The recent Court of Appeal decision Wood v Sureterm Direct Ltd & Capita Insurance Services Ltd  EWCA Civ 839 considered how to interpret an indemnity clause in a sale and purchase agreement, overturning the High Court decision. The Court examined its role in interpreting a contract between parties where the language was capable of having more than one meaning, finding that it is not for the courts to improve a party’s bad bargain where it would undermine the importance of the natural language used.
Friday 20th November, 2015
In April 2010 Capita Insurance Services Ltd (“Capita”) acquired the entire issued share capital of Sureterm Direct Ltd (“Company”), an insurance broker, from certain sellers (“Sellers”), including the appellant. The sale and purchase agreement (“SPA”) contained a set of warranties which one would expect in such a transaction and the following indemnity from the Sellers to Capita (numbering and underline added for emphasis):
“The Sellers undertake to pay to the Buyer an amount equal to the amount which would be required to indemnify the Buyer and each member of the Buyer’s Group against (1) all actions, proceedings, losses, claims, damages, costs, charges, expenses and liabilities suffered or incurred, and (2) all fines, compensation or remedial action or payments imposed on or required to be made by the Company (A) following and arising out of claims or complaints registered with the FSA, the Financial Services Ombudsman or any other Authority against the Company, the Sellers or any Relevant Person (B) and which relate to the period prior to the Completion Date pertaining to any mis-selling or suspected mis-selling of any insurance or insurance related product or service.”
Following the acquisition, Capita discovered that insurance mis-selling had occurred and reported this to the FSA (now Financial Conduct Authority), as was their obligation to do. They agreed with the FSA to a remediation exercise and to pay compensation to those customers affected by the mis-selling.
Capita brought a claim against the Sellers under the indemnity for approximately £2.5 million as a result of the exercise. The issue in dispute was whether the indemnity covered losses where Capita or the Company had self-referred to the FSA, rather than a claim or complaint being lodged by a customer. The High Court judgment helpfully divided the indemnity clause into sections (1), (2), (A) and (B), as noted above. Capita claimed that the indemnity was applicable in the circumstances because, under its interpretation of the different parts of the indemnity, only (2) (fines) applied to (A) (complaints to the FSA), which meant that (1) (losses) did not need to be connected to (A) (complaints to the FSA) and could simply be connected to (B) (pertaining to mis-selling pre-Completion). The High Court agreed with Capita’s interpretation.
On appeal, the Court of Appeal reversed the decision and found in favour of Mr Wood, on the following basis:
- It was necessary to look at the structure of the indemnity in its original form, read as a whole. The most natural reading was that it created an indemnity against two types of loss: those arriving from actions, claims, etc, and those arriving from fines, compensation, remedial action or payments, both of which applied to (A) and (B). Accordingly, any indemnifiable loss had to either arise from a claim against the Company (1) or a complaint registered with the FSA (2).
- Applying Capita’s interpretation would render the indemnity incoherent, as pairing (1) and (B) (and deleting (2) and (A)) failed to specify any entity against which an action must be brought. While stressing that it was only a small pointer towards his conclusion, Christopher Clarke LJ agreed with Mr Twigger QC’s entertaining analysis (for Mr Wood) that if one applied the phrase “I like cats and dogs which are black and fluffy”, to the structure of the indemnity in question, the most unlikely construction would be Capita’s, which would lead to “(1) I like cats (B) which are fluffy and (2) dogs which are (A) black and (B) fluffy”.
- It rejected the High Court’s conclusion that there was no good commercial reason to exclude the indemnity for loss caused by a self-referral to the FSA. Capita had other means of redress under the warranties covering FSA compliance; the fact that the indemnity was unlimited by time or financial liability meant that it was not surprising that its scope should be limited. In addition, it was not the court’s role to improve a deal which had been badly negotiated or drafted by Capita.
The decision highlights the broad principles of the interpretation rules which the courts will apply. It is not enough merely to rely on the assumed business common sense of a transaction, as two parties may have differing views as to what amounts to common sense. As a court will not always be aware of the parties’ intentions at the time of entering into a contract, it must assume that compromises may have been made, or that a party may have negotiated or drafted poorly. The courts will seek to find a balance between the indications given by the language and the implications of the rival constructions. As ever clear drafting, both in language and structure, is essential – whether regarding cats, dogs or otherwise.
The case of Portsmouth City Council v Ensign Highways Ltd  EWHC 1969 (TCC) considered whether a duty to act in good faith could be implied into the Council’s dealings with its service provider (Ensign).
The parties entered into a long term PFI contract for highway maintenance on 30 July 2004. Schedule 17 to the Contract set out certain Default Events for which service points could be awarded and a “Maximum Event Value” against each Default Event. The Council could issue warning notices, subject Ensign to closer scrutiny and ultimately terminate the contract if the total number of service points awarded passed a certain threshold in any 12 month period (150, 200 and 250 respectively).
Initially the Council operated on the basis that each Maximum Event Value figure in Schedule 17 was the upper limit of a range that could be awarded for the relevant Default Event. The Council would therefore consider the gravity of the breach when assessing how many service points should be awarded and informed Ensign on a monthly basis.
In 2012, following a number of cuts in local authority funding the Council started awarding Ensign with the maximum value of service points for every Default Event, refusing to communicate with Ensign in relation to breaches, finding breaches that Ensign might find difficult to remedy and awarding large numbers of Service Points at random intervals.
In June 2014 Ensign notified the Council that it intended to refer the dispute about the award of service points to expert determination in accordance with the terms of the Contract. It was Ensign’s assertion that the Council were deliberately trying to make satisfactory performance of the Contract difficult for Ensign. The expert concluded that the Council had acted in bad faith, without mutual co-operation and unfairly. The expert concluded that Ensign was, in general, delivering the required service but that the Contract did not provide any means of achieving long term improvements.
The Council commenced legal proceedings seeking various declarations relating to the performance of its obligations under the Contract. The key issues in dispute were:
- whether the Maximum Event Values represented the upper limit of a range of service points that could be awarded for a particular Default Event or were they fixed “tariffs” to be applied irrespective of the gravity of the breach in question;
- whether the duty to act in good faith set out in one clause of the Contract (which referred specifically to the parties obligations to secure continuous improvement and best value) extended to the Council’s obligations in relation to the award of service points under a different clause ; and
- if the duty to act in good faith did not extend to the award of service points, whether a term should be implied to that effect.
Edwards-Stuart J observed that failure of the duties under the Contract could take many forms and that it was therefore logical that parties build in some flexibility to the award of service points. He concluded that the word “maximum” had a very clear meaning – namely, the upper limit of a range and that the numbers in Schedule 17 could not therefore be fixed “tariffs” to be applied irrespective of the gravity of the breach.
As to the extent of the duty of good faith, the Judge stated that English law does not usually imply such a duty into commercial contracts.
The Judge, however, concluded that the Council was subject to an implied term when assessing the number of Service Points to be awarded under the Contract to act honestly and on proper grounds and not in a manner that is arbitrary, irrational or capricious.”
There are two main points to take away from this case:
- A duty to act in good faith set out in relation to a specific obligation will not imply that duty against other clauses within the same agreement;
- Whilst English law does not recognise an overriding duty to act in good faith there exists an implied term that a party must act in a manner that is not arbitrary, irrational or capricious when exercising a contractual right of discretion.
In the recent case Jetivia SA and another v Bilta (UK) Ltd  UKSC 23 (“Jetivia v Bilta”) the Supreme Court considered the application of the illegality defence.
Through its liquidators, an insolvent English company, Bilta (UK) Limited (“Bilta”), brought claims against its directors for unlawful means conspiracy involving them breaching their fiduciary duties and against a Swiss company, Jetivia SA (“Jetivia”) and its sole French director for dishonestly assisting them. Jetivia and its directors applied to strike out Bilta’s claim on the basis of the “illegality defence”, the principle that the courts will not assist a claimant whose claim is only possible due to the claimant’s own illegal action.
The liquidators also brought a claim under the fraudulent trading provisions of section 213 of the Insolvency Act 1986 against the directors, Jetivia and its sole French director. Jetivia claimed that section 213 did not have extra territorial effect. The application was dismissed by both the High Court and the Court of Appeal. Jetivia and its directors appealed to the Supreme Court.
Facts of the Case
Bilta was alleged to have been the vehicle for a VAT fraud involving a carbon emissions credit scheme. The liquidators alleged that Bilta’s two directors had breached their fiduciary duties to Bilta by causing Bilta to enter into a number of fraudulent transactions with third parties, including Jetivia, and therefore had conspired to injure Bilta.
In relying on the illegality defence to protect them from the claim, the directors and Jetivia argued that Bilta, through its directors, was a party to the illegality because any knowledge of the directors should be treated as though it was that of Bilta. If so then Bilta could quite properly bring a claim against them and there would be no illegality defence.
The Decision in Jetivia v Bilta
The Court unanimously held that section 213 has extra-territorial effect. The context of section 213 is the winding-up of a company registered in Great Britain, but the effect of such a winding up order is worldwide. It was difficult to see how the provisions of section 213 could achieve their object if their effect was confined to the UK.
In relation to the illegality defence the Court held that it was unjust and absurd to suggest that the answer to a claim for breach of a director’s duty could lie in attributing to a corporation the very mischief by which the director had damaged the company.
Lord Neuberger said in summary that the knowledge of the wrong-doing could not be attributed to the company in defence of a claim brought against the directors by the company’s auditors (or by the company itself). This was the case even if the directors were the only directors and shareholders of the company, and where the wrong-doing or knowledge of the directors might be attributed to the company were the proceedings of a different nature.
What Jetivia v Bilta means for Directors
Jetivia v Bilta makes it clear that the defence of illegality will not always be available to protect unscrupulous directors in claims brought against them by the company. This is because there remain circumstances where the director’s knowledge will be attributed to the company. In particular the defence is unavailable in the context of claims by or against a third party or where there are no innocent directors or shareholders and the controlling mind and will of the company is the same person as the directors.
That section 213 was held to have extra-territorial effect is perhaps unsurprising. In reality this will mean that directors residing in foreign jurisdictions will not be able to raise their foreign residency in defence.
Directors who find themselves the subject of such claims by companies will find it harder to raise the illegality defence. It is therefore now more important than ever for directors to carefully consider their duties and responsibilities; in particular the duty to promote the success of the company under section 172 of the Companies Act 2006.
The Supreme Court also indicated in Jetivia v Bilta that now is the time for a fuller analysis of the scope of the illegality defence. Jetivia v Bilta was held to be the time but not the place for such discussion but we await the next opportunity for the Courts to consider this most intriguing and technical of defences.
The case of Swynson Limited v Lowick Rose LLP  EWCA Civ 629 on appeal to the Court of Appeal concerned an amount of damages recoverable by a lender from a negligent firm of accountants which failed to perform a proper exercise of due diligence on the borrower to whom monies were lent on reliance on that negligent advice. The loan was repaid by using money lent to the borrower by the owner of the lending company. At first instance the High Court held that repayment was a collateral matter which did not go to reduce the damages recoverable by the lender from the negligent accountants. The appeal concerned, amongst other matters, whether damages due for that negligence could be reduced by “avoided loss”. The avoided loss came about through the repayment to the borrower of the two initial loans through the issue of a third refinancing loan from the borrower’s owner undertaken principally for tax reasons.
A majority of the Court of Appeal held that the repayments should not be brought into account when assessing damages against the negligent accountants. The accountancy firm would remain fully liable for its negligence, despite the repayment of the loans. The repayment by the owner of the borrower was “res inter alios acta” (acts between parties may not adversely affect the rights of others) and accordingly did not reduce the lender’s rights to recover damages.
Facts – abridged
The appeal concerned loans of £15m given in 2006 and £1.25m given in 2007 by Swynson Limited (“Swynson”) to Evo Medical Solutions Limited (“EMSL”). Central to the appeal was Mr Michael Hunt, an indirect owner of Swynson, who became a majority shareholder of EMSL in 2008 due to his involvement in the refinancing of EMSL.
On granting a loan to EMSL in 2006, Swynson relied on negligent due diligence undertaken by Lowick Rose LLP (at the time called Hurst Morrison Thomson (“HMT”)). HMT failed to update Swynson on a $3-$4m adverse difference between EMSL’s actual and forecast working capital. On the information that EMSL would collapse without extra funding, Mr Hunt caused Swynson to provide a further £1.25m loan to EMSL in 2007. As the loans became due for repayment, Mr Hunt himself provided a further loan in 2008 to help EMSL refinance the 2006 and 2007 loans. Swynson and Mr Hunt sued HMT for damages in negligence, HMT argued (amongst other matters) that by reason of Mr Hunt’s 2008 refinancing, Swyson had suffered no loss in respect of the 2006 and 2007 loans. The High Court held, amongst other things, that the 2008 partial refinancing was res inter alios acta and did not amount to reduce Swynson’s damages. HMT appealed this (and other matters). The appeal was dismissed by a majority of the Court of Appeal.
Longmore LJ dismissed the appeal, stating that avoided loss from the 2008 refinancing should not be taken into account in assessing damages. It was held that the avoided loss:
- Did not arise as collateral to the accountancy firm’s negligent advice, so would not be taken into account in Swynson’s claim for damages;
- Arose as a consequence of the breach, however, would not be taken into account and considered in the award of damages, as it was not a loan made in the ordinary course of business. The loan represented a worthless debt, which meant EMSL could not use the refinancing to procure business, in the ordinary sense;
- Came about as a result of the financial relationship of Mr Hunt to both Swynson and EMSL. Damages would not be reduced as the Court of Appeal did not feel it just for the accountancy firm to benefit as a result.
The decision in this case was made with the position of Mr Hunt in mind despite his not being a successful party to the appeal. The Court of Appeal tried to find a solution to make good Mr Hunt and Swynson and has done so with disregard to, as it put it, “technicalities” or which some would call the authorities. The judgment contains a very useful summary of the law on avoided loss then does its best to work its way around it. It nevertheless does provide (albeit very fact specific) guidance for claimants who fail to take or who are unable to take steps to mitigate their losses, but still nevertheless avoid loss as a result of the acts of third parties. The decision highlights the importance of considering the effects of action taken by third parties in relation to loss experienced by a claimant and the nature of those actions – whether the avoided loss arises by virtue of circumstances which are collateral to the breach of contract (eg an insurance payment, in which case the avoided loss need not be taken into account) or if the transaction giving rise to the avoided loss arises out of the consequences of the breach and in the ordinary course of business in which case it may be taken into account) eg where a supplier has failed to supply certain goods but the buyer ends up procuring better goods and a better economic bargain as a result. The judgment does not consider in detail the double recovery rule but that should always be borne in mind.
It may be the case that the defendant firm of accountants appeal this decision to the Supreme Court.