Rust Consulting v PB

This case is about an indemnity clause in an agreement for a transfer of assets and liabilities between two wholly owned subsidiaries in a corporate group. The facts are unusual. The group is the Parsons Brinckerhoff (or PB) group of companies. The group operates worldwide and has its principal headquarters in the USA.

The group includes a UK holding company which is the immediate parent of the claimant, Rust, and the defendant, PB Limited. Rust used to carry on business as geotechnical consultants. In 1995 it was engaged by developers, whom I will call Eagle, to provide geotechnical engineering services in connection with the proposed development of a shopping centre in Ebbw Vale. The development was built between November 1996 and September 1997.

Rust ceased to trade at the end of 1996. On 5 September 1997 Rust and PB Limited entered into an Asset Purchase Agreement (the APA agreement). Rust's accounts for its final year's trading were no doubt available in draft but were formally signed off on 27 October 1997. The broad purpose of the agreement was an intra-group transfer of Rust's assets and liabilities, as at the date on which it had ceased trading, at a notional valuation with the transferee taking over responsibility for any uncompleted contracts. The recitals included:

Clause 3 is the critical clause. It provided:

Assets, contracts, effective date, liabilities and market value were defined in the agreement as follows:

“‘Assets’: the whole of the property, undertaking, rights and assets of the Vendor whatsoever and wheresoever situate;

‘Contracts’: all contracts, orders and commitments of the Vendor or any of its Subsidiaries under which the obligations of all the parties thereto had not at the Effective Date been fully performed;

‘Effective Date’: close of business on 31^st December 1996;

‘Liabilities’: the book debts and other liabilities (including VAT thereon) owing by the Vendor at Completion insofar as they are attributable to the Business, the Assets, the Subsidiaries or the Contracts and insofar as they are reflected in the accounts of the Vendor or any of its Subsidiaries at the Effective Date;

‘Market Value’: the aggregate price reasonably obtainable at the close of business on the date of Completion on the open market on an arm’s length basis for the purchase of the Assets and the assumption of the Liabilities"

The balance sheet in the audited accounts for the year ended 31 December 1996 showed a net asset value of £1,000, which was itself referable to the sale price in the agreement. The profit and loss account showed an accumulated deficit at the year end.

Ten years later, by a letter dated 28 September 2007, Eagle gave a notice to Rust of a claim against it. It was alleged that Rust's advice had been negligent and had led to the buildings suffering substantial structural damage. On 13 November 2007 Eagle issued proceedings against Rust and another firm of consulting engineers, alleging negligence on the part of both firms and claiming damages of a little under £8 million plus interest.

Rust had no assets except its entitlement to be paid £1,000 under the APA, which unsurprisingly it has not been paid, and whatever rights and indemnity it might have under the APA. By early 2008 Rust had incurred legal costs in the defence of the claim in excess of £1,000. The bill was paid by the principal UK operating company in the PB group, which therefore became a creditor. Rust was then placed in creditors' liquidation.

Within the PB Group it was decided that the defendant, PB Limited, would take over the conduct of the defence, and it did so with the consent of the liquidators. On 28 November 2008 the liquidators, represented by solicitors appointed by PB Limited, consented to judgment being entered for Eagle against Rust for a total sum of £8,069,822. It is common ground that this represented 100 per cent of the maximum damages claimed by Eagle. Before doing so the solicitors wrote to Eagle's solicitors stating that they did not believe the claim to be worth as much as that, but that Rust was insolvent and had no cover.

Eagle's solicitors set about investigating what indemnities might be available to Rust. During that process they learned of the existence of the APA and obtained a copy of it. They pressed the liquidators to claim on the indemnity agreement, but the liquidators said that they had legal advice that the indemnity did not cover the judgment. Eagle then used its position as the only significant creditor to have the liquidators replaced. Rust through its new liquidators then sued PB Limited. PB Limited raised a number of defences. The parties agreed a long list of preliminary issues which led to a hearing before Akenhead J on 11 November 2010. He delivered a judgment on 21 December 2010, against which this is a second appeal. He considered that the list of issues was over-lengthy and he pruned it. PB Limited's first defence was that any liability of Rust to Eagle was not within the indemnity clause because it was not "reflected within the accounts" of Rust so as to be within the definition of liabilities. Akenhead J decided that point against PB Limited and his decision was upheld by this court, [2011] EWCA Civ 899. He also held that on its proper construction the indemnity against all proceedings, claims and demands in respect of liabilities was limited to actual liabilities. He added:

Under his judgment Rust could not rely on the judgment as between Eagle and Rust to establish that its liability was an "actual liability" unless the circumstances leading to the judgment being entered gave rise to an estoppel. The estoppel issue he adjourned to another hearing. That issue was decided by Edwards-Stuart J in a judgment handed down on 24 June 2011.

Edwards-Stuart J went into the reasons why PB Limited had caused Rust to submit to judgment. The PB Group had received legal advice that the defendant was not bound to indemnify Rust under the APA, but it was also concerned about the group's insurance position. In short, its concerns were that the group had insurance cover subject to a deductible of US $15 million. At that time the sterling dollar exchange was fluctuating heavily. It was contrary to the group's interest to allow the claim against Rust to go through the $15 million barrier because that might cause the group's insurers to undertake the defence of the claim and then recoup the amount paid in settlement within the deductible plus defence costs, from the group. Better therefore from the group's view to settle on any terms below the equivalent of $15 million, in the belief that PB Limited would not be liable to Rust, and therefore the judgment would simply go unsatisfied.

After reviewing various authorities, Edwards-Stuart J held that for an estoppel to arise in circumstances where the indemnifier had agreed to a compromise of a claim, it was essential to show that the indemnifier had acted in the knowledge or expectation of a claim being made against him under the agreement. Accordingly PB Limited was not estopped from denying that the judgment reflected the true state of affairs between Eagle and Rust with the consequence that if Eagle wished to prove that Rust was in truth liable to Eagle, Eagle must now seek to do so. He considered that this met the overall justice of the case because the alternative would be to give an unmerited windfall to Eagle.

Rust appeals against the judgments of both Akenhead J and Edwards-Stuart J. The matter has come on in the staggered fashion which I have described -- that is to say two judgments in the Technology and Construction Court followed by two appeals to this court -- because initially it was thought that the best method of case management would be to isolate the issues in the way that was done, and after his judgment Akenhead J extended the time for appealing in respect of the matters with which we are now concerned until after the determination of the estoppel issue by Edwards-Stuart J.

I begin with the question of construction decided by Akenhead J. David Thomas QC submitted that the claim by Eagle that Rust was liable to it for breach of contract, the proceedings to enforce that claim and the resulting judgment, fell within the indemnity clause on a proper reading. Andrew White QC submitted to the contrary that the judge's construction of the indemnity clause was correct; unless the alleged liability was well founded, the claim and the resulting proceedings and judgment were not within the clause. This was because the relevant part of the clause begins with the words:

“the Purchaser assuming responsibility for the satisfaction, fulfilment and discharge of all of the Liabilities and the Contracts of the Business outstanding at the Effective Date...”

Unless Rust established that it was under such a liability by reference to matters other than the consent judgement, it was therefore not entitled to any indemnity from PB Limited. PB Limited was not a party to the proceedings in which the consent judgment had been entered and was not bound by it.

Mr White candidly, and in my view rightly, accepted that his argument on construction would not have been available to PB Limited if the part of the clause referring to proceedings, claims and demands had come before rather than after the reference to liability. Many professional indemnity policies contain clauses which provide indemnity against loss from claims in respect of civil liability incurred in connection with the insurer's business. If in this case the clause had similarly said that “the purchaser shall indemnify the vendor against all proceedings, claims and demands in respect of all liabilities of the business at the effective date”, Mr White rightly accepted that it would provide cover whether the claim was well founded or otherwise.

I am not persuaded that the ordering of the language of the clause, in such a way that the reference to liabilities precedes the reference to proceedings, claims and demands, has the effect which the judge found.

In considering the rival constructions, it is right to consider their effects. Mr White accepted that on his construction the costs of defending a claim by a third party would be irrecoverable if the defence succeeded, but recoverable if the defence failed, provided that additionally Rust established that there was indeed an underlying liability so that it was right that its defence had failed. A firm of consulting engineers entering into an agreement of this kind might regard that as a somewhat paradoxical result. Mr White also accepted that the reasonable settlement of a claim would give rise to indemnity if it were later judged to have had a 51 per cent probability of success, whereas no right to indemnity would arise if it were judged to have had a 49 per cent chance of success. I recognise that the mathematical exactness of attributing such percentages to the prospects of success of a claim is spurious, but sensible professional people want to settle claims which carry any significant risk of success on the best terms they can, often without admission of liability. These are relevant factors to consider when deciding which construction more probably gives effect to the intentions of the parties.

The judge said that there would be no point in commercial terms reflecting a liability in the company accounts, even if that was done in purely verbal terms, if there was no liability. As to that I would make a narrow and a broader comment. On the narrow point, liabilities incurred but not reported, or IBNR in insurance language, are notoriously difficult to assess, but there is nothing inherently uncommercial in accounts making reference to them. On the broader point it is important not to lose sight of the reality that under this intra-group transfer the vendor was no longer going to have any assets to meet any claims or any existence other than as shell company.

Looking at the practical implications of the rival constructions, Mr White submitted that the construction advanced by the claimant would give rise to greater uncertainties and more uncommercial consequences than the construction advanced by the defendant. I take the opposite view.

I consider that Akenhead J was wrong in his construction of the indemnity clause. In my judgment it is capable of including bona fide settlements of claims, or sums reasonably incurred in the defence of claims, whether successfully or unsuccessfully defended. I do not suggest that it follows from the construction of the clause that such indemnity will necessarily be available; a dispute might arise whether a settlement was reasonable. We were referred, as were the courts below, to a line of cases about the position where an indemnifier has been notified of a claim and given the opportunity to take over a defence but has declined to do so. However, it is in my view unnecessary to consider that line of cases in the present case for this reason.

Factually the scenario is different. In the present case PB Limited consented to the judgment in the favour of Eagle; and the liquidators submitted the judgment on PB Limited's instructions. We have not been referred to any case where a defendant agreed to a judgment against the claimant in favour of the third party, or to a settlement of the claim made against the claimant by a third party, and later sought to deny that the claimant had been liable to the third party in the amount of the judgment or agreed sum. That is a striking feature of this case, and it is perhaps not surprising that we have not been referred to another like it. I do not consider that in this case it is strictly necessary for Rust to rely on the doctrine of estoppel. It can say, simply, in its claim against PB Limited that it has a liability to Eagle under the judgment which PB Limited caused it to enter. It could, however, be said that PB Limited is estopped by its conduct from denying that Rust is liable to Eagle, although that is a more roundabout way of arriving at the same result. Mr White submitted that this would be a novel form of estoppel. I have already observed that the circumstances in this case are distinctly novel. The underlying justification for the conclusion which I have reached is that it is not, and should not be, open to a party who causes a judgment to be entered in the belief that it is in its financial interest to do so, thereafter to challenge the correctness or reasonableness of the judgment because it comes later to perceive its commercial interest rather differently and regrets its earlier calculated decision.

On the question of the overall justice of treating the defendant as estopped, if it be necessary for Rust to rely on the doctrine of estoppels, Mr White advanced a number of arguments. He submitted that it would be just for Eagle to be made properly to prove its case, reminding us of the observations below about a windfall benefit. However, it has to be borne in mind that there is a public interest in the finality of litigation. Mr White submitted that it was only fair to PB Limited to take into account that it acted under a mistaken view of its potential liability under the APA based on legal advice which it had received, and that PB Limited was motivated by considering what was best for the PB Group. The best for the PB Group was that Rust should be allowed to sink without being able to recover either from the rest of the Group or from the Group's insurers. The real possibility that Rust might actually find its liabilities to Eagle met by the Group's insurers, who would claim back the uninsured amount from the Group, was the very thing which the Group was most anxious to avoid.

I am not persuaded that the motivation of the Group to try to prefer its interests over those of Rust's potential creditors is a factor which this court should take into account in PB Limited's favour. On the contrary it should be remembered that once a company has become insolvent the interests of the shareholders take second place to the rights of creditors.

I do not see why it should make a difference that PB Limited acted as it did under a mistaken view of the effect of the APA and of its commercial interests. It took a deliberate step; its judgment of its commercial interests may have been erroneous, but that is not of itself a reason for this court to disapply the natural consequence of the choice which it in fact made.

This case has been attractively argued on both sides, but my conclusion is that the appeals against both judgments should succeed and that, subject to any other defences which may have been raised, Rust is entitled to judgment for the sum claimed against PB Limited.

I agree.

I also agree. The business thinking behind the indemnity within the APA and the consent judgment is somewhat opaque, but what I think it amounts to is that the PB Group, while dealing with Rust in the way in which it did, was not willing to leave Rust exposed to default on its obligations, at any rate to the extent that those were reflected in Rust's accounts as at the effective date. In such a calculation the PB Group would be acting as one would expect a major group to do. When push came to shove, however, the PB Group was willing to allow Rust to default on the basis that the alleged liability was not reflected in Rust's accounts at the effective date. It is on that basis that the PB Group, including PB, was willing to consent to, indeed to engineer, the consent judgment being entered into by Rust. That was done with the apparent intention of leaving Rust and its creditors in the lurch. PB, as it turned out, was wrong, or at any rate its advisers were wrong, about the scope of the indemnity, but, for the reasons stated by my Lord, it can gain no comfort from that. If it had been more cautious or concerned to ensure that Eagle should receive through any arguable indemnity only what quantum of damage Eagle could prove, then PB could always have negotiated a more business-like settlement. As it was, it was concerned that if it delayed and its insurers thereby became involved, it could end up being required by its insurers to pay the liability because that would lie beneath the insurance deductible. These calculations went wrong, but they would not have done if PB had remained willing, as it had been at the time of the APA, to stand behind its hollowed-out subsidiary. So perhaps, after all the legal arguments have been worked through, what went wrong was simply a business miscalculation.

Be that as it may, I agree fully with my Lord's reasons for allowing this appeal and with his compliment to the submissions on both sides.