Anglo Petroleum Ltd & Anor v TFB (Mortgages) Ltd

This appeal is from the order of Peter Smith J dated 24 February 2006 at the trial of preliminary issues arising in three actions between the parties concerning the impact of s 151 of the Companies Act 1985 on the validity of three agreements dated 23 February 2001. The three agreements (“the credit transactions”) were a Credit Agreement made between Anglo Petroleum Limited (“APL”) as borrower and TFB (Mortgages) Limited (“TFB”) as lender, a Security Agreement made between the same parties, and a Guarantee given to TFB by Mr Paul Sutton.

Three months before the credit transactions, APL’s shares had been the subject of an acquisition. It is contended by APL that it gave financial assistance for the acquisition in breach of s 151 and that this tainted the credit transactions. The judge rejected these contentions. Permission to appeal was refused by the judge but granted by Neuberger LJ.

APL’s parent company was Repsol (UK) Limited (“Repsol”).

Under a Share Purchase Agreement dated 15 November 2000, Kaluna Limited (“Kaluna”) agreed to purchase from Repsol the entire share capital of APL for £1.

Under a Compromise Agreement made on the same date, APL (then called Repsol Petroleum Limited) agreed to pay Repsol £6m immediately and £9m six months later, and Repsol agreed to release APL from the balance of its indebtedness to Repsol in the sum of about £30m (none of which was secured).

APL simultaneously granted a charge to Repsol (“the APL/Repsol charge”) over a number of petrol stations to secure the debt of £15m remaining due to Repsol under the Compromise Agreement.

Under the Share Purchase Agreement, Kaluna guaranteed the performance by APL of its obligations under the Compromise Agreement. The guarantee was secured by a charge simultaneously granted by Kaluna to Repsol (“the Kaluna/Repsol charge”) over the shares which were the subject of the Share Purchase Agreement.

APL paid Repsol the initial £6m on completion of the Share Purchase Agreement.

Under the Credit Agreement, APL borrowed £15m from TFB repayable on 22 August 2001. APL agreed to pay TFB an arrangement fee of £1.75 million payable in six monthly instalments (equivalent to an interest rate of 23.33%). On 22 August 2001 the Credit Agreement was extended to 22 February 2002 on terms that APL made an immediate pre-payment of £750,000 and agreed to an increase in the arrangement fee.

Under the Security Agreement, APL granted TFB a floating charge over its assets and mortgaged its portfolio of petrol stations to TFB as security for its liability under the Credit Agreement.

Under the Guarantee, Mr Paul Sutton guaranteed the liabilities of APL under the Credit Agreement subject to a maximum of £15m plus interest and costs in enforcing the Guarantee.

On the day before the completion of the credit transactions APL stated in a fax sent to TFB:

“For your information, a condition of the acquisition [by Kaluna] was that the £30 million of loans from the parent… was to be paid off as to part and written off as to part, in its entirety, (the final balance to be paid off from the proceeds of the loan to be provided by your company).”

The Security Agreement was over the same or substantially the same properties as the APL/Repsol charge, which was released.

£9m of the £15m advanced by TFB under the Credit Agreement was used to effect early payment of the outstanding £9m due to Repsol under the Compromise Agreement.

On 9 November 2001 TFB demanded payment by APL of £14,250,000 outstanding under the Credit Agreement and appointed administrative receivers over APL’s assets.

On 7 December 2001 TFB demanded payment by Mr Sutton of £14,250,000 under the Guarantee.

There are three actions. One is by TFB to enforce the Guarantee against Mr Sutton. Summary judgment was refused on the ground that there might be a defence under s 151. One is by TFB to recover from APL the indebtedness due under the Credit Agreement. The third is by APL claiming damages from TFB on the grounds that the Security Agreement was in breach of s 151 and that the appointment of the receivers over APL was void. An attempt by TFB to obtain summary judgment was unsuccessful.

On 16 March 2005 Master Moncaster directed the trial of certain preliminary issues including the issues determined by Peter Smith J.

APL advanced two arguments (referred to as Routes 1 and 2) in support of the contention that the credit transactions were illegal and void.

The focus of Route 1 was on APL’s dealings with Repsol. It was contended that, by entering into the Compromise Agreement and the APL/Repsol charge, APL incurred liabilities and thereby gave financial assistance for the purpose of the acquisition of its shares by Kaluna within the meaning of s 151(1). By borrowing money from TFB and using it to discharge the balance of its indebtedness to Repsol, APL gave financial assistance for the purpose of discharging liabilities incurred for the purpose of the acquisition of the shares within the meaning of s 151(2). TFB knew the purpose of the loan and was therefore not entitled to enforce it.

The judge rejected Route 1. He held, first, that the giving of security by APL to TFB was not financial assistance within s 151 and, secondly, that TFB had no knowledge that its monies were being used for replacement of securities that were financial assistance.

The focus of Route 2 was on Kaluna’s dealings with Repsol. It was contended that the guarantee given by Kaluna under the Share Purchase Agreement and the supporting charge over the shares in APL were liabilities incurred by Kaluna for the purposes of its acquisition of the shares in APL, and that APL’s repayment of its outstanding indebtedness to Repsol, using money borrowed from TFB, amounted to giving financial assistance for the purpose of discharging Kaluna’s outstanding liabilities to Repsol.

The judge rejected Route 2. He held, first, that the repayment of the APL debt was not financial assistance to Kaluna; it was a repayment of APL’s reduced indebtedness and was a commercial transaction for the purpose of benefiting APL. Similarly, he held that the security given by APL to TFB was not financial assistance. Thirdly, as he had already held on Route 1, TFB was not aware of any underlying illegality.

The essential issues on the appeal are:

In Chaston v SWP Group Plc [2002] EWCA Civ 199, [2003] 1 BCLC 675, at para 31, Arden LJ described the mischief at which s151 is aimed as follows:

“I start with the mischief to which s 151 is directed. Section 151 is derived from s 45 of the Companies Act 1929 which was enacted as a result of the previously common practice of purchasing the shares of a company having a substantial cash balance or easily realisable assets and so arranging matters that the purchase money was lent by the company to the purchaser (see Re:VGM Holdings Limited [1942] 1 All ER 224 at 225-226, [1942] Ch 235 at 239). The prohibition was amended in 1948 and reformulated in 1981. The report of the Company Law Committee (the Jenkins Committee) (Cmnd 1749, 1962) para 180, p 66 expressed the view that it was “unwise” to attempt a precise definition of financial assistance. It is clear from the way in which s 151 and s 152 are drafted that it covers financial assistance in many forms apart from loans (see for example the wide wording of s 152(3)). The general mischief, however, remains the same, namely that the resources of the target company and its subsidiaries should not be used directly or indirectly to assist the purchaser financially to make the acquisition. This may prejudice the interests of the creditors of the target or its group, and the interests of any shareholders who do not accept the offer to acquire their shares or to whom the offer is not made.”

It is understandable that it has not been thought wise for the legislature to lay down a precise definition of financial assistance because of the risk that clever people would devise ways of defeating the purpose of the section while keeping within the letter of the law. However, the absence of a clear definition means that the section can give rise to uncertainties and has the potential to catch transactions which might be considered innocuous. In cases where its application is doubtful, it is important to remember its central purpose, to examine the commercial realities of the transaction and to bear in mind that it is a penal statute.

Recognition of the need to examine the commercial realities, rather than search for a legal formula for the meaning of “financial assistance”, comes from the judgment of Hoffmann J in Charterhouse Investment Trust Limited v Tempest Diesels Limited [1986] BCLC 1 at 10, cited by Arden LJ in Chaston at para 17:

“There are two elements in the commission of an offence under s 54 [the section that preceded s 151]. The first is the giving of financial assistance and the second is that it should have been given “for the purpose of or in connection with”, in this case, a purchase of shares…There is no definition of giving financial assistance in the section, although some examples are given. The words have no technical meaning and their frame of reference is in my judgment the language of ordinary commerce. One must examine the commercial realities of the transaction and decide whether it can properly be described as the giving of financial assistance by the company, bearing in mind that the section is a penal one and should not be strained to cover transactions which are not fairly within it.”

The court would not in any event strain a statute to cover transactions which are not fairly within it, but the fact that the statute is penal provides an additional reason for caution in doubtful cases.

Section 151 provides:

“(1)

Subject to the following provisions of this Chapter, where a person is acquiring or is proposing to acquire shares in a company, it is not lawful for the company or for any of its subsidiaries to give financial assistance directly or indirectly for the purpose of that acquisition before or at the same time as the acquisition takes place.

(2)

Subject to those provisions, where a person has acquired shares in a company and any liability has been incurred (by that or any other person), for the purpose of that acquisition, it is not lawful for the company or any of its subsidiaries to give financial assistance directly or indirectly for the purpose of reducing or discharging the liability so incurred.

(3)

If a company acts in contravention of this section, it is liable to a fine, and every officer of it who is in default is liable to imprisonment or a fine, or both.”

Under s 152(1) “financial assistance” is interpreted to include financial assistance given by way of guarantee or security (s 152(1)(a)(ii)), or any other financial assistance given by a company the net assets of which are thereby reduced to a material extent or which has no net assets (s 152(1)(a)(iv)).

Section 152(3)(a) provides that:

“A reference to a person incurring a liability includes his changing his financial position by making an agreement or arrangement (whether enforceable or unenforceable, and whether made on his own account or with any other person) or by any other means.”

Section 153(1) provides that:

“Section 151(1) does not prohibit a company from giving financial assistance for the purpose of an acquisition of shares in it or its holding company if –

(a)

the company’s principal purpose in giving that assistance is not to give it for the purpose of any such acquisition, or the giving of the assistance for that purpose is but an incidental part of some larger purpose of the company, and

(b)

the assistance is given in good faith in the interests of the company.”

Section 153(2) contains a similar provision in relation to section 151(2).

There was discussion during the course of the argument about the meaning of the word “purpose”, and the court was referred to the observations of Lord Oliver in Brady v Brady [1989] 1AC 755, 779-780, where he drew a distinction between a purpose and a reason for forming a purpose.

A purpose requires a mind. The relevant purpose is that of the company or subsidiary, through its relevant officer or officers, in giving the alleged assistance. At stages of his argument Mr Martin came close to eliding purpose and effect, arguing that if a person does an act knowing that it will have a particular consequence it must be his purpose (or at least one of his purposes) in doing the act to produce the consequence. There is no must about it. Whether the consequence was the actor’s purpose is a matter for inference from all the circumstances. There may be many situations in life in which a person does a particular act knowing that it will have a particular consequence, but without that consequence being the purpose for which he does the act.

As to Route 1, Mr Martin submitted that:

1.

The commercial reality was that Repsol was only prepared to sell its shares in APL if it would receive £15 million.

2.

The sale was structured in such a way that Kaluna would pay only £1 but Repsol would receive £15 million.

3.

Kaluna was assisted in buying the shares for £1 by APL undertaking to pay £15 million to Repsol under the Compromise Agreement and entering into the APL/Repsol charge to secure that obligation, and that was the purpose of APL’s assistance. There was no reason for the Compromise Agreement other than the sale to Kaluna.

4.

The APL/Repsol charge fell within the definition of financial assistance in s 152(1)(a)(ii).

5.

APL’s liabilities under the Compromise Agreement and the APL/Repsol charge having been incurred for the purpose of Kaluna’s acquisition of the shares in APL, the payment by APL of £9 million borrowed from TFB to discharge APL’s outstanding indebtedness involved giving financial assistance for the purpose of discharging liabilities incurred for the purpose of the acquisition of the shares contrary to s 151(2).

In support of his argument that the Compromise Agreement and the APL/Repsol charge amounted to APL assisting Kaluna to buy APL’s shares, Mr Martin submitted that they “smoothed the path to the acquisition of the shares” (adopting an expression used by Arden LJ in Chaston at para 38).

On the question whether the repayment of APL’s indebtedness to Repsol constituted financial assistance, Mr Martin accepted that the use of money by a company to repay its existing indebtedness would not normally fall within the concept of the company giving financial assistance to another person within s 151 (Armour Hick Northern Limited v Whitehouse [1980] 1 WLR 1520, 1524-1525, Gradwell (Pty) Limited v Rostra Printers Limited [1959] (4) SA 419, 424-426), but he submitted that this was because it would not ordinarily involve a depletion of the company’s assets and therefore would not produce the mischief at which the section is aimed. The lack of any diminution in the company’s assets formed part of the courts’ reasoning both in Armour Hick at p 1525 (“…such a payment does not alter the financial position, save to the extent that a debt due from the debtor is paid by the debtor, so no financial assistance is given”) and in Gradwell at p 426 (“The payer’s assets and liabilities are put into a different form but the balance is unchanged”). In this case, the interest (or arrangement fee) agreed between APL and TFB involved a material depletion of APL’s assets. Mr Martin submitted that it was proper to take into account the arrangements by which the funds were raised in determining whether the repayment of £9 million amounted to financial assistance, and in support of the proposition he relied on the judgment of Mr Richard Sheldon QC in Re Hill and Tyler Limited [2005] 1 BCLC 41.

The material facts of that case can be shortly summarised. The target company made a loan of the purchase price to the purchaser of its shares. The funds lent by the target company were derived in part from borrowings made by it from a company called Royscott. The company secured the repayment of the Royscott loan by a charge over its assets. The loan by the company to the purchaser was whitewashed under s 155. Issues arose as to whether the charge given to Royscott amounted to the giving of financial assistance and, if so, whether the whitewash procedure had been valid. The judge found that it would be artificial to treat the Royscott loan and charge as distinct from the loan by the company to the purchaser, and that by granting the Royscott charge the company indirectly gave financial assistance for the purpose of the acquisition. All parties knew that the Royscott loan, secured by the Royscott charge, was to be used by the company to provide assistance to the purchaser of the shares. The judge also found that the whitewash procedure had been valid and on that ground he upheld the validity of the Royscott charge.

Mr Martin’s arguments as to route 2 were similar to his arguments in relation to Route 1, except that they concentrated on the relationship between the payment of £9 million and the discharge of Kaluna’s (rather than APL’s ) liabilities to Repsol. Mr Martin submitted that by making the payment of £9 million APL gave financial assistance to Kaluna, in that Kaluna became discharged from its liability as guarantor of APL’s liability under the Compromise Agreement and also obtained the release of the Kaluna/Repsol charge over the shares.

Mr Todd QC’s main submissions were as follows:

1.

The transactions were far removed from the mischief at which s151 is aimed.

2.

The liability of APL under the Compromise Agreement to pay £15 million and the APL/Repsol charge were the cost of release of its liability to Repsol for £30 million. An arrangement reducing the company’s liabilities cannot properly be characterised as giving financial assistance to a purchaser.

3.

APL’s subsequent repayment of its indebtedness to Repsol did not fall within the s 151 concept of financial assistance.

4.

The purpose of APL was not the giving of assistance to Kaluna. It gave security to Repsol, as the judge found, as the price for a reduction of its debt. It gave security to TFB in order to discharge its liabilities to Repsol and to raise additional working capital.

5.

The arrangement fee agreed between APL and TFB was simply the cost to APL of borrowing. The fact that the borrowing came at a price cannot determine the question whether the use of the funds borrowed amounted to financial assistance within s 151. What mattered was not the terms on which the money was borrowed but what the company did with the money when borrowed: Gradwell at page 425 (“the question whether it was to give financial assistance would depend not on how it obtained the money – by loan, secured or not, by realising assets or otherwise – but on what it was to do with the money when available.”).

Mr Todd submitted that the decision in Re Hill and Tyler Limited that the Royscott charge constituted financial assistance was wrong or distinguishable. It was wrong because the giving of security to support borrowing by the company was nothing more than a term of the raising of funds and could not constitute the giving of financial assistance within the meaning of the statute. Alternatively, the case was distinguishable because the Royscott charge was to support borrowing which all parties knew was to be used for a loan to the purchaser (a loan which would be lawful only if whitewashed), whereas the link sought to be made by APL between Kaluna’s acquisition of the shares and the charge given by APL to TFB was much more remote.

I have summarised the arguments in outline. Supporting points were made of a more detailed nature. Standing back from the minutiae of the arguments, and looking at the transactions attacked by APL from a commercial perspective, I do not consider that they exemplify the mischief against which the section is aimed.

Mr Martin’s arguments are ingenious and were skilfully deployed, but in my view the commercial reality is that APL and Mr Sutton are seeking to avoid their liabilities to TFB, for what was in essence a straightforward commercial loan, by a strained reading of the statute.

I begin with the Compromise Agreement, the nature of which was that APL’s liability to Repsol was reduced. I do not consider that it should be characterised as giving financial assistance to the purchaser on account of the fact that it thereby made the company a more attractive acquisition and can thus be said to have smoothed the path to its acquisition. Just because it smoothed the path to the acquisition, it does not follow that it amounted to financial assistance. Nor can the APL/Repsol charge, by which APL gave security to Repsol for its reduced indebtedness, properly be described as financial assistance to the purchaser.

As to the purpose of the transactions from APL’s viewpoint, the judge fairly described them as “a bona fide restructuring of APL’s indebtedness with a significant reduction in exchange for a security”. Repsol’s reason for wanting to restructure APL’s indebtedness was in order to sell the shares to Kaluna and to obtain security for the reduced amount of the indebtedness, but that does not make APL’s purpose in entering into the restructure that of giving financial assistance to the purchaser.

In any event, the liabilities undertaken by APL under the Compromise Agreement did not come within any of the categories identified in s 152 (1) as capable of amounting to financial assistance under s 151. The APL/Repsol charge was ancillary to the Compromise Agreement in that its purpose was to secure APL’s obligation under the Compromise Agreement. The giving of security over a company’s assets can come within s 152(1)(a)(ii), but the APL/Repsol charge did not in my judgment amount to giving financial assistance within s 151 in the present circumstances where it was merely a means of enforcing an obligation of APL which did not involve the giving of financial assistance.

Moving on from the issues under s 151(1) to s 151(2), the next step of Mr Martin’s argument presents further difficulty. He accepts that APL’s agreement to pay £15 million to Repsol under the Compromise Agreement was not unlawful (because it did not fall within s 152 (1)), but he submits that APL’s payment of £9 million in discharge of that obligation was unlawful. That is a surprising proposition and goes against the grain of the authorities that the repayment by a company of its lawful indebtedness is not prohibited by s 151. Mr Martin does not dispute the correctness of those authorities, but he seeks to distinguish them by reference to the cost of the borrowing from TFB.

I am not persuaded that this a valid ground of distinction. Mr Martin makes the point that the cost of borrowing reduced APL’s assets, but I do not see how logically this converts the discharge of the company’s indebtedness from a lawful act into the giving of unlawful financial assistance.

I agree with the court in Gradwell that whether the payment contravened the section does not depend on how the money was obtained. I recognise that the making by the company of early repayment so as to relieve the purchaser from its obligations could amount to giving financial assistance to the purchaser. However the judge found that there were bona fide reasons for APL wanting to repay Repsol when it did. Mr Riches (APL’s managing director) and Mr Sutton (who was behind Kaluna) wanted to obtain further finance for expansion and development. The refinancing took place early because it enabled APL to borrow at what Mr Riches considered to be a favourable rate. There is no proper basis for disturbing those findings.

As to the Security Agreement (between APL and TFB), I agree with the judge’s reasoning that “if it is lawful for a company to repay its own indebtedness and there is a genuine commercial justification it must also equally be lawful [for] the company to assist that repayment by providing security”.

On that ground alone, the decision in Re Hill and Tyler is distinguishable, and it is unnecessary to express any view as to the correctness of the deputy judge’s decision about the Royscott charge or his reasons for reaching it.

Accordingly, I reject the Route 1 argument that APL incurred a liability for the purpose of Kaluna’s acquisition of the shares or (which would require a tortuous reading of the statute) that it gave financial assistance for the purpose of discharging such liability by repaying £9 million to Repsol. As to the Route 2 argument, there is no dispute that Kaluna undertook obligations for the purpose of its acquisition of the shares, but I reject the argument that APL by repaying its own indebtedness to Repsol gave financial assistance for the purpose of discharging Kaluna’s liabilities.

There are different ways in which a statute may give rise to an argument that a contract was illegal in its formation and therefore unenforceable. They are (1) that its formation was prohibited by statute, (2) that it was a contract to do an act prohibited by statute or (3) that was it was entered into for the purpose of doing an act prohibited by statute. Mr Martin argued that the Credit Agreement was unlawful on grounds 2 and 3. Since I agree with the judge that the use of the funds borrowed by APL from TFB did not contravene s 151, it is not strictly necessary to decide whether the credit transactions would have been unlawful if the use of the funds had contravened the section. But the judge found for TFB on the additional ground that it did not know of the (alleged) unlawfulness in the intended use of the proceeds of the loan, and Mr Martin attacked that finding.

Mr Martin put his argument as follows:

1.

Clause 3 of the Credit Agreement provided:

“PURPOSE

(a)

The proceeds of the Loan shall be applied in or towards the refinancing of indebtedness of the Borrower on the date of this Agreement and for the provision of working capital.

(b)

Without affecting the obligations of the Borrower in any way, the Lender is not bound to monitor or verify the application of any Loan.”

2.

TFB knew from APL’s fax sent on the day before the conclusion of the Credit Agreement that APL was indebted to its former parent, that a condition of the acquisition by Kaluna was that the indebtedness was to be written off in part and paid off in part, and that APL intended to pay off the final balance from the proceeds of the loan from TFB.

3.

TFB also knew that the Credit Agreement entailed a material reduction in APL’s net assets.

4.

The Credit Agreement and the Security Agreement are unenforceable because the Credit Agreement required that the proceeds of the loan should be used for a purpose which was illegal on the facts known to TFB.

5.

Alternatively, the Credit Agreement and the Security Agreement are unenforceable because

(a)

the purpose of APL and TFB in entering into the Credit Agreement and the Security Agreement was to effect a transaction which was illegal on the facts known to TFB, or

(b)

APL’s purpose was to effect an illegal transaction and TFB knew of that purpose and participated in it, or

(c)

APL’s purpose was to effect an illegal transaction and TFB knew of that purpose.

6.

It is any event irrelevant that TFB did not know of the illegality, because ignorance of the law is no defence.

Mr Martin submitted that the case was indistinguishable in principle from J M Allan (Merchandising) Limited v Cloke [1963] 2 QB 340. In that case the plaintiff rented to the defendant a roulette table, together with copies of a book of rules, for use in a club. The rules stated that a charge of sixpence was payable on any bet before the croupier spun the wheel. Using a roulette table in a club in that way was an offence under the Betting and Gaming Act 1960, although neither of the parties appreciated that fact. The trial judge found that it was the intention of both parties when they made the contract that the table would be used in the way described in the rules. Accordingly the agreement was unlawful and the plaintiff was not entitled to recover hire under it. The Court of Appeal upheld his judgment.

Lord Denning MR (p 348) stated the principle as follows:

“[Counsel for the plaintiff] argues before us that the parties to this letting were ignorant of its unlawfulness: and that, in these circumstances (as it is a contract which could lawfully be performed) it is not to be regarded as unlawful unless they had a “wicked intention to break the law.” He relies on the well-known judgment of Blackburn J in Waugh v Morris (1873) LR 8 QB 202. Now I desire to say that where two people together have the common design to use a subject-matter for an unlawful purpose, so that each participates in the unlawful purpose, then that contract is illegal in its formation: and it is no answer for them to say that they did not know the law on the matter. I would take a comparable case where there is a common design to use a subject matter for an immoral purpose. If a landlord lets a flat to a prostitute at a rent beyond any normal commercial rent, or if he lets her a brougham of a specially intriguing nature [a reference to Pearce v Brooks (1866) LR 1 Exch 213] it may fairly be inferred that it was their common design that it should be used for an immoral purpose. The letting is unlawful and he cannot recover the rent or hire. It is different with the washerwoman who washes the clothes of the prostitute or the butcher who supplies her with meat. They may know of her trade but they charge her normal commercial prices. There is there no common design. There is no participation in the immoral purpose, but merely knowledge of it. And that is no bar to recovering the price. Likewise with an unlawful purpose, active participation debars, but knowledge by itself does not. As I read Waugh v Morris there was there no participation in any unlawful purpose and the plaintiff could recover. In this case, however, there was participation. The common design was that a game should be played which was in fact unlawful.”

This passage was cited with approval by Scarman LJ in Ashmore, Benson Limited v Dawson Limited [1973] 1 WLR 828, 836.

Mr Martin submitted that in the present case TFB did more than simply provide monies knowing the purpose for which they were to be used. It provided the money on terms specifying a usage which was illegal on the facts known to TFB, and TFB accordingly participated in the illegality.

Waugh v Morris, on which Mr Todd relied,arose from a voyage charter party by which the plaintiff’s vessel was chartered for a voyage from Trouville to London. Under the charter party a cargo of pressed hay was to be loaded at Trouville and brought to London where it was to be taken from the ship alongside. The charterer’s agent told the master that the consignees under the bills of lading would require the hay to be delivered to them at a particular wharf in Deptford Creek and that he should proceed there on his arrival in London, which the master promised to do.

On arriving in the Thames, the master learned for the first time that by an Order in Council made under the Contagious Diseases (Animals) Act, 1869, France was declared to be an infected country, and it was made illegal to land in Great Britain any hay brought from that country. The Order had been made and published before the charter party was entered into, but neither the master of the ship nor the charterer’s agent was aware of it. On learning of the Order, the master refrained from landing the cargo at the wharf. After some delay, during which the contractual number of laydays elapsed, the charterer received the cargo from alongside the ship into another vessel and exported it. The owner claimed for detention. The claim was resisted by the charterer on the ground that the contract was unenforceable for illegality, because the purpose of the contract was the delivery of the consignment to London, which was prohibited by law. The defence was rejected.

Giving the judgment of the court, Blackburn J (p 207 – 208) distinguished the case from one where the contract could not be performed without illegality or which was entered into for the object of satisfying an illegal purpose. He observed that all that the owner had bargained for, and could properly be said to have intended, was that on the ship’s arrival in London his freight should be paid and the hay taken out of the ship. As to an illegal object, he never contemplated that the charterer would violate the law. He contemplated that the charterer would land the goods and thought that this would be lawful; but if he had thought of the possibility of the landing being prohibited, he would probably, and correctly, have expected the charterer not to break the law. The principle applied by the court was stated by Blackburn J as follows:

“We quite agree, that, where a contract is to do a thing which cannot be performed without a violation of the law it is void, whether the parties knew the law or not. But we think, that in order to avoid a contract which can be legally performed, on the ground that there was an intention to perform it in an illegal manner, it is necessary to show that there was the wicked intention to break the law; and, if this be so, the knowledge of what the law is becomes of great importance.”

130 years later, this statement of the law has added importance because of the explosion in the number of statutory regulations of one kind or another under English and European law.

The distinction between Allan v Cloke and Waugh v Morris depends on the view formed about the particular facts. In Allan v Cloke, as the trial judge found, the parties shared a purpose that the roulette table would be used in a way which could not be done without a violation of the law. By supplying the table and the books of rules, the plaintiff encouraged the defendant to use the table in a way which would be criminal. In terms of the criminal law, the plaintiff would be guilty of the offence of incitement. In Waugh v Morris the contract was capable of being carried out in a way which would not involve or lead to illegality, and it was no part of the owner’s purpose that the charterer should carry out an unlawful act.

It is therefore necessary in this case to examine whether the performance of the Credit Agreement and the Security Agreement was bound to involve illegality; and, if not, whether TFB entered into the contract with an illegal purpose in mind.

The obvious commercial objective of clause 3(a) of the Credit Agreement (specifying the purpose of the loan) was to restrict APL’s use of the funds to the specified purposes. The specified purposes were expressed in general terms as the refinancing of indebtedness of the borrower and the provision of working capital. The clause cannot reasonably be construed as imposing a positive obligation on the borrower to discharge any particular debt. The clause was no more than a generic restriction of the use of the funds of an ordinary kind in a commercial credit agreement. If it so happened that the borrower had no debts that it could lawfully repay, it would not follow that the Credit Agreement was an agreement to do an unlawful act; the consequence would simply be that the only use which the borrower could make of the funds without contravening the law or the terms of the Credit Agreement would be for working capital.

I therefore reject the argument that APL was required under the terms of its contract with TFB to do something that was illegal.

The next question is whether TFB entered into the contract with an illegal purpose in mind. I can see no basis for finding that TFB had any positive purpose how APL should use the monies loaned, provided that it did not use them for purposes other than the broad categories permitted by clause 3(a) of the Credit Agreement.

Mr Martin’s fallback position was that the mere knowledge of TFB that APL intended to use part of the proceeds of the loan to repay Repsol was sufficient to make the Credit Agreement and Security Agreement unenforceable by TFB. Either the knowledge of that intention and the advance of the loan were sufficient to make TFB a participant in APL’s unlawful purpose, or Lord Denning’s statement that “Likewise with an unlawful purpose, active participation debars, but knowledge by itself does not” was erroneous.

Mr Martin relied on Langton v Hughes (1813) 1 M and S 593 and Pearce v Brooks as authority for the principle that knowledge by one contracting party that the other party had entered the contract with an unlawful purpose in mind is sufficient to debar the first party from relying on the contract.

In Langton v Hughes the plaintiffs were suppliers of spirits and spices. The defendants were brewers in Chester. There was a statutory prohibition on the use of anything but malt and hops in the brewing of beer. The plaintiffs’ travelling salesman took orders from the defendants for goods which he knew were to be used in the brewery. An action by the plaintiffs for the price of the goods was met with the defence of illegality. The defence succeeded. The argument for the defendants, presented by the Attorney-General of the day, was that the statute prohibited the adulteration of malt and hops in the brewing of beer, but not the sale of goods for that purpose. Since that argument did not distinguish between knowledge and purpose, that point of distinction was not directly discussed in the judgments. It would therefore be wrong to try to read too much from the passages of the judgments which refer to knowledge and the passages which refer to purpose. Some sentences, taken in isolation, would suggest that all that mattered was the vendors’ knowledge, while others referred to the vendors’ purpose. The moral is that it is unwise to look to a case for guidance on an issue which was not the focus of argument.

By contrast, the distinction between knowledge and purpose was directly addressed by Lord Mansfield CJ in Hodgson v Temple (1813) 5 Taunt 181. The case was decided a few months after Langton v Hughes, which does not appear to have been cited. The plaintiff sued for the price of spirits sold and delivered to a distillery run by the defendant. As the plaintiff knew, the defendant also had a retail shop in Fleet Street for the sale of spirits. It was a statutory offence for a person to carry on the dual trades of distilling and retailing spirits. The defendant argued that the plaintiff was not entitled to recover the price of the goods sold because of his knowledge of the defendant’s dual occupations. This argument was rejected. Lord Mansfield declared with masterly succinctness that:

“This would be carrying the law much further than it has ever yet been carried. The merely selling goods, knowing that the buyer will make an illegal use of them, is not sufficient to deprive the vendor of his just right of payment, but to effect that, it is necessary that the vendor should be a sharer in the illegal transaction.”

Pearce v Brooks was one of a number of cases in which a seller supplied goods in a form tailored to an unlawful purpose. Other examples are Biggs v Lawrence (1789) 3 TR 454 and Waymell v Reed (1794) 5 TR 599, where goods were packed and delivered in a manner designed for smuggling. The sellers were held not to be entitled to enforce the contracts.

In Pearce v Brooks the contract was for the sale of an “ornamental” brougham particularly appropriate for use in the purchaser’s trade as a prostitute. It was held that the seller was not entitled to recover the price. The case was tried before Bramwell B and a jury.

At the trial Bramwell B put two questions to the jury:

“1.

Did the defendant hire the brougham for the purpose of her prostitution?

2.

If she did, did the plaintiffs know the purpose for which it was hired?”

The jury gave affirmative answers to both questions. The judge directed a verdict for the defendant but gave the sellers leave to take the case to the Court of Exchequer Chamber. Before that court, consisting of Pollock CB, Martin B, Piggott B and Bramwell B, the appellants argued that it was “impossible to say that there was any express purpose of prostitution; the defendant might have used the brougham for any purpose she chose, as to take drives, to go the theatre, or to shop.” During the argument Bramwell B intervened (p215) to say how he had put the matter to the jury:

“I put it to the jury, that, in some sense, everything which was supplied to a prostitute is supplied to her to enable her to carry on her trade, as, for instance, shoes sold to a street walker; and that the things supplied must be not merely such as would be necessary or useful for ordinary purposes, and might also be applied to an immoral one; but that they must be such as would under the circumstances not be required, except with that view. The jury, by the mode in which they answered the question, showed that they appreciated the distinction.”

The court upheld the verdict. The main area of dispute appears to have been the strength of the evidence to associate the fitting out of the brougham with the purposes of prostitution and the adequacy of the jury’s findings of fact, as to which the jury and the judges preserved a veil of Victorian decorum.

Bramwell B’s direction to the jury prompts the question why the legal result should have been different if the contract had been for the supply of an ordinary pair of shoes to a known street walker which, as he observed, would in a broad sense enable her to carry on her trade. A modern pair of contrasting examples might be the supply of an ordinary vehicle by a motor dealer in the ordinary course of business to a customer known to be a drug dealer, and the supply of a vehicle with special compartments for the concealment of drugs.

On Lord Denning’s analysis in Allan v Cloke, the differentiating principle is that, as Lord Mansfield had said 150 years earlier, the claimant has to have shared the unlawful purpose to be debarred from enforcing the contract. A shared purpose could be inferred, for example, from the letting of a flat to a prostitute at a rent beyond any normal commercial rent. It could also be inferred from “active participation”, for example, by the supply of goods tailored to an unlawful purpose.

I do not accept that before Allan v Cloke there was an established rule of law to the effect that in all circumstances a contract was unenforceable by a party who knew at the time of the contract that the other party was entering into it with a view to doing something which would be illegal on the facts known to the first party. But more importantly, the principle identified by Lord Denning in Allan v Cloke was an essential part of his reasoning, because it was part of the reasoning by which he distinguished Waugh v Morris. The point was not addressed by Danckwerts LJ, but Davies LJ (p 351) agreed with Lord Denning that the principle in Waugh v Morris did not apply in view of the judge’s express findings of fact. It is therefore fair to regard the principle identified by Lord Denning as part of the ratio of the decision and binding on this court.

What then amounts to “participation” from which a common design may be inferred? The Law Commission commented in its discussion on the subject in its consultation paper on Illegal Transactions: the Effect of Illegality on Contracts and Trusts, LCCP No 154, 1999, at para 2.25 and following, that the case law lacks clear guidance on the question of what amounts to participation in a guilty purpose. As Professor Furmston pointed out in an article “The Analysis of Illegal Contracts” (1966) 16 University of Toronto LJ 267, 287, cited by the Law Commission, “it is clear that there must come a point when the connection [of the contract] with the plaintiff’s intention is too remote”. Bramwell B’s examples of the supplier of shoes to a known street walker and the supply of a brougham furnished for the purposes of prostitution are in point. The latter has a much closer connection with prostitution than the former. But where the line is to be drawn in any particular case may be a question of fact and degree.

In judging where the line is to be drawn, it is important to remember that the law in this area is based on public policy. In Vita Food Product Inc v Unus Shipping Co Limited [1939] AC 277, 293, Lord Wright said:

“Each case has to be considered on its merits. Nor must it be forgotten that the rule by which contracts not expressly forbidden by statute or declared to be void are in proper cases nullified for disobedience to a statute is a rule of public policy only, and public policy understood in a wider sense may at times be better served by refusing to nullify a bargain save on serious and sufficient grounds.”

It is hard to see how public policy would be served by invalidating a contract which is not unlawful in its terms and which a reasonable person in the position of TFB would have seen as an ordinary, innocuous commercial transaction. It is also hard to see how public policy would be served by stretching the principle that ignorance of the law is no excuse so as to attribute to the party seeking to enforce the contract an unrealistic knowledge that the other party intended to act illegally. Waugh v Morris is authority against doing so.

In the present case it was reasonable for TFB to regard the loan as an ordinary commercial loan made in the course of its business. There is no good reason why public policy should have required TFB to investigate whether the proposed use of the loan would amount to a breach of s 151, and the law would be out of touch with reality if it deemed TFB to have knowledge that the proposed use would be a breach. Even if Mr Martin were right in his argument about the effect of the section, this would have been far from obvious to a lawyer, let alone to a party in the position of TFB. Moreover, as Mr Todd pointed out, even if s 151 was potentially engaged, it would not necessarily follow that it would be breached, because if APL had itself been aware of a problem it would have had the possibility of using the whitewash procedure.

Even if the use of the funds had involved a breach of s 151, the judge was right to hold that the Credit Agreement, the Security Agreement and the Guarantee were not illegal. The agreements did not necessitate any breach of the law, and it was not the purpose of TFB in entering into them to procure or assist the commission of conduct which would be a breach of the law. In the circumstances, it would not be just to equate TFB’s knowledge of APL’s intended use of the loan with knowledge of its alleged illegality, nor would it be just to draw an inference of a shared unlawful design if a reasonable person in the position of TFB would have seen it as an ordinary commercial transaction. I would dismiss the appeal.

I agree.

I also agree.