Morris v Swanton Care & Community Ltd

This is an appeal by the claimant, Philip Morris (“the claimant”), against the judgment of His Honour Judge Bird (sitting in the Mercantile Court, Manchester District Registry) (“the judge”) handed down on 24 March 2017 (“the judgment”). By the judgment, the judge rejected the claimant’s claim to additional “Earn-Out Consideration” under the terms of a written “Agreement for sale and purchase of

The issue is whether the judge was correct in his construction of the provisions of the SPA that governed the claimant’s right to Earn-Out Consideration (namely, Clauses 3.1 and 3.3 and Schedule 5 to the SPA) and, in particular, the judge’s application of well-established principles concerning the enforceability of agreements to agree.

On 9 November 2006, the claimant and his business partner, Christine Smith, sold their shares in the capital of Glenpath Holdings Limited (defined in the SPA as “the Company”) to the defendant for an initial consideration of £16,077,842 subject to certain adjustments, and a deferred consideration through an earn-out provision. The Company provided residential care for autistic men and women. The terms of the agreement were set out in the SPA.

Christine Smith was unwell at the time the Agreement was entered into and has since died. Her estate has played no part in the proceedings.

The relevant provisions of the SPA (in which the claimant was referred to as one of the Sellers and the defendant was referred to as the Buyer) provided as follows:

Contemporaneously with the execution of the SPA, the claimant and the defendant also executed a “SIDE LETTER”, bearing the same date as the SPA (9 November 2006) (“the Side Letter”). In summary, the Side Letter described the Earn-Out Consideration as being in the nature of deferred consideration and contained tax gross-up and other set-off provisions depending upon the treatment of the consideration by HM Revenue & Customs.

It was common ground before the judge that the claimant had the right to provide what were referred to as the Consultancy Services (although not defined as such) during the initial 4-year period of the SPA. It was also common ground that, in the years following the SPA, four New Properties were identified and redeveloped; that, by November 2010, four years after the SPA, 29 placements had been filled; and that, as a result, the claimant was paid Earn-Out Consideration of £4,146,371 in respect of these placements.

Towards the end of the initial 4-year period, the claimant asked the defendant for “a reasonable extension” by email dated 7 October 2010. The judge described what then occurred as follows:

“54.

On 7 October 2010 Mr Morris wrote to the Buyer [the defendant] to discuss the terms of an extension of time noting that “an extension would be appropriate in this case” then citing a number of factors which he felt justified an extension. The email ended with the words: “accordingly, I formally seek a reasonable extension”.

55.

At the time the request was received, Mr Parsons told me that:

“The focus of the business was to get back to the core strengths of the company and what we were doing from before 2010, but certainly 2010 onwards, was building brand new 60-bed private pay focused care homes.”

56.

The response to the request came on 27 October 2010. The extension was declined. A number of reasons were given, including the fact that the economic climate had changed dramatically since the agreement was entered into. When asked in cross examination about the refusal Mr Parsons told me that this was intended to convey the following message:

"Get real. There was a £16 million upfront payment, there's been a £4 million earn-out payment. You're a very lucky person to have received that".

57.

The refusal concludes with the words: “I do not see how it would be possible for the Board … To recommend an extension to the earn out”. When pressed about reasons for the refusal in cross examination Mr Parsons told me there was no appetite in the business for an extension. He went on to say:

“the world had moved on enormously. Any number of care home companies had gone bust. He would not have got that sort of deal even 18 months later. And the company has moved on, the company has confronted the new reality with a … new strategy, which is about how it allocated its resources.”

The claimant’s claim (issued in March 2015) was that, after the expiry of the four years of the Earn-Out Consideration in November 2010, he was entitled under paragraph 1.1 of Schedule 5 to a further period of time in which to be paid further Earn-Out Consideration.

At trial, the defendant submitted that it was not obliged to give the claimant a further period for the Earn-Out Consideration. The defendant contended that was because inter alia: (i) the reference in paragraph 1.1 of Schedule 5 to a further period to be agreed was no more than an agreement to agree and applicable only if both parties agreed; (ii) the wording of paragraph 1.1 was not mandatory on its true meaning; and (iii) the defendant did not act unreasonably (nor was it pleaded that it did) and it was reasonable for the defendant not to agree an extension.

In summary, the judge found that, whilst the claimant had an enforceable right to provide the Consultancy Services during the initial 4-year period, he did not have an enforceable right to provide the Consultancy Services during any further period to be reasonably agreed between the claimant and the defendant. In so holding, the judge took the view:

Mr Alain Choo-Choy Q.C., who appeared on behalf of the claimant on the appeal (Footnote: ³), in summary submitted as follows in relation to the grounds of appeal.

Mr Choo-Choy complained that, although the judge correctly summarised the principles of objective contractual interpretation at [26] and [27], noting in particular that he should disregard any evidence of the subjective intention of the parties, he nonetheless, when identifying the background against which the agreement was to be interpreted, stated at [61] that:

“a key aspect of the background which I ought to bear in mind is, as Mr Parsons [for the defendant] told me in evidence …, the buyer was very keen to have control over the period of the earn out and did not want to enter into an open-ended obligation.”

Mr Choo-Choy therefore submitted that the judge erred in his construction by wrongly taking account of (and indeed characterising as “key”) inadmissible evidence of the defendant’s subjective intentions and desires during the pre-contractual negotiations. In addition to being inadmissible as a matter of construction, Mr ChooChoy also submitted that the evidence of the defendant’s subjective intention and/or desire did not in any event conflict with the claimant’s construction that paragraph 1.1 of Schedule 5 imposed a binding obligation on the defendant to agree a reasonable period of extension with the claimant. He argued that such an agreement would not be “open-ended” since it would be subject to an objective requirement of reasonableness and there was in any event a cap of up to 35 new beds in total (the Target Capacity) and a clearly and carefully defined mechanism for determining the amount of the Relevant Earn-Out Consideration under paragraphs 2.1, 2.2 and 3.1 of Schedule 5.

Mr Choo-Choy submitted that the judge erred yet further in applying the interpretation principles set out at [26] and [27] by treating the period of 4 years from Completion and the “further period as shall be reasonably agreed between [the parties]” as being two separate or wholly distinct periods to which entirely different considerations applied (see [63] – [65]). Apart from the fact that the second period was to be reasonably agreed between the parties, Mr Choo-Choy contended that there was nothing intrinsically different between the two periods – the Earn-Out Consideration was part of the defined Consideration. Thus:

Mr Choo-Choy submitted that, in treating the two periods as being wholly distinct, the judge had failed to construe paragraph 1.1 of Schedule 5 as a whole and to have proper regard to its objective purpose and to the context in which it was agreed. He argued that, in construing paragraph 1.1 of Schedule 5 in the context of the agreement as a whole, and having regard to the objective purpose and context of that provision, the judge ought to have found as follows:

Third, Mr Choo-Choy contended that the judge had erred in holding (at [65]) that there was nothing in paragraphs 1.1.1 to 1.1.3 of Schedule 5 which could sensibly be read as providing any framework or objective standard that the court could use to fill the gap left by the parties’ failure to agree a reasonable period of extension. In adopting this defeatist attitude to the parties’ clear agreement that the further period “shall reasonably be agreed”, as opposed to a purposive construction, Mr Choo-Choy argued that the judge had ignored or paid insufficient regard to some fundamental principles of construction. In particular he submitted that:

Fourth, Mr Choo-Choy argued that the judge’s view (at [66] – [67]) that the adverb “reasonably” only related to the manner in which agreement between the parties was to be reached, but did not relate to the further period to be agreed, was devoid of common sense and realism. According to Mr Choo-Choy, it reflected a failure on the judge’s part to construe the expression “such further period as shall reasonably be agreed” as a whole and with commercial common sense. There was no sense in a construction which presupposed that there could be a reasonable agreement in respect of an unreasonable period. The notion of reasonableness had, objectively, to be taken to go to both the agreement and the period, on the sensible understanding that:

Fifth, Mr Choo-Choy submitted that the judge’s analysis of the issue of enforceability at [70] – [80] was inherently flawed in multiple respects. Although the judge had rightly reasoned at [68] – [69] that:

“[in]summary then, on its proper interpretation, the contract imposes on the parties an obligation to agree on the length of the second period with each adopting a reasonable approach to the negotiation”,

he then went on erroneously to conclude that such an obligation was not enforceable on the ground of uncertainty (see especially [75] – [77]).

Although the judge had correctly set out the principles laid down by the court of

Mr Choo-Choy submitted that, in summary, therefore, the judge’s conclusion of unenforceability on the ground of uncertainty was fundamentally flawed.

Sixth, Mr Choo-Choy submitted that the judge had failed to consider and appreciate that the net effect of his construction of paragraph 1.1 of Schedule 5 was to turn the language of mandatory option and mandatory agreement of a further period for the provision of the defined services into a mere possibility of an entitlement to such further period if the Buyer so agreed. On such a construction, he argued that it was impossible to see why the parties had chosen to use the language “shall have the option for … such further period as shall reasonably be agreed between [the Seller] and the Buyer to provide the following services”; they should instead have provided that the claimant “may be asked to provide the following services for such further period as the Buyer may agree”; they should not have expressed the matter in terms of the claimant having an option (i.e. a contractual right) to provide the Consultancy Services during the further period; and there would have been absolutely no reason for them to agree that the further period was to be “reasonably agreed”. As to the last point, if nothing was intended to be binding and enforceable unless and until agreed to by both the claimant and the defendant and if (as held by the judge) it was open to the defendant to refuse to agree for whatever reason (and indeed to refuse even to negotiate) in the naked pursuit of its self-interest, it was impossible to discern why the parties took the trouble of agreeing that the further period “shall reasonably be agreed” in paragraph 1.1 of Schedule 5. He thus argued that the peremptory language only made sense on the basis that it was objectively intended that a reasonable period was to be agreed between the parties, with the court stepping in if they were themselves unable to agree what that period should be.

Thus, Mr Choo-Choy submitted, taking the peremptory language into account and having regard to Chadwick LJ’s second and fourth points in BJ Aviation, it would not make sense to conclude that the parties’ intention was that the defendant was to have a right of veto over (or to be free to walk away without determination of) the further period. Nor would it make sense to conclude that the parties’ intention was that the defendant could take the full benefit of the transfer of Shares and of all of the claimant’s work during the initial 4-year period, with placements attributable to such work crystallising after the expiry of that period, without having to make any payments to the claimant in respect of such placements. Such a result was inherently uncommercial and did not amount to a sensible commercial construction of paragraph 1.1 of Schedule 5. Nor was it justified by the language of Clause 3 and Schedule 5 as a whole.

At the start of the hearing of the Appeal, Mr Choo-Choy abandoned the claimant’s appeal on the quantum point.

Mr Adam Zellick QC appeared on behalf of the defendant both at first instance and on the appeal. The court did not consider it necessary to call upon him to elaborate his written submissions by further oral argument. It is not necessary to summarise his arguments as they are reflected in the reasons which I rehearse below for dismissing the claimant’s appeal.

Despite Mr Choo-Choy’s careful and detailed arguments, I have no doubt that, on their true construction, the relevant provisions of paragraph 1.1 of Schedule 5 amount to an agreement to agree in relation to the further period after the agreed 4 years and are consequently unenforceable. It follows that I agree with the judge’s conclusion and would dismiss this appeal. My reasons may be summarised as follows.

The words “as shall reasonably be agreed between Mr Morris and the Buyer”, when construed in the context of the entire agreement, make it plain that, for there to be any further period, there first has to be a further agreement between the parties. The parties did not at the time of entering into the SPA specify a further period but, instead, only agreed that there would have to be a further agreement in the future. As Mr Zellick submitted, that is the very paradigm of an agreement to agree.

As a matter of grammar, the word “reasonably” is an adverb that modifies the verb

“shall be agreed”. It is not the adjective “reasonable” nor does it qualify the phrase the

“further period”. Although the verb “agreed” is used in the passive form, it is clear that it is the parties who have to do the agreeing. On the proper construction of the relevant provisions, therefore, there was no existing agreement in place that the Consultancy Services would be extended by a reasonable period. To the contrary, the option is expressed to continue for “such further period as shall reasonably be agreed”. Thus, any period of extension could be agreed, with the words “shall reasonably” applying to the agreeing, and not to the further period itself. The claimant’s argument seeks to transfer the “reasonable” requirement to the period itself, on the basis that if the clause is read to provide for a reasonable period, the court can then determine what a reasonable period is. But that is wrong for two reasons: first, it is not what paragraph 1.1 of Schedule 5 says and the exercise would require transposing reasonableness from agreeing to the further period. Secondly, the proposition is that, on the assumption that there was such a thing as an objectively reasonable period, that is what the parties acting reasonably should have agreed. The difficulty with this, apart from the actual terms of the clause, is that it presupposes that there is such a thing as a reasonable period which everyone could equally recognise as being reasonable, rather than the different commercial interests and different perspectives involved in any extension of the Earn-Out Consideration. Moreover, the court would have to identify some objective benchmark for determining the reasonable period without reaching an alternative subjective view or descending into the commercial fray; but that is not possible.

Accordingly, I accept Mr Zellick’s submission that, at most, the agreement was reasonably to agree a further period. On a true construction of the words used, the parties intended to leave the issue of any extension to the period to be agreed. This necessarily meant that either of them would be free to agree or disagree about that matter and they would need to reach agreement between them. The consequence was that that provision of the agreement was void for uncertainty, albeit that the SPA in other respects was a binding agreement; see: Lewison, The Interpretation of Contracts (6th ed, 2016) at 8.17; May & Butcher Ltd v R [1934] 2 KB 17 per Lord Buckmaster at 20, per Viscount Dunedin at 21 and per Lord Warrington at 22; and, generally, Walford v Miles [1992] 2 AC 128.

This was an agreement where, as in BJ Aviation Ltd v Pool Aviation Ltd [2002] 2 P&CR 25, the parties intended to leave an essential matter, namely the length of the extended option period, to be agreed between them in the future, on the basis that either would remain free to agree or disagree about that matter. Accordingly, there was no bargain which the courts could enforce.

Moreover, the law is clear that, in such a case, there is no obligation on the parties to negotiate in good faith about the matter which remains to be agreed between them; see Walford v. Miles supra, at page 138G.

The fact that the relevant provision required the parties “reasonably” to agree did not turn an unenforceable provision into an enforceable agreement. Thus, for example:

Nor was I persuaded by Mr Choo-Choy’s submissions in relation to the claimant’s individual grounds of appeal. I now turn to deal with these individually.

Ground 1 – inadmissible evidence. Mr Choo-Choy rightly did not press this submission forcefully in his oral argument. Even if it had been the case that the judge had taken into account inadmissible evidence in reaching his conclusion on construction, that does not lead towards a different construction of the relevant provision.

In any event, I do not find the criticism justified. The judge correctly directed himself as to what he was permitted to take into account (e.g. at [26]) and expressly reminded himself of the relevant requirements again (at [60]) when he came to construe the provision. He set out accurately that he was to disregard evidence of subjective intention. Although the judge mentioned one aspect of Mr Parsons’ arguably subjective evidence, as Mr Zellick submitted, on one analysis that was no more than a finding by the judge that the background commercial circumstances were that the parties had agreed to provide for a fixed period but also to leave the door open for a further period if at the end of the fixed period they were both willing to agree. But this ground of appeal goes nowhere. Irrespective of whether the judge was wrong to refer to this piece of evidence, he reached the right conclusion.

Ground 2 – separate periods. I disagree with Mr Choo-Choy’s criticism of the judge’s statement referring to the obvious fact that the clause included two separate periods. It was clear as a matter of construction that the second period required a further agreement between the parties if it was to follow on as a second option period. Nor do I accept his submission that paragraph 1.1 or the remainder of Schedule 5 predicated a construction that the further period was in effect a “right” of the claimant. The judge was in my view correct to conclude at [65] that there was nothing in the remainder of Schedule 5 which informed the approach or gave any indication that a further period was required, nor was there any basis for the

“necessary implication” advanced by the claimant in Mr Choo-Choy’s written skeleton.

Ground 3 – absence of objective standard. I reject Mr Choo-Choy’s submissions under this head. The judge was right to conclude on the terms of Schedule 5 that the express terms did not impose any framework or objective standard from which the court could determine what an appropriate further period should be if the parties did not “reasonably” agree. Even if, contrary to my view as set out above, one should construe the words “as shall reasonably be agreed between Mr Morris and the Buyer” as imposing an obligation on the parties to agree a “reasonable further period”, there are, in the circumstances of this case, no criteria by which a court could judge what was such a further period. Indeed, the judge himself stated at [81] that:

“It is almost impossible to decide the remaining questions sensibly. To answer those questions, I must engage in the exercise of working out what the parties would have agreed.”

In my judgment he should not have embarked on such a task at all. Whether he was attempting – on a hypothetical basis – to decide what the parties would have agreed, or (a different issue) to decide what would objectively have been a reasonable period, there was no reference point in the contract, or indeed externally to justify any conclusion on any basis other than guesswork.

This was not a case where, absent a further agreement, the parties could be taken to have agreed that there was objective criteria of fairness or reasonableness by which the period could have been determined. Thus, for example, Mr Choo-Choy’s references to Rix LJ’s principle (viii) in Mamidoil and his dictum at paragraph 69, to the citation from Lord Wright’s speech in Hillas and Co Limited v. Arcos Limited [1932] 147 LT 503, at 517, and to Chadwick LJ’s fifth point in BJ Aviation were all in my view besides the point. This was simply not a case where a court could conclude that the true intention of the parties was that the matter to be agreed in the future – here the length of the further period - was capable of being determined, in the absence of future agreement, by some objective criteria of fairness or reasonableness.

Ground 4 - artificial restriction of criterion of reasonableness to the manner of agreement as distinct from the length of the further period. The contention in Ground 4 is that the judge should not have construed the word “reasonably” as an adverb going with the words “be agreed”, as those words appear in the clause, but should have adopted an interpretation re-writing the clause to have provided for a requirement to agree a “reasonable period”. I have already addressed this suggested construction of the relevant provisions and concluded that the claimant’s proposed interpretation is wrong.

Ground 5 – alleged uncertainty in determining the further period. None of Mr ChooChoy’s arguments under this head persuaded me. His principal points were that paragraph 1.1 included a “binding option” within it in relation to the further period and that the judge failed adequately to apply the part performance considerations referred to in Mamidoil.

So far as the first point is concerned, the use of the word “option” carries the issues of enforceability and certainty no further. If the further period were subject to further agreement, the fact that the claimant was granted an option (i.e. a right as opposed to an obligation to perform the consultancy services during the relevant period) does not affect the construction or effect of the relevant provisions relating to any agreement in respect of a further period.

As to the part performance point, the judge in my view rightly rejected this argument (at [79]). The authorities emphasise that all cases turn on their own facts and this case is no exception. The claimant in this case had already received substantial consideration in terms of the Initial Consideration and the Earn-Out Consideration for what he had provided under the SPA. There is nothing in his past performance (the transfer of the shares and the provision of the consultancy services), or the consideration that he had received to date, or indeed anything else, from which the court could legitimately extrapolate the length of any further “reasonable” period for provision of his consultancy services. The relevant principles identified in Mamidoil in relation to part performance do not transpose the situation in the current case into one which came within the description of one “where the parties may desire or need to leave matters to be adjusted in the working out of their contract,” in which case “the courts will assist the parties to do so, so as to preserve rather than destroy bargains, on the basis that what can be made certain is itself certain.” The fact is that, in the present case, the parties had not left matters “to be adjusted” in a certain way but had decided that they required further agreement if their contract was to continue longer. This was not a case of the court being able to render certain what could be made certain. All that the court could do was impermissibly to make a new bargain for the parties – and the judge’s attempt to do so even on a hypothetical basis was in my view impermissible. Indeed, the judge himself recognised that there was no sensible basis for doing so.

As Mr Zellick submitted, whether the time was to be extended in the context of an Earn-Out after a fixed period of four years had to be regarded as a commercial matter for negotiation. It could not sensibly be regarded as being a given because the primary period had been granted and expired.

Nor do I accept Mr Choo-Choy’s criticisms of the judge’s application of the principles as articulated in Mamidoil, BJ Aviation and MRI Trading. All the authorities emphasise the need to look at the particular facts and contractual provisions of an individual case. The authorities do no more than set out guiding principles to be applied in cases such as the present. Some of those principles, not relied upon by Mr Choo-Choy, support the defendant’s case. The judge considered and applied the principles correctly and was entitled to reach the conclusion that, on their proper construction, the relevant provisions in the SPA amounted to an agreement to agree, and as such were unenforceable.

Moreover, although Mr Choo-Choy attempted to identify a number of factors which he contended would have enabled the court to determine the further period, the reality was that all such factors were commercial factors on which the court could not sensibly reach a determination based on objective criteria. Likewise, the factors identified by the defendant as relevant to any decision as to the length of a further period (if any), were also commercial factors which were for the parties, and not the court, to take into account in any commercial negotiation. All these matters support the judge’s conclusion on the key question of construction that this was effectively an agreement to agree.

Ground 6 – commercial absurdity. Mr Choo-Choy submitted that the construction upheld by the judge was commercially absurd. I do not agree. There was every commercial reason, given all the uncertainties, why, on execution of the SPA, the parties should have decided not to agree any period beyond four years, but, rather, defer agreement on any further period and agree that they would “reasonably agree” such period at a future date. It is hardly likely that they would have understood their agreement to mean that, if they could not at that stage agree a further period, they would nonetheless leave it to a court to decide (a) that there should be such a period, and (b) how long it should be. As the judge himself said, in his conclusion (at [87]), the construction was not only clear from the words of the contract but also “has the added benefit of according with common sense.” I agree.

I would dismiss this appeal.

I agree.