of a properly prepared forecast, it must follow that it would have
been proper to put that figure forward as the mean. This proposition has only
to be stated to be seen to be fallacious. There is no connection between the
range of foreseeable deviation in a given forecast and the question of whether
the forecast was properly prepared. Whether a forecast was negligent or not
depends upon whether reasonable care was taken in preparing it. It is
impossible to say in the abstract that a forecast of a given figure "would not
have been negligent". It might have been or it might not have been, depending
upon how it was done.
19. Assume,
for example, that the vendor had forecast $1.25 million and that the limits of
foreseeable deviation would have been regarded as $50,000 either way. Assume
that the forecast was unexceptionable in every respect but one: there had been
a careless double counting of sales which, if noticed, would have reduced the
estimate by $25,000. To that extent, the estimate has not been made with
reasonable care. If on account of some compensating deviation the outcome is
$1.25m or more, the purchaser will have suffered no loss and the vendor will
incur no liability. But if the outcome is less than $1.25m, their Lordships
think that the purchaser is entitled to say that if the estimate had been made
with reasonable care, the figure put forward by the vendor as the mean and upon
which he relied in fixing the price, would have been $25,000 lower. To this
extent, he has suffered loss by reason of the breach of warranty. It is
nothing to the point that the
20. Their
Lordships think that the judge confused the concept of potential deviation
between the forecast mean and the eventual outcome with a related but different
concept, namely the variation which may exist in forecasts of the mean by
different forecasters, all of whose forecasts are made with reasonable care.
In other words, we are concerned here not with the possible variance between
forecast and outcome, but with possible variances between one reasonable
hypothetical forecast and another. Because the prediction of the mean involves
questions of judgment and degree, there will obviously be a range of possible
forecasts which can all be regarded as reasonable interpretations of all the
relevant information. The judge of course had this well in mind when he
considered whether the actual forecast which the vendor had made complied with
the warranty. Having made the finding that the vendor had not taken reasonable
care, he had then for the purposes of assessing the damages to decide what
figure should actually have been put forward as the most likely outcome.
21. In
a case in which it is possible to isolate the negligent error from the rest of
the forecast, as in the example of the single $25,000 mistake, it would be
reasonable to say that in other respects the forecast would have been the same.
All that is necessary is to adjust the figure by $25,000. But in this case,
the breach of warranty went to the whole methodology of the forecast. It is
not possible to say that in any particular respect, this vendor would, if he
had taken proper care, have produced elements of the same forecast. It is
therefore necessary to approach the question objectively and ask what a
reasonable forecast would have been. This in turn involves choosing from
within the range of forecasts, all of which would have been reasonable
interpretations of the information then available to the vendor. Where within
this range should the court choose?
22. Mr.
Sumption Q.C., who appeared for the appellant, said that the court should
choose the highest figure, which on the
23. All
this makes perfectly good sense when damages depend upon a prediction of how
the defendant would have performed outstanding contractual obligations which
gave him a choice of what to do. But this is not such a case. Paragraph 32
did not allow the vendor to choose from the range of figures which would have
counted as reasonable forecasts and put forward the highest figure in the range
in order to obtain the highest possible price. The PRS had to be "calculated
in good faith" and therefore had to be a
bona
fide
estimate made without regard to whether it would have produced a higher or
lower price. There is accordingly no basis for calculating the damages on the
assumption that the vendor was contractually entitled to choose the highest
figure. All that can be said is that there would have been a range of possible
figures. But there is no legal basis for assuming that the hypothetical figure
would have been at the upper rather than the lower end of the range. So far as
the estimates which could reasonably have been made differed from the mean of
those estimates, it would have been on a random basis and not because the
vendor was entitled to choose the highest figure. In those circumstances, the
only rational course open to a court is to choose the figure which it considers
that a forecast made with reasonable care was most likely to have produced.
24. The
Court of Appeal held that the judge had found this figure to be $1.2m and had
then added 33
a%.
It would therefore have substituted $1.2m for his figure but for the fact that
the plaintiffs' claim was based on the assumption that the right figure would
have been $1.223m. It therefore used this figure instead.
25. Their
Lordships find it difficult to read the passage in the judgment, which has
already been cited, as a finding that $1.2m was the figure which a forecast
made with reasonable care was most likely to have produced. It is possible
that this is what the judge meant, but the judgment goes no further than to
ascribe it to the plaintiffs' experts and to say that the "highest tolerable
forecast" would have been 33
a%
higher. Unless, therefore, the judgment provides material upon which a finding
of the correct figure can be made, the case would have to be remitted to the
judge.
26. Their
Lordships think that in considering this matter, one may start with a
prima
facie
assumption that the range of reasonable possible forecasts will be distributed
around the figure which was the actual outcome. The uncertainty inherent in
the process of forecasting may have led to reasonable forecasts both higher and
lower than the actual outcome. But since those uncertainties tend in both
directions, the only way in which a court, required to find a particular
figure, can deal with the matter is to regard the unpredictable factors as
cancelling each other out. The actual outcome is therefore
prima
facie
likely to have represented the mean and therefore the figure most likely to
have been put forward. This
prima
facie
assumption may however be displaced by evidence that the outcome was affected,
in one particular direction, by a factor which could not have been reasonably
foreseen. For example, if demand was reduced by the imposition of an
unforeseen tax after the date of the forecast, the mean of the whole range of
reasonable forecasts will to that extent be higher than the actual outcome.
But the mere existence of uncertainties which could have affected the outcome
either way is no more than the reason why there would have been a range of
reasonable forecasts and does not affect a conclusion that the most likely mean
figure would have been the actual outcome.
27. The
learned judge makes two references in his judgment to matters which occurred
after the forecast and would or might have been unforeseeable at the time. One
is a passing reference, in the passage already quoted, to the possibility that
the level of competition offered by Pepsico "could not have been fully
foreseen". The other, earlier in the judgment, was to the increased sales in
August in advance of an announced price rise taking effect at the beginning of
September, which the judge said were not predictable. The amount of the
increase was unknown.
28. Their
Lordships think that these two factors may, at best for the vendors, be
regarded as cancelling each other out. There is accordingly no evidence to
displace the
prima
facie
assumption that the most likely forecast would have reflected the actual
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