A L Challis Ltd v British Gas Trading Ltd

This appeal is about payment for water widgets manufactured by the appellant (“Challis”) and supplied to British Gas. In order to understand the dispute there is a matrix to be considered. I can largely adopt the uncontroversial parts of the judge’s summary of the background facts.

The agreements, pursuant to which Challis supplied the widgets to British Gas, were made against the background of the Government's Carbon Emission Reduction Target (“CERT”) scheme, introduced to give effect to a reduction in carbon emissions pursuant to the Kyoto Protocol. The CERT scheme originally covered the period between April 2008 and April 2011, but was later extended to 31st December 2012. It was administered on behalf of the Gas and Electricity Markets Authority by the Office of Gas and Electricity Markets (“Ofgem”). British Gas was subject to obligations to promote schemes in domestic households which achieved a reduction in carbon emissions, which would then give rise to a carbon credit in favour of British Gas. The agreements between the parties provided for Challis to supply water widgets directly or indirectly to consumers in a way which enabled British Gas to obtain such carbon credits to count towards its obligations. These water widgets aerated the water supply in domestic showers, causing less water and less energy to be used by the consumer than would otherwise have been the case.

Under the CERT scheme, products which achieved a requisite degree of innovation qualified for a market transformation uplift (“MTU”) such that an additional 50% of carbon savings could be attributed to them for the purposes of the energy supplier's CERT target. The water widgets qualified as such innovative products. The dispute between the parties is, in essence, whether on a true construction of the agreements British Gas was obliged to pay to Challis an additional 50% to reflect this uplift in the carbon credit as obtained by British Gas. Challis claims that it was entitled to be paid by reference to the MTU uplift obtained by British Gas from Ofgem in relation to the water widgets. British Gas contends that the agreements contained a fixed price formula which provided for defined payments irrespective of the carbon credits ultimately awarded by Ofgem to British Gas on the application of the MTU uplift.

The Electricity and Gas (Carbons Emissions Reduction) Order 2008 (“the Order”) required Ofgem to impose obligations on energy suppliers such as British Gas to deliver schemes achieving carbon emission reductions in domestic households between 1st April 2008 and 31st December 2012. Under the Order each large energy supplier was set a carbon emissions reduction obligation by reference to its share of the domestic market (articles 6(1) and 7), which it was obliged to meet by promoting qualifying actions to domestic energy users (article 9). The qualifying actions were divided into four categories, namely 1) demonstration actions, 2) market transformation actions, 3) priority group flexibility actions, and 4) standard actions (article 2(2)). The Order also set out various sub-targets and contained mechanisms to oblige or encourage suppliers to meet their overall targets in particular ways. One of the sub-targets was that 40% of each supplier's overall carbon obligations should be met by actions carried out in a “priority group” (article 13) which consisted of domestic consumers in receipt of certain benefits or aged over 70 (article 2(1)). On 31st July 2010 the Order was amended to include a “super priority group obligation”, requiring suppliers to offer measures to a sub-set of the priority group (article 13A).

Market transformation actions had to be different from existing measures and significantly more effective in reducing carbon emissions (articles 2(3)(b) and 12(3)(b)). To encourage the use of such measures, the MTU could be applied to them if the supplier so elected, increasing by a uniform 50% the reduction in carbon emission attributed to such actions (articles 15(3)(b) and 19(4)). There was, however, a cap of 10% of a supplier's overall carbon emissions reduction obligation which was permitted to be met by market transformation actions, applicable across all categories of heating, lighting and insulation (article 9(3)). Market transformation actions which exceeded the 10% cap could still be useful to a supplier as actions generating the relevant reduction in CO₂, but there would be no MTU available in respect of them.

Suppliers were obliged to notify Ofgem of any scheme they intended to use to meet their carbon emissions reduction obligations within one month of commencement of such scheme (article 11). The notification had to include sufficient information to show how the supplier intended the action to be within one of the four categories. Under article 12 Ofgem was then obliged to determine whether it approved the action within the particular category and notify the supplier of the decision. It was also obliged under article 15 to provide an estimate of the reduction in carbon emissions for an action it approved as a qualifying action. Article 15(3) provided for MTU to apply to market transformation actions in the following terms:-

Once approved, suppliers were encouraged to report the interim progress of the schemes. Ofgem would then record the interim estimates of resulting carbon emission reductions, in a process known as “banking”. The judge observed that this was a somewhat misleading word since Ofgem was entitled at any time to recalculate the amount of carbon saving attributable to the widgets, a possibility expressly recognised in clause 6.4 of the agreements.

Following the end of the scheme period on 31st December 2012 (as extended), suppliers had to notify Ofgem not later than 31st January 2013 of the number and type of qualifying actions which they had completed in the priority group and outside the priority group (article 19). On receipt of that notification Ofgem had to determine the reduction in carbon emissions to be attributed to those actions, and notify the supplier by 30th April 2013 (articles 19 and 22(1)). In making such final determination, the 50% MTU was provided for in article 19(4) in terms materially identical to article 15(3). Suppliers who failed to meet the targets were susceptible to fines.

Before Challis and British Gas entered into any written agreement, Challis had already been in discussion with Ofgem to establish the carbon saving which could be attributed to the widget if used in the CERT scheme by an energy supplier. This involved supporting scientific evidence, and resulted in Ofgem agreeing on or about 26th January 2010 that the widget would have a carbon saving “score” for the purposes of the scheme of 84.8 kg of CO₂ per year over a life time of 12 years, which was equivalent to 1.10176 tonnes of CO₂ saving per widget. The carbon score was confirmed in a letter from Ofgem to Challis of 28th January 2010.

There followed discussion between Challis and British Gas, and joint presentations by them to Ofgem in April and May 2010, seeking approval of the proposed scheme for promotion and distribution of the widgets. Ofgem informally gave its approval to the scheme as a qualifying market transformation action on or about 16th June 2010 (later formally confirmed in a letter of 5th November 2010). By the time of the conclusion of the first of the two agreements between Challis and British Gas on 29th June 2010, therefore, the parties believed that the scheme would qualify as market transformation activity, and appreciated that the supply of water widgets constituted action which would qualify for MTU. British Gas would not have been interested in buying the widgets but for the fact that they qualified for MTU, which was one of its attractions to British Gas in seeking to meet its obligations under the Scheme. As a result of an express discussion, both parties understood that the carbon score of 1.10176 tonnes per widget was net of any such MTU.

One consequence of (1) the 10% cap being applicable across all categories of scheme, including heating, lighting and insulation and (2) the fact that it was not until 31^st January 2013 that British Gas notified Ofgem of the number of qualifying actions (both inside and outside the priority group) was that nobody could know until British Gas did give such notification how much carbon saving was to be attributed to the widgets supplied by Challis. British Gas would have to decide whether it was Challis’s widgets (which were in the heating category) which they wanted to use towards the 10% cap – and indeed how many of such widgets they wanted to use – or whether they wanted to use any other market transforming activities and how many of them in order to make up the 10% cap. As the judge said (para 12(1)).

The first agreement between the parties was dated 29th June 2010 (“the 2010 Agreement”). Its title was “AGREEMENT FOR CERT CREDITS”. British Gas was defined as “the Company” and Challis as “the Supplier”. The 2010 agreement provided amongst other things:

The 1.018 tonne figure in the last line of paragraph 2 of Schedule 4 arose from the widget's carbon score determined by Ofgem in January 2010. In fact that figure involved a slight rounding, the true figure being 1.0176 tonnes. In the event Ofgem used the latter in “banking” and awarding credits to British Gas, and British Gas invoiced Challis for the small difference occasioned thereby, which Challis paid.

The first invoice for widgets supplied under the 2010 Agreement was dated 28th June 2010, and invoices were presented regularly thereafter. The scheme was a success in that Challis rapidly distributed a large number of the widgets. As early as September 2010 it became apparent that supplies might well cause Challis to reach the £4 million figure provided for in clause 6.3. The parties did not invoke the clause 9 procedure for an extension to the cap, but as the numbers supplied “steamed through” the £4 million mark (as Mr Challis described it in evidence), it was recognised by British Gas that Challis should continue to distribute the water widgets, and British Gas would continue to pay in accordance with the 2010 Agreement without reliance on the maximum figure. In essence British Gas waived the maximum aggregate figure for the time being.

The 2010 Agreement was then renegotiated and replaced with an agreement dated 3rd March 2011 (“the 2011 Agreement”). It had the same title “AGREEMENT FOR CERT CREDITS”, with materially the same recitals and definitions as set out above. So far as payment was concerned, clauses 6.2 and 6.4 were in materially identical terms as in the 2010 Agreement. The maximum amount in clause 6.3 was raised to £21.2 million. A new clause 6.5 was added providing that British Gas would be entitled to withhold payment where it had reasonable grounds to suspect that Challis or the products had not complied with the Scheme. The payment calculation set out in Schedule 4 to the 2011 Agreement was substantially more complicated than its 2010 counterpart. It distinguished between widgets distributed as a result of marketing through Sainsbury's and those sold as a result of other marketing activities. There were 3 bands of payment depending on the number of widgets sold. The payment was again calculated by reference to a price in respect of the tonnes of CO₂ savings which were calculated on the basis of 1.018 tonnes per widget. Schedule 4 was considerably more complicated than the corresponding schedule 4 in the 2010 Agreement but it was not suggested that anything turned on those complications.

Challis invoiced and was paid, a total of £14,349,380.85 in respect of water widgets distributed directly or indirectly to consumers prior to 15th July 2011. When British Gas came to claim its carbon saving credits from Ofgem 18 months later, in January 2013, part, but not all, of such activity was treated as market transformation activity by British Gas attracting the MTU credit towards its carbon emissions target. In particular, of a total of 2,776,485 tonnes of CO₂ savings attributable to the distribution of Challis' widgets, MTU was claimed and granted on only 425,593 tonnes.

Challis contended before the judge that the price under clause 6 of the 2010 and 2011 Agreements fell to be calculated by reference to the amount of credit that British Gas claimed from Ofgem in relation to the widgets, including in particular the 50% MTU uplift: it was said that British Gas agreed to pay Challis by reference to the entire amount of the carbon savings which Ofgem deemed to have been achieved as a result of the distribution of the water widgets. British Gas contended that the wording of clause 6 and Schedule 4 in each of the Agreements established that payment was to be of a fixed price amount, irrespective of the credits sought by British Gas from Ofgem. Until shortly before trial, Challis had claimed that it was entitled to an uplift in the price of 50% on all widgets supplied, whether or not used by British Gas to claim MTU. By the time of the hearing, however, Challis' claim was confined to a claim for a 50% increase in the price in respect of the carbon savings from the widgets on which British Gas had in fact obtained MTU.

Popplewell J decided, in favour of British Gas, that the payment provisions of the agreements were not defined by reference to “carbon credits” but by reference to “carbon savings”. He considered this to be deliberate and pointed to the limited number of times the word “credits” appeared in the agreements. In particular clause 6 did not use the word “credits” to define the payment obligation. Moreover carbon savings were identified as something which might be recalculated by Ofgem whereas MTU could not be recalculated but, unless the Order was itself amended, were always fixed at 50%. He held further that the invoicing provisions excluded the notion that invoices could be submitted at a later date for a price which could only be calculated and invoiced in 2013. He held that the concept of the cap of 10% also militated against Challis’ construction and there was no way, when it came to quantification, that Challis could construct an accurate invoice in circumstances in which British Gas claimed MTU from Ofgem for fewer than the number of widgets actually supplied to British Gas, as in fact had happened. He also said that there was nothing un-commercial in the construction British Gas adopted because they took the longer-term risk of the legal scenery changing, while Challis which was a small firm, to whom cash flow was important, got paid within 30 days of invoice.

Mr Philip Shepherd QC for Challis relies on Recital E to demonstrate that the purpose of the agreement was to enable British Gas to claim credits from Ofgem which counted towards its CERT target. How those credits arose was irrelevant and there was no exclusion of MTU credits from the payment obligation which was for those credits as much as for the initial credits (or savings) initially attributable to the widgets. The “fixed amount” payment in clause 6.2 was agreed as being based on the carbon savings for the widgets and must include MTU which is itself defined as a “carbon emission reduction” (and thus a carbon saving within clause 6.2) in articles 15(3) and 19(4) of the Order. The judge was therefore wrong to draw any distinction between the concept of “carbon saving” and “carbon credit” and wrong to hold that the agreements did not cover the credits obtained by virtue of the MTU. Once this was clear, the judge’s other considerations only amounted to no more than procedural difficulties which could not stand in the way of a proper construction of the contract. He submitted further that if the parties had intended a straightforward exchange of price for widgets it would have been easy to say so. Instead they had deliberately incorporated references to the carbon savings agreed between British Gas and Ofgem. The only inference was that Challis should be paid for such savings when they became carbon credits. If that were not the position British Gas would effectively be getting the MTU (and avoiding any consequent penalty for failing to meet its target) for free.

Mr Orlando Gledhill QC for British Gas supported Popplewell J’s reasoning. He also submitted that the notion of a fixed amount in clause 6 of the Agreements excluded any further sums becoming payable in addition to the sums specified in Schedule 4 especially when there was no reference to MTU in the Agreements.

Since the parties are disputing what is due to be paid under the agreements, it is natural to start with the Payment provisions. The first obligation is that British Gas is to “pay the Payment to the Supplier”. Payment is defined to mean

Two important points emerge from these payments provisions. First there is the obligation to pay £8.70 or £6.70 per tonne of CO₂ deemed to have been claimed by British Gas (as set out in Challis’s invoice). At the time Challis sent its invoices, the CO₂ deemed to have been claimed could only be the CO₂ saving of 1.018 tonnes per widget about which both parties knew; this is indeed how Challis’s invoices, beginning with the invoice of 28^th June 2010, are framed. The invoices could not be deemed to be claiming (let alone “to have claimed”) savings or credits which had not been claimed and the amount of which it was impossible to know until British Gas had decided how many of the widgets would be included in its claim for MTU in April 2013.

Secondly, and perhaps more importantly, paragraph 2 of the Schedule states that the parties agree that the supply of the widget to the consumer is to equate to 1.018 tonnes of CO₂ savings. If in fact British Gas was obliged to pay a sum (in addition to the specific sums set out in paragraph 1) attributable to the MTU, the supply would not equate to 1.018 of CO₂ savings but would equate to a saving of an extra 50%. It cannot have been contemplated by the parties, when they agreed the saving was to equate to 1.018 tonnes for each supply, that payment should be made for a saving made in an entirely different amount. Mr Shepherd sought to get over this difficulty by submitting that the contract should be read purposively so that the figure of 1.018 should be taken merely to reflect the base figure from which calculations would then proceed. But there is no indication of that in the Schedule or, indeed, anywhere else in the contract.

To my mind these two points strongly support the judge’s construction of the agreement. It is, nevertheless, incumbent on the court to conduct what has become known as “the iterative process” whereby the rival constructions are assessed by reference to other relevant clauses of the contract and their commercial consequences, see Re Sigma Finance Corp [2009] BCC 393 at para 98 and in the Supreme Court [2010] 1 AER 571, para 12 and Wood v Capita Insurance Service [2017] 2 WLR 1095.

The rival constructions are (1) that British Gas must pay for all credits, attributable to the widgets, however they arise and (2) that British Gas is only obliged to pay the amount attributable to the carbon savings made at the time of supply not for carbon savings or credits which cannot be calculated at the time of supply and will not be calculable until some future time over two years away.

It is fair to say that the recitals to the agreements and clause 2 (Term) refer to the CERT target and British Gas’s obligations under CERT which is itself defined in the definition section. That can be said to support the notion that credits obtained under CERT are a relevant consideration in a general way. Clause 4 (about marketing) requires Challis to provide any necessary evidence of the percentage of widgets sold to the Priority Group. That also shows the background relevance of the Order.

There is then the important clause 6.1 requiring “the Payment” as defined to be paid. Clause 6.2 explains how “the Payment” is to be calculated and that it “is a fixed amount based on the carbon savings for the Products as agreed between Ofgem and [British Gas] under the Scheme”. “The Scheme” is itself defined as meaning:-

The difficulty with this argument (particularly when set beside the clear terms of Schedule 4) is that despite the references to the “Scheme” and the Scheme’s reference to “Credits”, the fixed amount payment is only said to be “based on the carbon savings for the Products”. As the judge pointed out it is not said that payment is to be for carbon credits. It is only based on carbon savings. To say that something is based on something else is not the same as saying that it is the same as that something else and, even if it were, the base is carbon savings not carbon credits. The MTU may be a carbon credit but in no sense is the notional and fixed uplift of 50% itself a carbon saving. The saving is that which is stated in Schedule 4 to be

The judge enumerated the comparatively few places in the Agreements when the defined term “Credits” is used and took the view that the distinction between carbon savings and carbon credits must have been deliberate. I agree with him; but even if I did not and even if it were the case that in some general way carbon savings could be equated with carbon credits, I would still take the view (for the reasons earlier set out) that the express terms of Schedule 4 are too clear to permit Challis to recover payment for such MTU as was granted two years later by Ofgem to British Gas.

Clause 6.3 sets a maximum aggregate amount for payments by British Gas of £4,000,000. Clause 9.2 provides that in certain events Challis can by a First Extension Notice request that figure to be replaced with a figure of £10,000,000 and clause 9.4 provides that in certain further events Challis can by a Final Extension Notice request that the figure of £10,000,000 be replaced with a figure of £37,500,000. On Challis’s case each of these aggregate amounts would apply to the total amount payable by British Gas including the amount payable in respect to the MTU. But there would be no way of knowing when the aggregate amount was exceeded and thus when a relevant Notice could be served. If no extension notice was served, Challis would not know when to stop supplying widgets if it wanted to be sure that it was not supplying them for nothing; it would have to guess how many widgets would be utilised by British Gas for the purpose of gaining MTU, something that could not be known until well after the widgets had been supplied and invoices had been paid. Mr Shepherd submitted that that was just a matter of process which could not affect the true interpretation of the Agreements but I agree with the judge who said (para 28.1):-

Clause 7 sets out the invoicing and payment arrangements namely weekly invoicing for the first 4 months and monthly invoicing thereafter. Payment is to be made within 28 days of receipt. There is no provision for invoicing after termination of the Agreements and the weekly/monthly invoices could not conceivably include anything for an uplift that had not then been claimed and could not be claimed until January 2013. This is also a strong indication that the parties did not contemplate that the uplift would have to be paid for.

Mr Shepherd asked rhetorically why the Agreements referred to the CERT target required by the Order and used the term “Credits” at all, if all British Gas were required to do was to pay the invoiced price for the widgets 28 days after invoice. Mr Gledhill responded by saying that there was plenty of point in explaining that the price was to be tied to the carbon savings made by the widgets and stating that the figure was 1.018 tonnes of such savings. Apart from anything else, if there was to be a renegotiation for any reason it would be useful to know the starting point of reference in the existing agreement. That is no doubt an answer to the rhetorical question but, in the end, the question is what the contract means and that has to be derived from the words the parties have used in their agreement. Schedule 4, to my mind, makes the matter clear.

Mr Shepherd submitted that, if British Gas were right in their interpretation, they would be getting the MTU without paying for it. But that is a bootstraps argument. The price settled on in Schedule 4 was a price which may or may not have taken into account that an uplift of some amount might be obtained and might be referable to an extent to the widgets supplied by Challis. That does not mean that British Gas gets the uplift for nothing. In that context it is not irrelevant to notice that in the event of early termination British Gas agree in Clause 12.8 to purchase the amount of Approved Stock at expiry at a price (£3.30) considerably less than the agreed price in Schedule 4.

The iterative process does not therefore lead me to doubt my conclusion that British Gas is under no liability to pay more than it has already paid in response to the invoices originally provided by Challis.

I agree with the judge’s careful and lucid judgment and would dismiss this appeal.

1 agree.

I also agree.

ON APPEAL FROM THE HIGH COURT OF JUSTICE

QUEEN'S BENCH DIVISION

COMMERCIAL COURT

THE HONOURABLE MR JUSTICE POPPLEWELL

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B E T W E E N:

ORDER

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The Claimant's appeal is dismissed.

The Claimant shall pay the Defendant's costs of the appeal, to be the subject of detailed assessment if not agreed.

The claimant shall pay the defendants the sum of £30,000, as an interim payment on account of its costs within 14 days.