Cavendish Corporate Finance LLP v Gil Investments Ltd

This appeal is about a commission agreement in relation to the sale of shares in a company, Tractiv Group Ltd (I will call it the Company). The Appellant, GIL Investments Ltd (“GIL”), was one of its three shareholders, the others being Close Brothers Private Equity Ltd (“Close”) and Mr Anthony Howat, who was the CEO of the Company. All three entered into an agreement with the Respondent, Cavendish Corporate Finance LLP (“Cavendish”), under which Cavendish agreed to assist in arranging a sale of the shares in Tractiv. In the end, Mr Howat did not sell his shares, but GIL and Close did, and the question is to what commission is Cavendish entitled as a result of the sale.

The agreement between the parties takes the form of a letter from Cavendish addressed to the three shareholders, dated 27 January 2006, though sent at the end of February, and countersigned on 6 March 2006. It has been referred to as the Engagement Letter, and I will use that label. The sale of the shares held by GIL and by Close (amounting to 77.5% of the shares) took effect under a Share Purchase Agreement (“SPA”) dated 19 February 2007. The price paid by the purchasers was stated as £2,452,100 in the SPA, but after adjustment came to £2,110,864. The issue is what other sums are relevant for the purposes of Cavendish’s claim to commission. £5,281,304 was payable to an associated company of Close by way of the repayment of loans. Neither Close nor GIL disputed Cavendish’s assertion that it was entitled to commission by reference to that amount. However, GIL disputes that Cavendish is entitled to commission by reference to any other sum apart from the cash received.

In the Engagement Letter Cavendish described “the way in which we would operate a trade sale exercise, as well as setting out our thoughts on valuation and confirming details of our fee arrangements”. Under the heading “Valuation” it said this:

“Based on our specific experience of the sector and our wide experience of selling businesses, we would expect a private company of Tractiv’s size to attract an earnings multiple of between 6 to 7 times earnings before interest and tax. Based on the adjusted profits before taxation of £2.1 million for the year to 31 March 2005, we would expect a value for Tractiv of between £14 million and £15 million.

We would stress that this is only our estimate of the valuation which Tractiv would achieve if it were placed on the market, based upon the information provided by you and our discussions. The valuation is given solely for the purposes of our discussions and it should not be relied upon by you nor should it be released to third parties. Clearly, we cannot guarantee that the price will be achieved nor indeed that, with the right purchaser (i.e. one able to extract significant cost savings), it could not be exceeded.”

Then the letter dealt with the basis of Cavendish’s fees. Apart from a non-refundable retainer, and out of pocket expenses, the transaction fee was to be 1.65% of the consideration up to £13.5 million, and 5% thereafter, with a basic minimum fee of £200,000. This required a definition of consideration, for which the letter included the following paragraph:

“For the purposes of calculating the Transaction Fee, purchase consideration is defined as the gross amounts received by the shareholders in cash or in kind, including the settlement or assumption of any shareholder liabilities and bank loans and pre-acquisition dividends or other payments made to shareholders to extract cash from Tractiv prior to disposal.”

Much of the argument before us turned on the significance of the reference to bank loans in this paragraph, but it is common ground that it must be read and understood in the context of the Engagement Letter as a whole and of the admissible factual material. The Company had liabilities to its bank, Barclays, exceeding £5 million, as well as hire purchase liabilities of about £700,000. The decision against which the appeal is brought has the effect that both of these amounts are to be included in the sums by reference to which Cavendish is entitled to commission, as is the value referable to Mr Howat’s shares.

The appeal is against an order of His Honour Judge Stephen Davies, sitting as a Deputy Judge of the Chancery Division in Manchester, made on 22 July 2008, to give effect to a judgment delivered orally immediately on the conclusion of a two day trial. The judge ordered GIL to pay to Cavendish £116,480 and interest, as the balance of the sum claimed in respect of commission. GIL admitted that £38,730 was due, because there was a minimum fee entitlement, so the dispute was as to £77,750.

The judge refused permission to appeal, but I gave permission to appeal on one ground on a consideration of the papers. Recently GIL applied to add a further ground of appeal. This was opposed at the hearing before us, but we gave permission, and I will explain our reasons for doing so in the course of this judgment.

The Engagement Letter, as agreed to, provided for Cavendish to represent the shareholders of the Company in seeking buyers for their shares, though it also provided for the possibility of a sale of the business and assets of the Company. The parties proceeded on the basis that the Company’s adjusted profits, before taxation, for the year to 31 March 2005 were £2.1 million. On that basis Cavendish held out the expectation of a valuation for the Company as a whole of £14 to £15 million. The valuation was given as an estimate based on information provided by the shareholders, but relied on by Cavendish at any rate to the extent of setting “the consideration thresholds”, which was a potentially significant element of the fee structure.

The judge recorded at paragraph 17 that the evidence of Mr Barker, for Cavendish, was that the Engagement Letter was a fairly standard letter which Cavendish used when it was involved in transactions such as this. Mr Barker gave evidence of his involvement in quite a large number of such transactions, in relation to all of which, he said, the engagement letter had been in substantially similar terms. The judge saw documents relating to one other such transaction, in which there were differences in the wording (it had the reference to shareholder liabilities but not to bank loans), but that dated back to 1999, before Mr Barker’s time with Cavendish.

The factual material available to both parties by the time the Engagement Letter became binding in contract included a first draft of an information memorandum about the Company which in its final form would be used in support of the efforts to attract a purchaser. Under Trading Overview, this draft gave figures of £2,083,000 and £2,222,000 for adjusted profits before taxation for the years to 31 March 2004 and 2005, and a budget or forecast figure of £2,366,000 for the following year.

The Company had been the vehicle for a management buy-in in 2002, supported by Close and by Barclays. The memorandum recorded (inaccurately as it turned out) that the loan notes were held by Close (rather than by an associated company) to the tune of £3.4 million, and that there was an unstated amount of loan indebtedness to Barclays Acquisition Finance, as well as unspecified amounts of working capital facilities and cash (actual figures were given in balance sheet format as at 31 March 2005). At two points in the document it was stated that offers were sought on a “cash free debt free” basis.

The judge heard evidence as to different bases of valuation used in transactions of this kind. He found that buyers and sellers in this kind of transaction were familiar with these approaches. Enterprise value, sometimes called deal value, or “cash free debt free”, involves stripping away any cash but including the amount of any debt to which the asset or the business is subject. The comparison was given of a sale of a house subject to a mortgage: the value to the owner is the net amount after discharge of the mortgage, but the equivalent of “enterprise value” would be the valuation of the house as such regardless of the mortgage. The £14 to £15 million estimate given in the Engagement Letter is an enterprise value figure.

I have summarised Cavendish’s entitlement to fees above, but it is right to set out the whole of the relevant part of the Engagement Letter:

“We would charge Tractiv an initial sum of £40,000 as a non-refundable retainer. This retainer is payable on confirmation of our appointment.

Thereafter, other than reasonable out-of-pocket expenses, we would charge a Transaction Fee as follows:

First £13.5 million consideration	1.65%
Thereafter	5.00%

For the purposes of calculating the Transaction Fee, purchase consideration is defined as the gross amounts received by the shareholders in cash or in kind, including the settlement or assumption of any shareholder liabilities and bank loans and pre-acquisition dividends or other payments made to shareholders to extract cash from Tractiv prior to disposal.

Should a sale of the business and assets of Tractiv occur, rather than a sale of shares, purchase consideration would equate to the total amount received by Tractiv in cash or in kind, and the assumption of debt or other liabilities.

The above fee scale is based on an indication from you that Tractiv achieved operating profits before tax and interest of £2.1 million for the year ending 31 March 2005. If in the course of the sale exercise the profitability of Tractiv falls significantly below this level, then we reserve the right to adjust, on a pro-rata basis, the consideration thresholds set out in the fee scale above to reflect the change in Tractiv’s performance.

A non-refundable fee representing 10% of the anticipated transaction fee would be payable at the heads of terms stage, with the balance payable at completion, directly out of the completion proceeds. The transaction fee would be subject to minimum fee of £200,000.”

The judge’s decision was that the definition of consideration meant that the figure was the enterprise value of the entire Company, £14.6 million, whereas GIL argues that the correct figure is the amounts received by it and Close as shareholders for their shares, directly or indirectly, in cash or kind, and without deductions for, for example, transaction costs.

One of Cavendish’s arguments in support of the judge’s decision is that, on GIL’s interpretation, there could be no realistic prospect that it would ever earn more than the minimum fee. In order to earn more than that, on GIL’s arguments, we were told that the business would have to have been valued for sale at more than £20 million. The prospect of a better figure than £14 to £15 million was not ruled out by the Engagement Letter, and Cavendish said it had considerable experience in generating an auction between interested parties, but it cannot have been supposed that a purchaser was at all likely to put forward a figure on the basis of an enterprise value of the order of half as much again.

In March 2006 all three shareholders contemplated selling their shares. By October 2006, however, when draft Heads of Agreement for the eventual sale were signed, only GIL and Close were to sell, and Mr Howat would remain as a shareholder. In the meantime it seems that Cavendish had ceased to be actively involved in promoting the sale, but this did not affect its right to a fee on completion of the eventual sale, and there was no alteration to the agreement constituted by the Engagement Letter under which Close, GIL and Mr Howat were all equally liable for Cavendish’s fee. Under the SPA the sale was of 77.5% of the shares of the Company. Recital (g) explained the calculation of the purchase price as follows:

“(g)

The Purchase Price has been calculated by the Parties as follows: the Enterprise Value £14,600,000 less the Net Financial Position, with a balance deficit of £11,436,000, comprising of cash of £1,177,000 and interest bearing debt of £12,613,000, of which the Loan Stock accounted for £4,550,000 and bank borrowings and hire purchase accounted for £8,063,000. Accordingly, as of March 31 2006, the Equity Value is equal to £3,164,000, and the Purchase Price for the 77.5% interest belonging to the Vendors has been determined in £2,452,100;”

The SPA included definitions which should be noted, as follows:

“Enterprise Value” means £14,600,000 being the value of the entire share capital of the Company as at March 31, 2006, including the Net Financial Position;

“Equity Value” means £3,164,000, being the implied value of the entire share capital of the Company as at March 31, 2006, (i.e. the Enterprise Value, less the Net Financial Position);

“Net Financial Position” means the net financial position of the Group, as shown in the Last Accounts, which corresponds to £11,436,000, comprising of cash of £1,177,000 and interest bearing debt of £12,613,000, of which the Close Brothers’ Loan Stock Deed and accrued interest account for £4,550,000 and bank borrowings and hire purchase account for £8,063,000 million;

Close and GIL were to sell their respective shares in the Company, the price (before any necessary adjustments) being stated as £2,452,100: clause 7.1. Completion was conditional on Barclays “waiving its right to redeem the monies due to it by the Company under the Financing Facilities and consenting to the Financing Facilities’ current terms and conditions remaining unaltered, unless the GB Group decides to replace [Barclays] with other financial institutions”: see clause 3.4. At completion the purchaser was to procure that the Company repay the loan stock held by Close Investment Partners Ltd: see clause 4.3.3. Clauses 6 and 8 provided for the adjustment of the purchase price following a review of the latest financial statements within 30 days after completion.

It seems that, in practice, the purchasers did not require that the Barclays’ loan stock and facilities should remain in place after completion, but that they made separate arrangements for financing the Company. We do not know the details of how that was done, but we can take it that, at or soon after completion, the indebtedness to Barclays was paid off, and replaced by debt to another lender.

The completion statement on the sale, after adjustments, showed that the eventual price payable to Close and GIL was £2,110,864. This was calculated from the Enterprise Value of £14.6 million as follows. The net financial position was deducted, originally at £11,436,000 but after review at £11,756,000. This was made up of £792,000 cash, £5,063,000 Bank debt (Barclays), £5,197,000 for the Close loan notes and £704,000 hire purchase liabilities. There was also an adjustment of £36,000, which represented an agreed contribution of that amount by the vendors towards audit costs associated with the sale and borne by the Company, as extraordinary costs under clause 8.6. That left a total purchase price of £2,808,000 of which 77.5% was £2,176,000. From that position, there was a “reconciliation to final figures”, showing a further adjustment for the actual Close loan note figures, deducting an extra £84,304. That gave a final equity value of £2,723,696, of which 77.5% was £2,110,864. GIL received £885,201 for its shares, £1,225,663 was payable to Close for its shares, and £5,281,304 was payable to Close Investment Partners Ltd in respect of the loan notes.

Cavendish claims to be entitled to its transaction fee on the basis of a consideration of £14.6 million, namely the Enterprise Value, which was the starting point for the calculation under the actual sale. The judge held that this was correct. GIL disputes this. It contends that the consideration consisted of the price payable for the shares themselves, together with the amount payable for the Close loan notes, but not (a) the sum outstanding to Barclays, either on loan notes or on overdraft (£5,063,000 and £792,000 respectively), nor (b) the hire purchase liabilities (£704,000), (c) the £36,000 adjustment as regards the audit fee, or (d) the notional sum attributable to Mr Howat’s shares (£612,832).

One point taken against these arguments is that it is inconsistent to accept that the Close loan notes should be counted in but to argue that the Barclays loan notes, or overdraft, should not. Mr Randall Q.C. for GIL acknowledged that this might be so, but pointed out that the concession had been made in GIL’s pleadings at an early stage, and there was no attempt to resile from it and, in any event, it would make no difference to the figures whether the Close loan notes were counted in or not, because it would not bring the consideration above the level at which more than the minimum fee would be payable. If the Barclays borrowings are to be included, then the minimum fee was exceeded, and if in addition either the value of the Howat shares or the HP liabilities were included, then the 5% rate would come into play.

In the Particulars of Claim, Cavendish alleged that it was entitled to its transaction fee at the stipulated rate on £14.6 million. GIL admitted the sale but asserted that the consideration was not £14.6 million but rather £2,110,864. Paragraph 24 admitted that £5,281,304 paid in respect of the Close loan stock was included in the consideration for this purpose, and asserted that accordingly the total consideration was £7,392,168. Issue was therefore taken with Cavendish’s assertion that any other sum was properly included in the consideration. Cavendish took issue with this in general terms in its Reply. Cavendish sought Further Information on the point, but in terms such that the response did not clarify the matter.

It seems that at the trial most attention was devoted to the issue of the bank indebtedness. The judge did not deal separately with the other items which GIL sought to have ignored in favour of the actual amount received by itself and Close, plus the Close loan stock. However, he concluded that the correct figure was the enterprise value, so that it was unnecessary to consider any deductions from that amount.

The single ground of appeal on which permission was originally granted took issue with the inclusion of sums paid in settlement or assumption of the Company’s bank debts. Logically, if the Barclays debt was excluded, it would have followed that the other items should be excluded as well, but they were not addressed in terms. The additional ground of appeal for which permission was granted at the hearing is to the effect that, even if the amount of the bank debts was properly included, nevertheless the consideration is not to be equated with enterprise value. Though not there stated in terms, the point is to exclude the HP liabilities, the notional value of Mr Howat’s shares, and the £36,000 adjustment in respect of the audit costs.

Miss John for Cavendish resisted the application, partly because it was too late. It seemed, however, that the only point on which an objection could be made which would have substantial force was that other evidence would have been called at trial if it had been known that the point was in issue. Miss John made that submission, but it seemed to us that this was not persuasive. It was for Cavendish to adduce at trial all evidence relevant to proving all aspects of its case. There was no admission except as regards the Close loan stock. If there was evidence which could have a bearing on whether, on any given reading of the contract, the HP liabilities (for example) were included, it was for Cavendish to adduce it. So adding this ground of appeal did not amount to taking a wholly new point which could not have been anticipated, if there could have been relevant evidence. It is doubtful whether there could in any event have been such evidence. Accordingly, it seemed to us right to allow the point to be argued on appeal.

Miss John made the point that Cavendish could not expect necessarily to have any involvement in the detailed negotiations of any sale agreement (and in this case it had no such part at all), and that accordingly it would be in its interests to draft the terms of the Engagement Letter in such a way as to cover the risk that the sale agreement might be formulated in a way which could affect (whether or not in an artificial way) Cavendish’s entitlement to its fee. For that reason the Engagement Letter should be construed broadly. This is supported both by the tenor of the Engagement Letter as a whole, and by the reference to “gross amounts” received by shareholders, and to “in cash or in kind”. She submitted that this shows the approach of the Engagement Letter is to look at gross consideration, whereas GIL’s reading is a “net receipt” approach, which does not give proper effect to the terms of the document as a whole.

She also stressed the point already mentioned that, on GIL’s reading, the reference to the higher rate of 5% was purely theoretical, since there could be no real expectation that the consideration would ever exceed £13.5 million, and indeed it was most unlikely that Cavendish would ever earn a fee higher than the minimum. Accordingly, the parties must have intended that the consideration would be the amount which represented the Enterprise Value, as fixed for the purposes of the actual sale. The significance of the ratchet factor is underlined by the provision by which Cavendish reserved the right to renegotiate that element if it turned out that the Company’s operating profit for the year to 31 March 2005 was significantly below £2.1 million. On GIL’s reading, the Company’s profitability would probably have had to have been significantly higher in order to generate a price which would bring the higher rate of fee into play.

She pointed out the reference in the part of the Engagement Letter dealing with fees to the alternative possibility of a sale of the business and the assets, where the consideration would be the sum received by the Company in cash or in kind, together with the assumption of debt or other liabilities, which would include the Company’s debt to its bank. In that case the debts and other liabilities would be assumed by the purchaser of the assets and business. She also pointed to the fact that all parties knew, before the Engagement Letter became binding in contract, that the Company did have significant bank indebtedness, not only to Close but also to Barclays. Cavendish would not have known how that debt would be treated in the eventual sale, but all would have recognised that it would be a factor in the transaction.

Further, she contended that the shareholders’ interest in a company is necessarily and always affected by the amount of the company’s liabilities. That is consistent with the reference to bank loans in the Engagement Letter. In that context there was nothing artificial, she submitted, in treating the Enterprise Value for the purposes of the particular transaction as being the consideration relevant for the Engagement Letter. Equally, given that the Engagement Letter was entered into by all three shareholders, all of whom were to be liable equally for the whole of the transaction fee, and that Cavendish was engaged to find a buyer for all the shares (or for the entire business and assets) and that the change to a sale of 77.5% of the shares was made without any reference to or agreement with Cavendish, there is no reason why Cavendish should be entitled to less than its agreed fee rate on the entire Enterprise Value.

Mr Randall, leading Mr Pepperall who had conducted the case for GIL below, focussed more closely on the words in the paragraph in which consideration (or purchase consideration) is (as it says) defined for the purposes of the Engagement Letter. He pointed to the phrase “amounts received by the shareholders”. He said that the point that these amounts were to be gross meant no more than that there was to be no set-off or deduction of, for example, costs of the sale incurred by the shareholders. He accepted that receipts might be direct or indirect, and in cash or in some other form: money or money’s worth. He submitted that the phrase “the gross amounts received by the shareholders in cash or in kind” (which I will call the primary phrase) governs the definition, and that nothing which cannot fairly be said to be an amount which, in a relevant way, is received by one or more shareholders can be included in the consideration on which the transaction fee is calculated.

On that footing he argued that none of the disputed items could fairly be regarded as an amount received by the shareholders, in any sense. The bank liabilities, if paid off, are received by the lender, and likewise the HP liabilities, if settled, are owed to and received by the relevant finance company. The £36,000 was not received by anyone, nor was the 22.5% of the overall figure that would have been attributed to Mr Howat’s shares, had they been included in the sale.

He accepted that the words that follow, “including the settlement or assumption of any shareholder liabilities and bank loans and pre-acquisition dividends or other payments made to shareholders to extract cash from Tractiv prior to disposal”, which I will call the “secondary phrase”, must also be taken into account, but submitted that they are governed by the primary phrase, and that, being introduced by the word “including”, they do not suggest that what follows widens what would otherwise be the normal reading of the primary phrase. Rather it would introduce a non-exhaustive list of ways in which sums might be received by a shareholder. The last two items in the list are clearly of that kind, and the settlement or assumption of shareholder liabilities could easily be as well. He accepted that it is not so clear why “bank loans” is included here, but submitted that it cannot expand the phrase so as to make it something other than an illustrative list of items that would in any event have been included.

He accepted that, on his argument, the Close loan notes might not properly be included, even if they had been payable to the particular Close company which also held the shares. He argued that this did not matter, since it did not in any event affect the amount payable to Cavendish.

As for the argument that, on this basis, Cavendish could never have expected to get a fee at a rate higher than 1.65%, or indeed more than its minimum fee, he submitted that this may well be right, but that an unfulfilled or even unfulfillable hope or expectation did not and could not make the matter so absurd and uncommercial as to prevail over the proper meaning of the words of the definition of consideration.

The judge said it was right to start with the definition of consideration in the contract, to look at that in the context of the contract as a whole, and to consider all relevant factual background material, in order to reach a conclusion as to the meaning of the central text, the words of definition (paragraph 51).

He drew from the use of the word “gross” a contemplation of the totality of the consideration received. He also saw that indirect benefits could be relevant, which is not controversial, but went on to say, at paragraph 53:

“It seems to me that both those words [“gross” and “in kind”], together with the reference to settlement or assumption of shareholder liabilities and bank loans, tend to indicate that one should not put too much emphasis on the word “received”, because in my judgment it is apparent from the clause, read as a whole, that it would be satisfied by payments being made or benefits being conferred which were not received directly by the shareholders.”

As regards “including”, he felt unable to place any particular reliance on the word (paragraph 54):

“It seems to me that the use of a word such as “including” in a definition such as this can be used in a number of different ways. Sometimes it can be used to give examples from which the overall meaning of the preceding general words can be more easily ascertained. Other times it can be used to identify particular cases which were thought by the parties to be sufficiently important to require specific mention in the contract definition. There are other occasions where it would be used in order to identify specific situations about which there might be some doubt as to whether or not they were included by the general definition and to make it clear that those particular cases were to be included, regardless of the true extent of the general definition. It seems to me that in this case, I am not confidently able to identify which of those reasons is provided for using the word “including” and therefore I gain no particular benefit from the use of that word in itself.”

He then considered the pattern of the secondary phrase. He had heard argument (as we did) as to whether the four elements in the secondary phrase should be read as a single list of four items, or as a list containing two pairs of items. “Shareholder liabilities”, at least, is governed by “settlement or assumption”, and perhaps “bank loans” is as well. “Other payments made to shareholders to extract cash … prior to disposal” does not seem to go with “settlement or assumption”, but “pre-acquisition dividends” does seem to belong with the fourth item, both being examples of a payment to shareholders and a way of extracting cash from the Company before the disposal.

The judge favoured the reading of the phrase as comprising two distinct pairs of items (paragraph 55). I am inclined to agree. Thus, “shareholder liabilities” and “bank loans” belong together for this purpose, and are governed by the words “settlement or assumption”. He only had to consider this pair. He held that “shareholder liabilities” must be liabilities of the Company to a shareholder, such as the Close loan notes (on the assumption that they had been held by the same company as held the shares). As for “bank loans”, he rejected as implausible the theory that they might be loans made by a bank to a shareholder, on the footing that it was unlikely that a purchaser would undertake to pay or assume liability for something of that kind, unconnected with the transaction. In order to find consistency within the phrase, he considered that, just as “shareholder liabilities” would be liabilities of the Company to a shareholder, so “bank loans” would be liabilities of the Company to a bank.

He held that this preliminary view of the construction of the definition was supported by the apparent expectation of the parties that the consideration might exceed £13.5 million, which it could not be expected to unless the bank indebtedness was included.

He said this at paragraphs 71-2:

“71.

It also seems to me that the parties in the position of the parties to this transaction must be taken to have been aware that the ways in which a sale and purchase of a company shareholding can be structured can be many and multifarious. So that, for example, one could have a case where the full enterprise value would be paid to the seller, who would then use the value in part to discharge existing liabilities such as bank loans and so on. In which case, they are obviously, in my judgment, within the definition of purchase consideration in this case. One could also have the alternative situation where the buyer would discharge those liabilities directly and then deduct those liabilities from the amount paid to the seller. In which case, there would not be a physical receipt of those monies and on the defendant’s contention they would fall outside the definition of purchase consideration.

72.

Yet it seems to me that there is no essential difference between the two different structures of the share transaction. It does seem to me that a construction which produced a result that in the former case they counted for the definition of purchase consideration but in the latter case they did not, would be one which would be uncommercial. Therefore, I would strive to avoid such a result, unless I am constrained to do so by the clear words of the phrase in question.”

Later, at paragraph 74, specifically in relation to bank indebtedness, he said this:

“I conclude, as a matter of pure construction of the definition of purchase consideration, that bank loans were objectively intended to refer to or at least to include the amount of any bank loan which as part of the sale and purchase transaction was either paid off, whether by the purchaser or vendor or responsibility for which was assumed by the purchaser, in the sense that the bank loan was not discharged on completion but remained in the company. In other words, it seems to me, that where the offer which is accepted is on an enterprise or cash free, debt free basis, then the reference to bank loans will mean that the purchase consideration will include the amount of any bank loan debt which is in the company at the time and which is provided for as part of the payment terms of the sale and purchase transaction. It seems to me that that construction follows either by looking at the agreement by itself or taking into account the relevant admissible factual background.”

He then proceeded from this conclusion to the more general question of what was the purchase consideration for the purposes of the Engagement Letter. He said at paragraph 76 that it was the enterprise value, “because that is the cash free debt free valuation which forms the basis of the offer which was accepted under the heads of agreement”. The interest bearing debt was netted off from the gross sum, and as part of the SPA transaction, the Close debt was repaid and the bank loan was “either continued and therefore assumed by the new shareholders”, or “paid off and replaced by a bank loan arranged direct by the new shareholder, and therefore settled as part of the transaction”. For that reason he held that the Barclays debt as well as the Close debt fell within the definition, and that the consideration under the Engagement Letter was therefore £14.6 million.

In their respective clear and concise submissions, Mr Randall and Miss John demonstrated that there is a substantial tension within the terms of the Engagement Letter, between indications that the consideration was expected to be potentially of the order of £13.5 million or more, on the one hand, and the emphasis in the definition on the sums received by the shareholders, which did not, and could not reasonably have been expected to, approach anywhere near that figure, on the other.

Taking by itself the specific definition of the consideration, there is much force in Mr Randall’s contention that the guiding indication is the focus on what the shareholders received, accepting that it is to be seen as a gross figure, and to include sums received by any shareholder whether directly or indirectly, and whether in cash or in kind. That would include the sums payable in respect of the shares themselves, but it might also include sums paid to a shareholder in another capacity as a term of the transaction, such as the repayment of the Close loan, ensuring which was no doubt part of Close’s objective in entering into the transaction. It is more difficult to see why and how it could include sums payable by the Company to a third party, such as Barclays, or the HP finance company, quite apart from sums not paid at all, such as the notional sum attributable to the shares of Mr Howat which, in the event, were not sold but retained.

Looking more closely at the definition, the inclusion of the words “bank loans” is undoubtedly puzzling. The words “shareholder liabilities” pose a question as to whether the liabilities are to be owed to or by the shareholder. Either could make some sense: if the liability is owed to the shareholder, it would be owed by the Company, and for the purchaser to settle the debt or to assume liability for it would or could be of value to the shareholder. Similarly, if the liability were owed by the shareholder, it would be of benefit to it for the liability to be settled or assumed (assuming that this was done without recourse) by the purchaser. It is not obvious why such a liability should be so assumed or settled, unless it were a liability of the shareholder to the Company, or perhaps a secondary liability such as a guarantee of a debt owed by the Company. But either way, it would be a way of conferring a benefit on the shareholder which would not amount to a direct payment. It is understandable that Cavendish should wish to cover such a possibility.

The judge read the phrase as meaning only liabilities of the Company to a shareholder. That may be correct, and his reasoning has force. I am not sure that it is necessarily so limited, though I can see that it is more likely as a matter of fact that, if liabilities having something to do with a shareholder are to be settled or assumed as part of the transaction, they would be liabilities of the Company to a shareholder.

On any basis, the reason for the reference to “bank loans” is more obscure. In principle, it seems that it would not be a bank loan which is a liability of the shareholder, because if it were, it would, or might, be covered by “shareholder liabilities”, depending on the view one takes of the scope of those liabilities. If it is not a loan which is a liability of the shareholder (primary or even secondary, as guarantor), then in what sense does the assumption or settlement of that liability generate the receipt, in any sense, of any sum by the shareholder?

As Mr Randall submitted, where a company has an overdraft or other credit facilities from a bank, and the shareholding in the company changes hands, then, assuming that the vendor shareholder is not personally liable, for example as guarantor, on the debt, and is not the bank itself, it is immaterial to the seller what happens to the liability to the bank, and what happens to it has no bearing on an assessment of the value of the shares. If the facilities continue in being, the purchasing shareholder does not assume liability for them; if they are paid off and replaced by lending from another bank, equally the purchaser does not assume that new liability, which remains that of the company. Accordingly, in strict legal analysis, there is force in Mr Randall’s criticism of some observations in the judgment, at paragraphs 29 and 76, the latter being quoted at paragraph [44] above, where he spoke of the bank borrowing being assumed by the purchaser. Strictly, it is not, but in economic terms, it is, since it affects the value of the shares in the purchaser’s hands, just as it did in those of the vendor.

I see some substance in Miss John’s argument, and the judge’s conclusion, that the inclusion of the phrase “bank loans” shows Mr Randall’s reading of the definition of consideration to be too narrow. But for that phrase, his submissions as to the meaning of the definition itself would be compelling, though it would still present a difficult issue as to how it could be reconciled with the apparent contemplation of the parties that Cavendish might reasonably expect to be able to earn more than the minimum fee, and to achieve a sale at a price sufficient to bring into play its higher rate of fee. However, the presence of these words could be an indication that the Company’s indebtedness is relevant to the definition of consideration, even if it is not owed to a shareholder.

But that is not the end of the matter. According to the words of the definition, to be relevant the bank loan indebtedness must be assumed or settled as part of the transaction, presumably by or at the expense of the purchaser. That makes sense in relation to a debt such as the Close loan notes. It would fit if for some reason the purchaser had to take a personal liability, for example, by replacing the vendor as guarantor. But where the indebtedness is that of the Company, and if it remains in place notwithstanding the share sale, it is difficult to see why it should be regarded as having been settled or assumed by anyone. The Company remains the person liable for it, and no-one has either settled it or assumed any other liability for it. If in such a case the Company’s bank liability is within the phrase, it amounts to saying that the consideration will include all of the Company’s liabilities to any bank, regardless of what happens to the liability, and there is no content to the words about settlement or assumption, because the liabilities would be included in any event. If, as in the case of the Close loan notes, they are paid off, that is settlement, but if they are not paid off, so that they remain in being as liabilities of the Company, then they are to be regarded as having been assumed. That gives no real meaning to the word “assumption”, and deprives the phrase about settlement or assumption of any point. The provision would say, in effect, that the consideration includes all of the Company’s liability in respect of bank loans.

That point fits in with another of Mr Randall’s submissions, namely that, since (as the judge held) all these parties well understood concepts such as enterprise value, if they had intended that the consideration should be the enterprise value, they would have said so much more simply and specifically. The judge rejected this argument at paragraph 73, on the basis that it would require some definition, but I do not find that objection very powerful, since some definition was required, and was provided, in any event.

Accordingly, it seems to me that the judge’s reliance on the reference to bank loans puts too much weight on that phrase. To conclude that, because of the inclusion of those two words, the definition of consideration includes all of the Company’s liabilities to any bank, whatever happens to those liabilities on the sale, puts a considerable strain on the words of the definition of consideration.

The judge did not address separately the other items which have been the subject of submissions to us: the HP liabilities, the £36,000 audit adjustment and the notional value of Mr Howat’s shares. Mr Randall’s submission was simple: none of these was “received” by the shareholders in any sense. Miss John submitted that the HP liabilities were in the same category as bank loans, even though the liability is not, strictly, by way of loan. She categorised the £36,000 adjustment as a cost of the transaction, to be borne by the shareholders, but not deducted from the consideration because of the word “gross”. As for Mr Howat’s shares, she pointed out that Cavendish was retained by all the shareholders to find a buyer for all their shares (or for the business and assets as a whole), and that the fee structure was negotiated and fixed on the basis that this would be the transaction. If Cavendish had been told that a sale of 77.5% might be contemplated, they might have agreed to proceed on that alternative basis, and to entitlement to a corresponding proportion of their fee, but they would have been entitled to insist that the ratchet figure of £13.5 million would also be applied on a proportionate basis, i.e. 77.5% of that figure would be used instead of the whole.

The difficulty as regards Cavendish’s arguments on these items derives from the use in the definition of the words “amounts received” by the shareholders. If one can accept the proposition that a liability of the Company to a bank is to be included even though it either remains in place, so as to continue to be binding on the Company, or it is repaid and replaced by another such facility from another bank, then it may not be difficult to conclude that the same applies to HP liabilities of the Company, which could with as great, or as little, ease be regarded as assumed as part of the transaction. But if the sale extends to only 77.5% of the shares, the remaining 22.5% continuing to be held by the same shareholder as before, so that nothing is paid by anyone to anyone else in respect of those shares, I do not myself see how the notional value of those shares can be said to have been received by anyone in any sense, so as to form part of the consideration as defined. Miss John argued that the continuing shareholder would benefit from the repayment of the Close loan notes and other liabilities. So far as that is concerned, whether that shareholder does benefit depends on the arrangements for their repayment. If they are merely replaced by other indebtedness, whether to the purchaser or to another lender, the position seems to be neutral as regards the continuing shareholder.

It seems to me that it is not possible to construe the definition of consideration so as to include a notional figure, not in fact paid by anyone, attributable to Mr Howat’s shares. The judge’s conclusion that, because bank loans are included, therefore the whole £14.6 million is the right figure, seems to me to overlook the need to identify a receipt of some kind as regards this element in the calculation, which cannot be done because this amount was not paid or received by anyone.

For the same reason I agree with Mr Randall as to the small item of the £36,000 adjustment for the vendors’ contribution to the audit costs. This £36,000 was not paid by the purchasers and was not received by the vendor shareholders. It is not in the same category as the vendors’ costs of the sale (such as payments to their own advisers), because the cost was not incurred by the vendors. It is a simple adjustment to the overall price, and cannot be brought into the account.

So I come back to the bank loans and the HP liabilities. The latter are not loans, as a matter of law, and so they are not covered by the express words “bank loans”, but they share with the Barclays debt the characteristic that they were liabilities of the Company as regards which it did not directly affect the vendor shareholders whether they were paid off or not. The Barclays debt was specifically referred to in the SPA, and we know that, despite that reference, it was in fact paid off and replaced with other facilities from a different lender. The HP facilities were referred to in the SPA, in the definition of Net Financial Position and in recital (g), but not dealt with in any special way, and I assume that they remained in place, unaffected by the transaction.

If Mr Randall is right, and these items are not part of the definition of consideration, then the intention which is apparent from the Engagement Letter, that Cavendish might receive more than its minimum fee, and might earn a fee at a rate of 5%, was never realistic. The question is whether that factor can overcome the limitations in the wording adopted by the parties to define the consideration for the purposes of the transaction fee. These items were not in any realistic sense received by the shareholders, however broadly one considers the scope of the benefits they derive from the transaction. If one ignores the fact that the Close loan notes were held by a different company from that which held the shares, the repayment of those loan notes was a benefit derived by a shareholder from the transaction. In one sense it might be odd to see that these loan notes are treated differently for the purposes of this transaction from the Barclays Acquisition debt, which was originally incurred for the same purpose. However, the use of the words “received by the shareholders” does seem to me to make a material difference, sufficient, for example, to account for a different treatment of the Close debt and the Barclays debt respectively. I would accept that in construing the Engagement Letter, it is fair to assume that Cavendish was seeking to protect itself against the possibility that the particular way in which the transaction was structured might operate to its disadvantage, without it being in a position to protect itself at that stage. But the question remains as to what is the fair meaning, in their context, of the words used for that purpose.

On the one hand, the apparent contemplation that Cavendish might earn more than its minimum fee, and enough to get over the £13.5 million threshold, points in favour of including the Barclays debt, and also the HP liabilities, since on what was known to the parties at the relevant time, those would be likely to be essential for that purpose. On the other hand, to include those liabilities does not fit with the words of the definition because neither of them was received by the vendor shareholders in any sense, whatever happened to them on the sale, and because to include them on a more general basis deprives the reference to “settlement or assumption” of any content in this regard. The liabilities would be included whether they were paid off (which would be a settlement) or not (which could only in a very extended and artificial way be said to be an assumption of the liability). There would therefore be no point in the inclusion of those words.

The judge regarded the reference to “gross receipts” as pointing to a broader view of the transaction, not looking narrowly at what the shareholders received. He also said that he got no help from the use of the word “including”. With respect, it seems to me that he could have got more help from both of these words than he did. I agree that one should look in a broad way, rather than narrowly, at what the shareholders received, but the judge’s conclusion seems to have no regard to the question whether anything was received by a shareholder at all: most obviously by including the notional value of Mr Howat’s shares which was neither paid nor received. The word “including” also seems to me to carry some weight. At the very least it indicates that the secondary phrase contains examples of what is already included within the primary phrase.

It is a fair point that if the transaction had taken the form of a sale of the business and assets, the purchaser might well have assumed liability for, or settled, such liabilities as the bank loans. Economically such a transaction might have been similar to a sale of shares if all the shares in the Company had been sold. However, I do not find it helpful to consider what would have been the position under a transaction which did not take place, and which does not ever seem to have been seriously contemplated by the parties, and was certainly not economically analogous to that which did take place.

In the end I come to the conclusion that the meaning for which Cavendish contends, and which the judge accepted, strains the words of the definition too far, and that the consequent frustration of Cavendish’s expectation, apparent from the tone and terms of the Engagement Letter, that it had a reasonable prospect of earning a fee at the rate of 5%, and in any event more than its minimum fee, is not a sufficiently powerful context to impose on the words of the definition a meaning which, in my judgment, they cannot reasonably bear.

The judge’s conclusion was that the consideration under the SPA, for the purposes of the transaction fee to which Cavendish was entitled, was the enterprise value sum which was the basis of the purchaser’s offer, on the cash free debt free basis on which offers were invited. With respect I do not find it possible to draw that out of the definition of consideration or to reconcile it with the deliberate choice of the reference to amounts received by the shareholders, however widely one interprets such receipts. The notional value of the Howat shares and the £36,000 extraordinary costs adjustment were not received by anyone. The bank loans and the HP liabilities were not received by any shareholder, and were not, as I see it, settled or assumed by anyone as part of the transaction in such a way as to count as a receipt by a shareholder.

I would therefore allow the appeal, and hold that Cavendish was only entitled to its minimum fee, in the events which happened.

I agree.

I also agree.

The Appellant do have permission to amend its Notice of Appeal in accordance with the draft filed on 23^rd March 2009.

This appeal be allowed and the Order of His Honour Judge Davies below dated 22^nd July 2008 be set aside.

In substitution for the said Order below, it is ordered and adjudged as follows:

The Respondent do pay the Appellant’s costs of this appeal, those costs being assessed summarily in the amount of £40,000.

The sum due under paragraph (4) above is to be set off against that due under paragraph (3)(a) above