Investec Bank (Channel Islands) Ltd. v The Retail Group Plc

The Claimant (“Investec”) is a bank. The Defendant (“TRG”) is a property development company. TRG’s sole shareholder and one of its two directors is David Murphy. This is a claim by Investec for a payment which it says is due from TRG in respect of what has been termed an “exit fee”. This is a fee which Investec says is due to it under a profit-sharing arrangement in the form of an Exit Fee Agreement dated 22 October 2004 made between Investec and TRG (“the EFA”) in respect of the development of a shopping precinct at Palmerston Road in Southsea.

The shopping precinct was comprised of shops and other retail outlets on the east and west sides of Palmerston Road. I will refer to the properties owned by TRG on the east side of Palmerston Road as “the East Block”. I will refer to the properties which TRG purchased from Portsmouth City Council (“Portsmouth CC”) in October 2004, located on the west side of Palmerston Road, as “the West Block”.

From 2003 TRG had been acquiring properties in the East Block piecemeal in order to build up a property portfolio which could be developed as a coherent unit. The plan was to try to improve the overall quality of the shops and outlets so as to achieve better rental income over time and improved capital values, and also to obtain planning permission to build residential flats above the retail outlets, which could then be let or sold. Mr Murphy also entered into negotiations on behalf of TRG with Portsmouth CC to acquire the West Block, so as to achieve a larger portfolio capable of development as a still larger unified project. I will refer to the East Block and West Block together as “the portfolio”, and to the development of the portfolio as “the development” or “the project”.

By letter of 15 June 2004 Portsmouth CC offered to sell the West Block to TRG for £9,750,000, subject to contract. This was an important opportunity for TRG. TRG had to raise the finance necessary to acquire the West Block and also to refinance the East Block at the same time. Mr Murphy therefore entered negotiations with a range of possible lenders.

By July 2004 it appears that Mr Murphy had found possible senior loan providers for TRG (i.e. lenders who would take a first charge over the portfolio and lend TRG funds equal to some 70-75% of its value), but he still needed to find a provider of higher risk lending (referred to as “mezzanine lending”), secured by a second charge over the portfolio ranking behind the first charge in favour of the senior loan provider, in order to fund the balance of the purchase price for the West Block and the refinancing of the East Block. Investec was a well-known provider of such mezzanine lending for property development transactions.

TRG’s then solicitors were Messrs Glinert Davis. Mr Murphy had a particular connection with that firm, because his sister Ms Hibberd (now Ms Biagi, by which name I shall refer to her throughout this judgment) was a solicitor there. Daniel Glinert of Glinert Davis had contacts with Investec, so Mr Murphy arranged for Mr Glinert to approach Investec to see whether it would be interested in providing mezzanine lending of £2.5m for the development. Mr Glinert wrote a letter dated 21 July 2004 to Marc Weinberg at Investec setting out summary details of a proposal that Investec provide mezzanine lending of £2.5m for a term of 30 months to be discharged at the end of that term by a payment of £4m. The disparity between the sum lent and the sum repaid reflected the risk inherent in mezzanine lending in relation to a property development of the kind in question.

Investec was interested. Mr Weinberg and Michael Donovan of Investec met Mr Murphy and a surveyor representing TRG, Tim Clark. They also visited the site of the development. TRG supplied Investec with detailed information about the project.

On 5 August 2004 Mr Weinberg sent Mr Murphy an e-mail asking for, amongst other things, simplified cash flows to be provided and a breakdown of the £8m profits which TRG had suggested could be made from the development. Mr Clark responded on 9 August 2004 on TRG’s behalf. He attached some new cash flows to his reply, as requested. He wrote:

“The breakdown of profits is as follows - £3.75m residential gains, £5.75m commercial gains. As at completion none of the commercial gains are included in the projected figures.”

The cash flows included an exit return analysis which showed a projected property valuation for the portfolio as at December 2007 of about £20.2m. The cash flows showed senior debt of £12.25m, mezzanine debt from Investec of £2.5m and further subordinated lending (including what was described as “equity” from Mr Murphy) of about £1.2m. In addition, an investment return was expected on the residential element within the development. This was projected to be in the order of about £3.75m.

By a letter dated 10 August 2004, Investec Bank (UK) Limited made an indicative offer to provide mezzanine funding to TRG subject to approval by its credit committee. (In due course the relevant loans were made by another company in the Investec group, namely the Claimant; in this judgment it is not necessary to distinguish between these companies and for convenience I refer to them both as Investec). The indicative offer proposed mezzanine lending of £2.5m by Investec for a term of three years to assist with the acquisition of the portfolio for a consideration of £16.35m (i.e. covering both the East and West Blocks). There was to be an arrangement fee of 1% of the value of the loan. The letter also stated that there should be: “A profit share of 35% of the net profit after all costs with a minimum fee of £500,000 at expiry of the Loan.” Investec was to be protected by a second legal mortgage over the portfolio, ranking behind the first mortgage in favour of the provider of the senior loan.

On 11 August 2004 Mr Murphy sent Mr Weinberg some additional information by e-mail. This included an exit analysis showing the anticipated valuation of the portfolio as about £19.6m in December 2007 which (after deduction of combined senior and mezzanine lending of £14.5m) gave an equity or profit value of about £5.1m, excluding any return on the residential elements in the project. The information Mr Murphy provided also showed expected rents of the order of about £1.1m a year against interest payable on the senior and mezzanine lending of about £920,000 a year. A degree of coverage of interest by anticipated income of the order of about 20% would be normal in a transaction of this kind, to give the lenders comfort that the interest payments would indeed be met.

In the course of July and August 2004 TRG negotiated with various potential providers of senior lending. In the event, however, it was Investec which was chosen as the provider of the senior loan as well as a mezzanine loan. On 26 August 2004 Mr Weinberg and others presented an application to Investec’s credit committee for a loan in the total sum of £14.75m, made up of a senior loan of £12.25m and a mezzanine loan of £2.5m. This lending was proposed in order to refinance the East Block for £3.8m and to fund the purchase of the West Block for £10.45m. The terms proposed involved payments of interest, an upfront fee and a profit share in these terms:

“35% of the net profit after all costs with a minimum fee of £500,000 at expiry of the Loan.”

The application contemplated an exit at the end of three years. The value of the East Block was estimated at £6.15m. The application referred to the scope for improving the commercial rental values within the development and improving its capital value. It also referred to the residential planning gains which it was hoped would arise from a substantial residential development as part of the East Block. The application referred to planning permission dated 9 June 2004 for the development of part of the East Block and to further applications for planning permission. There was also a reference to a potential further phase of the development to expand holdings close to the West Block. This was referred to as “phase 4”, but it was stated not to form part of the application. The financial analysis set out in the application referred to purchase costs for the portfolio of about £16.3m, proceeds of sale of the commercial development of about £20.4m and net proceeds from residential sales of about £3.6m. On these projected figures, and making allowance for interest charges and rental receipts, the analysis showed a profit share for Investec of about £2.7m at the end of the three year term and for TRG of about £5m at the end of that term, reflecting the 35% / 65% division between them. These figures reflected information provided by TRG and were broadly in line with the predicted profits previously indicated by TRG.

On 26 August 2004 Investec’s credit committee approved the transaction in principle. One of the conditions set out in the approval was, “the client is to receive no coupon [i.e. interest] on his equity in the profit share calculation.” The reference to “equity” related to the finance which it was expected TRG would provide (from its own resources or borrowings from third parties) in relation to the purchase of the West Block and the refinancing of the East Block.

Investec indicated to TRG that it would issue a letter of offer. By letter dated 15 September 2004 from Glinert Davis to Investec it was indicated that Mr Murphy was proposing to exchange contracts with Portsmouth CC on the strength of the letter of offer from Investec. The same day Investec sent TRG a facility letter (“the Facility Letter”) referring to senior lending (“loan 1”) of £12.25m and mezzanine lending (“loan 2”) of £2.5m to assist with refinancing the East Block and purchasing the West Block. Both loans were to be available for a period of three years. The letter provided that prepayments of the whole or part of the loans could be made at any time. It provided that a non-refundable management fee of 1% (£147,500) would be payable. Under clause 8, the Facility Letter provided for an exit fee in these terms:

“[Investec] is to receive an Exit Fee of 35% of the profit with a minimum of £500,000 on re-sale or refinancing of the properties [in the portfolio] in accordance with the agreed business plan. The profit is defined in [Investec’s] Exit Fee agreement.”

Although reference was made there to Investec’s Exit Fee Agreement, no such document was provided at this stage. It was negotiated subsequently. The Facility Letter provided for TRG to give Investec a first legal mortgage over all the properties in the portfolio as security for the loans.

On 23 September 2004 Mr Murphy countersigned the Facility Letter for TRG and paid the first part of the management fee which became due. The remaining part of the management fee was paid upon initial drawdown.

By letter dated 24 September 2004 from Glinert Davis to Investec, Mr Glinert referred to an earlier telephone conversation he had had with Mr Weinberg and recorded:

“With regard to the exit fee, you have kindly confirmed that you will let me have a copy of the draft profit share/exit fee agreement. We discussed and agreed the basic principle is that where a unit is sold off or a long lease granted at a premium and [Investec] has attributed a collateral security value to that property, the appropriate sum needs to be repaid to [Investec] on completion of that sale. Any profit over and above the security value is to be available for distribution as to 35% to [Investec] and 65% to [TRG].”

It appears from that letter that the discussion at this stage contemplated that there might be sale of individual units within the portfolio rather than a sale of the whole, and that part of the overall exit fee would become payable on such part sales.

On 27 September 2004 Mr Clark for TRG sent Mr Donovan a copy of TRG’s business plan for “Southsea Village”. This addressed in some detail the proposed steps in the development of the West and East Blocks from 31 October 2004 until 30 September 2007 (i.e. over the anticipated three year period of the loan facility). The business plan was discussed at a meeting between Mr Clark and Mr Donovan on 29 September 2004.

On about 27 September 2004 Mr Weinberg sent to Investec’s solicitors, Messrs Eversheds, a draft of the proposed EFA. However, this was based on an old precedent which had been superseded, so Ms Joanne Canning, the associate solicitor at Eversheds responsible for the banking aspects of the transaction at Eversheds, produced a revised draft based on the most up-to-date precedent. Ms Canning checked this draft with Investec and on 29 September she sent it to Ms Biagi for TRG. That draft contained a definition of “Exit Fee” as:

“the amount by which the aggregate of Net Sale Proceeds or the Estimated Net Sale Proceeds (as the case may be) and the Net Rental Income exceed the aggregate of the Completion Costs, (Planning Costs), (Management Costs), Development Costs and Interest.”

This was the relevant definition of the profit which was to be shared between Investec and TRG under the terms of the proposed EFA. Clause 8 of the draft (which provided for distribution of net sale proceeds upon a sale) stipulated that the net sale proceeds or estimated net sale proceeds should be distributed, first, by repayment to Investec of the debt due to it and, second, by distribution of the exit fee as follows:

“8.2

The Exit Fee shall then be distributed as follows:

8.2.1

If the Profit is between zero and £500,000, [Investec] shall receive all of the Exit Fee;

8.2.2

If the Profit is £500,000 or above, [Investec] shall receive £500,000 and 35% of any excess amount over £500,000”

Mr Murphy informed Investec in early October that the 10% deposit payable to Portsmouth CC in respect of the West Block in the sum of £975,000 would be funded by a loan from Tristmire Limited (“Tristmire”), which would require a second charge over the portfolio in respect of its loan. Investec indicated to Glinert Davis for TRG that Tristmire’s legal charge would have to rank behind Investec’s charge and that Investec should have unlimited priority. Eversheds for Investec asked for details of the proposed second chargee and their solicitors, as Eversheds would need to prepare a deed of priority. Ms Biagi provided these details, identifying Tristmire and their solicitors by letter of 6 October 2004.

By report dated 7 October 2004 the surveying firm C B Richard Ellis provided Investec with a valuation of the portfolio in the sum of £16,695,000.

Also on 7 October Ms Biagi wrote to Investec indicating that exchange of contracts with Portsmouth CC in relation to the West Block was proposed to take place the next day, and seeking comfort that there were no outstanding points from Investec which might provide any impediment to the eventual provision by Investec of the loan funds necessary to complete the transaction. The same day, Eversheds confirmed that Investec would consent to the creation of a second legal charge in favour of Tristmire subject to Investec having unlimited priority and Tristmire entering into an appropriate deed of priority.

In the event, exchange of contracts with Portsmouth CC was postponed until 11 October 2004. The same day, TRG entered into a loan agreement with Tristmire (“the Tristmire loan agreement”). The Tristmire loan agreement provided for a loan of £975,000 by Tristmire to TRG for a period of three years. The purpose of the loan was stated to be to assist TRG in the purchase of the West Block. The agreement provided for the loan to be discharged at the end of the three year term by a payment of £3m (“the Redemption Payment”), which was stated to be “inclusive of the Loan and all and any interest on the Loan”. Clause 5 of the Tristmire loan agreement was in these terms:

“5.1

[TRG] may repay part of the Redemption Payment during the third year of the three year period following the date of advancement of the Loan up to the Loan Repayment Date by, inter alia, the payment by [TRG] to [Tristmire] of Sixty Five per centum (65%) of the net sale proceeds of any of the [portfolio] or parts thereof that are sold during that period and in this context “net sale proceeds” means the sums remaining after payment to/of:-

(i)

the first mortgagee of the relevant property of the amount required by the first mortgagee to secure the release of the relevant property and

(ii)

all legal and professional fees wholly and exclusively incurred in relation to the sale and release of the relevant property and

(iii)

the profit element (if any) payable to the first mortgagee under the first mortgage from time to time of any property sold or released and

(iv)

any payments made to tenants to secure surrenders or lease variations in relation to any such property and

(v)

any construction, demolition or fitting out costs reasonably incurred in connection with the sale and/or release of the relevant property.

5.2

[Tristmire] acknowledges that [TRG] is entitled to sell or lease the [properties in the portfolio] or parts thereof from time to time and [Tristmire] shall on the occasion of each such lease or sale immediately do all things necessary to release the relevant property or part thereof from its legal charge … and for the avoidance of doubt [Tristmire’s] consent is not required for any such sale or lease provided that [TRG] utilises the net sale proceeds of such sales and/or leases towards the acquisition of further property interests arising out of the [portfolio] or other properties in Palmerston Road, Southsea aforesaid or the net sale proceeds of such sales and/or leases are applied in reduction of the first mortgage on the [portfolio] from time to time.”

TRG also eventually entered into a legal charge dated 22 October 2004 in favour of Tristmire (“the Tristmire charge”) in relation to the Tristmire loan and the Redemption Payment. It provided for Tristmire to have the benefit of a second charge over the portfolio behind the first charge in favour of Investec. Clause 5.9 of the Tristmire charge provided as follows:

“[TRG] must not sell or dispose of the premises or any part thereof without effecting payment of the Redemption Payment in accordance with the [Tristmire loan agreement].”

Completion of the purchase agreement with Portsmouth CC was set for 22 October 2004.

On 12 October 2004 Ms Canning sent Ms Biagi and Tristmire’s solicitors a draft of the proposed deed of subordination asking that their respective clients should sign it. She also wrote to Ms Biagi to inquire whether the draft EFA was agreed.

At this stage, Ms Biagi was dealing with a considerable quantity of documentation in relation to the transactions involving TRG in relation to the development and it is not surprising that the proposed EFA came some way down the list in terms of priority in dealing with it. By e-mail on 15 October Ms Canning chased for Ms Biagi’s comments as soon as possible during the course of the day, as Mr Weinberg was due to go on holiday and wanted to get the EFA sorted out before he left.

Also on about 15 October, Ms Biagi spoke to Mr Murphy about the terms of the draft EFA which Ms Canning had sent. There were two points of particular significance for Ms Biagi, on which she advised Mr Murphy and which were reflected in the marked up version she sent to Ms Canning later on 15 October. First, in the definition of “Exit Fee” (para. [17] above) Ms Biagi deleted the words, “and the Net Rental Income”, as a plus item in the profit calculation. Her manuscript comment against this deletion was in these terms: “The rents will be used to pay the mortgage interest and are not part of the equation”. Secondly, in relation to clause 8.2 (para. [17] above) she was concerned that the draft EFA appeared to provide for a payment of £500,000 (or any profit realised below that figure) in respect of each part sale of the portfolio which might be effected before the end of the term. That was not in accordance with her or Mr Murphy’s understanding of the commercial arrangement between TRG and Investec. Against clause 8.2, therefore, she had included the written note, “The principle is agreed as to the final position your client will be in, but we understood that on every sale throughout the term Investec would be entitled to 35% of net profit. Obviously this clause cannot apply on each and every sale during the term because [TRG] would have to pay £500,000 every time. Can you please consider?”

Ms Biagi advised Mr Murphy to take up these points directly with Mr Weinberg. Mr Murphy telephoned Mr Weinberg on about 15 October to discuss them. Mr Murphy told Mr Weinberg that he could not agree a document which required TRG to pay Investec £500,000 every time it sold one of the properties in the portfolio or which inflated the profit figure under the agreement. Mr Weinberg said that he would speak to Eversheds about these points. A day or two later he called Mr Murphy to say that Investec would agree to TRG having a “cushion” of £928,571 of the whole profit after £500,000 had been paid to Investec. Although this was not spelled out in their conversation, it is clear that the logic of this was that Investec would receive the first £500,000 of profit which was realised, that TRG would receive the next £928,571 of profit which was realised (thus producing the 35% / 65% split in profits which was the foundation of their agreement), and that further profits realised beyond this would be split in accordance with that ratio. Mr Murphy was content with that proposal.

In this further conversation, Mr Murphy and Mr Weinberg did not discuss the question of the inclusion of “Net Rental Income” in the calculation of the profit under the proposed EFA. However, Mr Weinberg did make a comment along the lines that Ms Biagi had made a mistake. Mr Murphy did not understand the significance of this at the time. It seems likely to have been intended by Mr Weinberg to indicate disagreement about the position adopted by Ms Biagi in deleting reference to this element in the calculation of the profit in the marked up version of the draft EFA which she had sent Ms Canning on 15 October. Certainly, Investec did not accept the logic of Ms Biagi’s position on this point. The expectation of TRG and Investec was that rental income would largely be used to meet interest payments in respect of the senior and mezzanine lending. Therefore, since “Interest” on that lending was included as a minus item in the calculation of profit, Investec (and Eversheds) considered that the commercial logic was clearly that “Net Rental Income” should be brought into account as a plus item in that calculation – otherwise, the calculation of profit would be unacceptably diminished and skewed in favour of TRG. There was considerable force in Investec’s position on this, and it was not a point which it regarded as open to negotiation.

Meanwhile, Ms Canning worked through the marked up version of the draft EFA which Ms Biagi had faxed to her. She noted the proposed amendments which she could agree and marked for her own reference those which needed to be discussed with Ms Biagi. She marked that the deletion of “Net Rental Income” from the “Exit Fee” calculation had to be queried. So far as the difficulty identified by Ms Biagi with clause 8.2 was concerned, it was not Ms Canning’s understanding that it was intended that £500,000 should be payable on each part sale from the portfolio. Therefore, she was willing to accommodate Ms Biagi’s concern in that regard in the drafting. She did not, however, work out a new text for clause 8 before she spoke to Ms Biagi about the marked up version of the draft EFA, which she did by telephone on 18 October.

Neither Ms Canning nor Ms Biagi made notes of this conversation. In their evidence, both of them were doing their best to remember what had been said in a relatively short conversation several years ago. In these circumstances, in assessing the probable course of events, I place considerable weight on what seems to me to be the inherent commercial probability in relation to what was said.

Ms Canning’s recollection was that she raised with Ms Biagi the deletion of “Net Rental Income” in the definition of “Exit Fee” and the proper approach to when the exit fee would be payable; that after explaining to Ms Biagi Investec’s view on the “Net Rental Income” point Ms Biagi seemed to be content for that term to remain as a plus item in the calculation of the “Exit Fee”; that it was agreed that wording would be inserted to make it clear that £500,000 would not be payable by TRG every time a property in the portfolio was sold; and that Ms Biagi proposed that the words “Bank Debt amendment” referred to in para. [33] below should be included in the definition of “Exit Fee” to address that same point. Ms Biagi’s recollection was that on both issues Ms Canning simply said she would take instructions. Ms Biagi denied that she had put forward the Bank Debt amendment in the course of their conversation.

In my judgment, the true position lies between these competing recollections. I find that Ms Canning did put Investec’s position on the “Net Rental Agreement” point to Ms Biagi. I think it likely she did this because she knew Investec’s view on the point, the commercial logic of its position was strong, she was responding to a textual deletion made by Ms Biagi, Ms Canning had checked her instructions before the call and she was the person who made the call to respond to the points Ms Biagi had made (Ms Biagi had been chasing her to do so). It is very unlikely Ms Canning would have called and then simply have said that she would take instructions on a matter like this. I find that Ms Biagi did not respond to the arguments which Ms Canning put forward on this point, which left the impression that she did not disagree with them (although I think Ms Biagi was silent because she intended to discuss this further with Mr Murphy, rather than commit herself one way or the other in the conversation).

In relation to the timing for payment of the exit fee, I find that Ms Canning indicated in general terms that Investec accepted the general principle that TRG should not have to pay £500,000 each time a property in the portfolio was sold. She had checked Investec’s position on this before the call, and there was no reason why she would have failed to give this indication during the call. However, I do not accept Ms Canning’s evidence that Ms Biagi proposed that words should be inserted in the definition of “Exit Fee”, after the reference to the “Net Sale Proceeds” and “Estimated Net Sale Proceeds”, as follows: “(after repayment in full of the Bank Debt)”. The interpretation of these words as included in the final version of the EFA is the main point in issue between the parties. I refer to this insertion as “the Bank Debt amendment”.

Contrary to Ms Canning’s evidence, I think it is likely that she simply indicated that she would provide a further draft of the EFA which would accommodate TRG’s concerns on the issue regarding sale of properties in the portfolio on a piecemeal basis, and that Ms Biagi was happy with that. There is no evidence that either of them went into the conversation with any specific proposed text to deal with this issue, and it is unlikely that either of them would have attempted to draft amendments to a complicated agreement like the EFA in the course of their short conversation. It is much more likely that Ms Canning would have indicated that she would produce a further draft to deal with the issue: the draft EFA was an Eversheds draft of an Investec document, Ms Biagi had raised the point of principle in general terms and the ball was in Eversheds’ court to respond to it with detailed drafting proposals. Moreover, there is a copy of the marked up version of the draft EFA supplied by Ms Biagi to Ms Canning which bears some additional jotted notes by Ms Canning and ideas for textual changes. These reflect a concern to deal with the issue of piecemeal disposal of properties in the portfolio. It is likely they were made shortly after her conversation with Ms Biagi. They do not include any reference to the Bank Debt amendment.

After this conversation, Ms Canning turned her attention to producing a further draft of the EFA. By this time she had become aware that work had been carried out by Eversheds and Investec further amending the precedent EFA which Investec used in its banking business. In the light of this, she was unsure whether she should continue using the existing draft EFA, which had been the subject of discussion between her and Ms Biagi, or should translate the agreement into the terms of the new precedent used by Investec. She consulted her managing partner, who advised that he thought it would be better to translate the proposed EFA using the terms of the new precedent. Accordingly, that is what Ms Canning did.

The changes to the draft document that this entailed were so extensive that Ms Canning opted to provide a new clean draft of the revised terms of the EFA to Ms Biagi on 20 October. This undoubtedly created problems for Ms Biagi, who was confronted at short notice and without warning with a draft agreement in rather different terms from the draft that she had been working on. Nonetheless, she worked through the documents comparing them to satisfy herself that the new draft was acceptable.

The new draft EFA was in the terms of the final EFA which was eventually executed on 22 October 2004. The calculation of profit which had previously been contained in the definition of “Exit Fee” was now contained in the definition of a new term, “Surplus”, as follows:

“Surplus” means the amount by which the aggregate of Net Sale Proceeds or the Estimated Net Sale proceeds (as the case may be) (after repayment in full of the Bank Debt) and the net Rental Income exceeds the aggregate of the Completion Costs, Planning Costs, Management Costs, Development Costs and Interest.”

Thus, Ms Canning had re-inserted “Net Rental Income” as a plus item in the calculation. She had also inserted the text of the Bank Debt amendment. “Bank Debt” was defined to mean “all monies and liabilities (whether in respect of principal, interest or otherwise) due, owing or incurred by [TRG] to [Investec] under the Facility Letter”. I find that this was the first time that the Bank Debt amendment was raised between the parties.

Ms Biagi’s evidence was that she understood that the Bank Debt amendment meant that the “Bank Debt” was to be treated as a full deduction from the calculation of the “Surplus” and that she thought that this was being offered as a quid pro quo by Investec in return for re-inserting “Net Rental Income” as a plus item in the calculation. This was her subjective understanding of the language that had been used: she did not discuss it with Investec or Eversheds, although she did discuss it with Mr Murphy. Neither Ms Biagi nor Mr Murphy worked through the existing projected figures in respect of the development in relation to the calculation in order to see how it might work in practice.

Ms Canning, on the other hand, believed that the Bank Debt amendment simply provided comfort to TRG that there would be no exit fee payable if parts of the portfolio were sold off piecemeal by TRG. I find that this was her intention in including that amendment in the EFA. She also sought to accommodate TRG’s concerns in that regard by including clauses 6 and 7 of the new EFA, as follows:

“6.

When Exit Fee is Payable

6.1

[Investec] shall be entitled to receive the Exit Fee in the following circumstances:-

6.1.1

Immediately upon a sale of the whole of the Property; or

6.1.2

Within 28 days of the Bank serving a Crystallisation Notice on the Borrower.

6.2

Upon the Bank serving a Crystallisation Notice on [TRG], [TRG] shall within 2 days instruct the Valuer to carry out a Valuation to determine the Estimated Net Sale Proceeds. If any part or parts of the [portfolio – referred to in the EFA as “the Property”] have been previously sold the Net Sale Proceeds of such part(s) shall be added to the Estimated Net Sale proceeds for the purposes of calculating the Exit Fee.

6.3

[Investec] shall not be entitled to serve a Crystallisation Notice prior to the Termination Date except in the event that the Bank Debt is repaid prior to the Termination Date.

6.4

[Investec] shall be entitled to serve a Crystallisation Notice on [TRG] upon a repayment of the Bank Debt prior to the Termination Date PROVIDED ALWAYS that if [Investec] elects not to serve a Crystallisation Notice at the time of repayment of the Bank Debt this Agreement shall continue in full force and effect regardless of the fact that the Bank Debt may have been repaid and [Investec] shall continue to be entitled to receive the Exit Fee either upon a sale of the Property or upon [Investec] serving a Crystallisation Notice.

6.5

In the event that a Crystallisation Notice is served and the Valuer calculates the Exit Fee based upon the Estimated Net Sale Proceeds, the Exit Fee shall be paid by [TRG] to [Investec] within 10 days of the Valuer calculating the Exit Fee.

7.

Payment of Exit Fee

[Investec] shall be entitled to receive the Exit Fee as follows:-

7.1

The first £500,000 of any Surplus shall be paid to [Investec] by way of Exit Fee.

7.2

Any Surplus in excess of £500,000 but less than £1,428,571 shall be retained by [TRG].

7.3

35 per cent of the balance of any Surplus in excess £1,428,571 shall be paid to [Investec] by way of an Exit Fee.”

The executed EFA, dated 22 October 2004, was sent by Ms Biagi to Ms Canning under cover of a letter of 21 October 2004, together with other documents (presumably the executed version bore the later date that was the date on which it was to come into effect on completion of the purchase of the West Block from Portsmouth CC).

On about 22 October the executed deed of subordination between TRG, Investec and Tristmire was provided to Eversheds. That deed referred to the Tristmire charge, and it is likely that Eversheds saw a copy of that charge in the course of finalising the transaction. The Tristmire charge referred to the Redemption Payment of £3m payable by TRG in respect of the Tristmire loan.

TRG completed its purchase of the West Block from Portsmouth CC on 22 October.

There was then an interlude in which the loan relationship between Investec and TRG appears to have run smoothly. In May 2006 TRG switched its bank accounts from HSBC Bank to Clydesdale Bank. In relation to this, Clydesdale Bank wanted TRG to give a third charge over the portfolio in its favour, in the amount of £300,000, to cover any overdraft. Investec agreed to this in about late July 2006 on the basis that such a charge would be subordinate to its first charge over the portfolio.

However, the change in TRG’s banking arrangements caused problems to arise in relation to the smooth payment of interest in respect of the loans from Investec. On 25 August 2006 Mr Donovan e-mailed Mr Murphy to point out that TRG was now seriously in arrears in relation to its payment of interest in respect of the Investec loans. By a fax sent at about the end of August 2006 by Mr Murphy to Mr Donovan, Mr Murphy sought to explain how the situation had arisen. He stated that “the equity in the property has been building steadily for some time now”, and claimed that “at least £8m of equity” had accrued. Mr Donovan asked C B Richard Ellis for a desktop valuation of the portfolio, which they valued at £20.5m. That lent support to TRG’s claim.

On 30 August 2006 Mr Donovan, through his assistant Mr Irvine, put a further proposal to Investec’s credit committee to increase the mezzanine facility by £330,000 to cover TRG’s additional need for funds. This was put forward on the basis of what appeared to be the improved value of the portfolio (which had improved the value of Investec’s security) and the improved rental income in relation to the portfolio, which was then at a level of £1.126m p.a.. This proposal represented a helpful increase by Investec in its mezzanine loan facility at a time when TRG was experiencing cash flow difficulties. It was made without taking any additional security or increasing the amount of the exit fee which would be payable, to compensate Investec for the additional risk which it would assume. The proposed increase in the mezzanine loan facility was approved and was notified to TRG by a further facility letter dated 13 September 2006.

In about October 2006 TRG received an offer from Schroder Emerging Retail Property Trust (“Schroders”) for the West Block in the sum of £14.7m. On about 13 October Mr Clark for TRG informed Mr Donovan of this offer. Both TRG and Investec regarded this as a very good offer for the West Block and both were keen to proceed with it.

On 13 October Mr Donovan e-mailed Mr Murphy to schedule a meeting on Monday, 23 October with Mr Murphy and Mr Clark. He said:

“You need to come with a proposal in respect of apportioning the debt and part payment of the Exit Fee. Perhaps your accountants can help you with the calculation of the potential profit to date.”

At this stage neither Mr Donovan nor Mr Irvine had gone back to the EFA to check its terms. They made the assumption going into the meeting that the EFA included provision for part payment of the exit fee when part of the portfolio was sold. In fact, however, this was not allowed for under clauses 6 and 7 of the EFA and by reason of the terms of the Bank Debt amendment. Mr Murphy was aware of this, and checked his understanding with Ms Biagi before attending the meeting.

At the meeting on 23 October Mr Murphy asked to be allowed to withdraw money (about £1m) from the sale proceeds to be received from Schroders in order to recoup costs that TRG and he had been incurring in relation to development of the portfolio. Since Investec held the first charge over the West Block, Mr Murphy understood that he needed Investec’s agreement to do this. I accept his evidence that he raised the fact that the EFA did not allow for early part payment of the exit fee at the meeting. I think it is likely he did so, since it was a powerful commercial negotiating point for him in trying to persuade Investec to allow him to withdraw the money he requested to emphasise that he too would be making a major concession in return by agreeing to make an early part payment of the exit fee. In that regard, I find that Mr Murphy proposed that his accountants should prepare figures to calculate an early part payment in respect of the exit fee payment. He said the figures should be ready by about mid-December. Mr Donovan and Mr Irvine, for their part, indicated that Investec would in principle be prepared to agree to release from the sale proceeds of some monies for TRG.

The parties also discussed how the Schroders sale proceeds should be apportioned as between the senior and mezzanine lending by Investec, and pending payment of the early part payment of the exit fee which Mr Murphy proposed to make in about December 2006. Mr Murphy pressed for the whole of the balance of the sale proceeds (after withdrawal of the monies which TRG requested) to be used to pay down as much of the outstanding senior and mezzanine lending as possible, to reduce the continuing interest payments which TRG had to meet. He and Mr Clark emphasised that the debt due to Investec would thereby be reduced to about £1.3m, secured against the value of the East Block of about £8m. Against this, Mr Donovan and Mr Irvine pressed for a significant part of the balance of the sale proceeds to be paid into an escrow account as a fund out of which the early part payment of the exit fee could be made, rather than being used to reduce TRG’s debt (and interest payments) to Investec. Contrary to a later claim in correspondence by Mr Clark and evidence from Mr Murphy that at the meeting Mr Donovan and Mr Irvine agreed with TRG’s proposal, I find that no agreement was reached on this point. There are a number of reasons for reaching this conclusion, which I set out below.

On 24 October Mr Irvine put a further proposal to Investec’s credit committee. This reflected the approach taken by Mr Donovan and him at the meeting on 23 October. It is very unlikely that Mr Irvine would have done this if there had in fact been agreement on TRG’s proposal at the meeting. The proposal which Mr Irvine put forward to the credit committee was that the sale proceeds should be used to reduce the senior and mezzanine loans from Investec by 63%, in line with the proportion of the original lending which related to the funds used to purchase the West Block (as against 37% attributable to the refinancing of the East Block). The proposal also recommended that the remainder of the net sale proceeds should be held in a blocked deposit account (i.e. in escrow) pending finalisation of the profit sharing calculations in relation to the West Block, estimated to give rise to an early exit fee payment of about £1.4m (i.e. about 35% of £5m of net sale proceeds in respect of the West Block). It was also proposed that the EFA should be redrafted to protect Investec’s position, allowing for a further 35% profit share relating to the East Block which would be due on the expiry of the loan term. It was noted that these proposals would leave residual debt in relation to the East Block of about £5.58m against a valuation of the security represented by the East Block of about £8m, which gave a healthy loan to valuation ratio of about 70%.

The credit committee approved Mr Irvine’s proposal, so on 25 October he e-mailed Mr Murphy to put the proposal to him on behalf of Investec. That e-mail did not lead to any protest by Mr Murphy that Mr Irvine had gone back on anything that had been agreed at the meeting on 23 October.

By e-mail of 27 October from Mr Murphy to Mr Donovan, Mr Murphy set out the detail of the sums which he and TRG wished to withdraw from the sale proceeds of the West Block as follows:

“£162,000 (approx) Schroders rental payment – assuming completion 31.10.06 £130,000 Barlow Lyde & Gilbert £282,000 Garner Wood & MSBL £100,000 Dental surgery works £320,000 Clydesdale

£50,000 D. Murphy”

The £320,000 for “Clydesdale” was to provide for repayment of TRG’s overdraft with Clydesdale Bank and discharge of its third charge over the property. The £50,000 for Mr Murphy was explained by him shortly afterwards to be required to pay off an overdraft of £40,000 with NatWest Bank and general expenses, all in relation to the development of the portfolio. Mr Donovan responded to agree that these sums could be retained by TRG out of the sale proceeds and that TRG should account to Investec for the balance remaining. Mr Murphy’s proposal left a balance of some £13.67m of the sale proceeds.

The same day, Mr Clark e-mailed Mr Donovan in these terms:

“To confirm the payment arrangements to Investec that we agreed when we met. On completion The Retail Group Plc will pay Investec £13,750,000, which is to be used to pay off completely the Senior Debt of £12,250,000 and £1,500,000 of the Mezzanine Debt. This will leave an outstanding sum of £1,323,000 which is to be retained on a first charge basis over the eastern block of property, which I estimate to be worth £8,000,000. The £1,323,000 will continue to attract the Mezzanine Debt rate of interest. As agreed David Murphy will prepare all accounts for The Retail Group Plc and we will meet in early December to discuss the profit share.”

Mr Donovan replied shortly afterwards to say, “This is still under discussion with David [Murphy]” (i.e. he disputed that these arrangements had been agreed at the meeting).

Also on 27 October, Mr Murphy e-mailed Mr Donovan to compare the financial implications for TRG of the proposal in Mr Irvine’s e-mail of 25 October and “our proposal” (i.e. the TRG proposal made at the meeting on 23 October). Again, it is relevant to note Mr Murphy’s e-mail contained no assertion that an agreement had been reached at that meeting regarding the allocation of the proceeds of sale. On TRG’s proposal the balance of £13.67m would be used to pay off the whole of the outstanding senior loan of £12.25m and £1.42m of the mezzanine loan. That would leave £1.403m of the mezzanine loan outstanding. Use of the balance in this way would reduce the interest payable by TRG as far as possible. On the other hand, on Investec’s proposal, TRG would suffer a detrimental interest charge because of the difference in the interest that TRG would earn from monies in the escrow account as compared with the greater interest it would have to pay to Investec on the balance of the Investec loans which would be left outstanding. Mr Murphy pointed out that Investec would suffer part of this loss in relation to their share of profits under the EFA. He continued:

“I do not mind if a time limit of three months is used to hurry up all sides to come to an agreement for the profit share.

Also I am very wary of interest rate rises that are on the way and would not like to be at any more risk than I have to by having continuing large mortgage… It is imperative we resolve this issue quickly as any delay could mean I could lose this deal with Schroders…especially with interest rate rises and the insistence from Schroders that this deal is completed quickly.”

Later on 27 October Mr Donovan replied to this e-mail to suggest that the difference in interest costs was not as great as Mr Murphy suggested and inviting him to reconsider Investec’s proposal “as we already have credit approval [for] the proposal”.

On 30 October 2006 Mr Murphy replied to Mr Donovan in these terms:

“…Thanks for your latest figures on your proposal… I would like to propose another option which may be acceptable to you. This option would be more suitable for me as I am minded to sell the eastern block once we have completed the transaction for the western side. On advice from Tim, it is best to sell this asset as shortly as possible before the department stores vacate and there is a downward move in rents. The air rights, if developed, would not compensate the difference in the drop in investment value if rental values dropped £10 or £15 per sq ft (please speak to Tim about this if required).. Apart from investing a further £2 or 3 million it seems to be too much risk… I would propose that we go along with what we originally agreed at our meeting to pay off the senior debt and the difference off the mezz debt…To make this deal more acceptable to you, I could make a £500k payment to Investec towards the total profit share now and then sort out the up to date figures for remaining profit share within 3 months.. I do not want to have money left on a escrow account, especially when rates and values can go up or down, also it will cost me an extra £16k per quarter to do it this way.. This proposal means that I will have approx £1.91m left on mezz debt with you having first charge on a £8m asset..

It is important that we sort this out asap as Schroders insist on completing tomorrow.. Any delay and I will lose this deal…”

This proposal, involving immediate payment of £500,000 out of the sale proceeds on account of the exit fee, was acceptable to Investec and was agreed.

Eversheds were instructed to draft a new exit fee agreement to cover the position. A draft was prepared by Ms Beth Evans at Eversheds. This was forwarded by Investec to Mr Murphy on 2 November 2006. He forwarded the draft agreement to Ms Biagi, and she responded to it by e-mail dated 2 November to Ms Evans. Ms Biagi pointed out that the Facility Letter allowed for prepayments of the loans under it and did not provide for allocation by Investec to other accounts. She also pointed out that the exit fee under the EFA did not have to be paid until the whole of the portfolio was sold or following service of a Crystallisation Notice after the three year term had expired. She maintained that TRG was not obliged to pay Investec the net sale proceeds but wished to do so to redeem the loans (save for a relatively small balance). She emphasised the importance of a speedy resolution in view of the urgent timetable imposed by Schroders and a requirement for an executed DS1 (i.e. the necessary certificate for the Land Registry notifying it of Investec’s consent to removal of notice of its first charge over the West Block) to be available on completion. She said:

“Notwithstanding the fact that the Exit Fee is not payable for at least another 12 months, and in order to secure a quick “turn round” by your client, (as apart from anything else, speed is the purchaser’s overriding requirement), my client then agreed with yours that on completion of the sale of the western block he would pay £500,000 on account of the Exit Fee, which is money that he would otherwise use to reduce the lending with your client. This is therefore costing him interest, which he should not have to pay.

There is no need to re-cast either the facility letter or the exit fee agreement. All that is needed is a side letter to record the prepayments that are being made and the basis upon which they are being made and I prepared such a letter this afternoon, as you will see below.”

She complained at the delay which had been caused by the demand for the documents which might result in the sale being lost. She concluded by emphasising the extreme urgency of the matter. She enclosed a draft side letter dated 2 November 2006.

After some negotiation the side letter was put into an agreed form by about 3 November. It was first signed by the parties on 6 November 2006, but Schroders then dropped the price that it was prepared to pay for the West Block by £200,000 so a revised form of side letter reflecting this was signed on 17 November 2006. That letter was addressed to Investec and set out that TRG had agreed to forward to Investec on completion the sum of £12,957,000 from the net sale proceeds by way of prepayment of loans 1 and 2 referred to in the Facility Letter to redeem loan 2 (the mezzanine loan) in its entirety and the balance to be assigned to loan 1. The letter continued in these terms:

“5.

Notwithstanding the terms of the [EFA], we [i.e. TRG] have agreed to make a further prepayment to you of £500,000 on account of the final calculation of the Exit Fee, being the sum referred to in paragraph 7.1 of the Exit Fee Agreement.

6.

Save as varied herein, the Facility Letter and the [EFA] continue as before, mutatis mutandis, and in particular, as provided by clause 6.1 of the [EFA], the remainder of the Exit Fee is not payable until the sale of the whole property, i.e. the entirety of both the Western Block and the Eastern Block or following the service of a crystallisation notice after 21^st October 2007.”

After receipt of that letter Investec supplied TRG with the executed form DS1 which enabled TRG to conclude the sale of the West Block to Schroders under a sale contract dated 28 November 2006 and completed the same day.

On 30 November 2006, Investec received £13,457,000 from the sale proceeds which was used to discharge the mezzanine loan (with interest), to repay about £10m of the senior loan and as payment of £500,000 in respect of the exit fee.

In December 2006 Ms Biagi carried out detailed work to draw together the figures to calculate the part payment of the exit fee in relation to the West Block, as had been proposed by Mr Murphy at the meeting on 23 October 2006. It was while doing that work that she came to appreciate that on her interpretation of the definition of “Surplus” in the EFA no exit fee would be due. This was because she interpreted the definition of “Surplus” (and in particular the Bank Debt amendment) to mean that one added together “Net Sale Proceeds” in respect of the West Block and “Estimated Net Sale Proceeds” in respect of the East Block, then deducted the full amount of the “Bank Debt” (i.e. the principal, interest and other charges due from TRG to Investec under the Facility Letter), then added the “Net Rental Income”, then deducted the “Completion Costs”, “Planning Costs”, “Management Costs”, “Development Costs” and “Interest”. Ms Biagi (who had moved to a new firm of solicitors, Barlow, Lyde & Gilbert, which was now acting for TRG) wrote to Investec on 23 January 2007 to say that TRG wished to refinance the remainder of its portfolio and so intended to redeem the remainder of loan 1 (the senior lending) by 31 January 2007. Relying on her interpretation of the definition of “Surplus”, she stated that no exit fee was due, set out a calculation to demonstrate that and provided five lever arch files of calculations and accounting information to support that calculation. On the basis that no exit fee was payable, she stated that the sum of £500,000 which TRG had paid to Investec on account of the exit fee should be repaid.

Meanwhile, TRG also entered into negotiations with Tristmire with a view to discharging the Tristmire loan and the Redemption Payment in respect of it.

Investec did not agree with Ms Biagi’s claim that no exit fee was payable. Correspondence ensued between solicitors, culminating in a detailed letter from Eversheds for Investec dated 14 February 2007. This stated that the EFA contained “an error in [its] drafting” and that it did not reflect the common intention of the parties. The letter maintained that the EFA should be rectified so as to remove the Bank Debt amendment from the definition of “Surplus”. Barlow, Lyde & Gilbert wrote on 20 April 2007 to maintain that TRG’s case was that the wording of the EFA was clear and unambiguous and that there was no good case for rectification. The letter also sought to set out that there were other extensive deductions to be made in the calculation of the “Surplus”, including large figures in relation to interest and costs associated with the Tristmire loan and capital gains tax (“CGT”). These items and others have remained in dispute between the parties since then.

TRG eventually refinanced the East Block in June 2007 and discharged Investec’s loan on 5 June 2007, whereupon Investec’s charge over the balance of the portfolio comprising the East Block was cancelled.

By letter dated 6 June 2007 from Investec to TRG, Investec gave a Crystallisation Notice for the purposes of the EFA, requiring the exit fee due under that agreement to be calculated and paid. The letter referred to the requirement that a valuer be appointed to determine the “Estimated Net Sale Proceeds” in respect of the East Block. In due course, King Sturge LLP was appointed as valuer for these purposes and produced a valuation report valuing the East Block as at 25 June 2007. This valuation was accepted by both sides as the basis for calculation of the “Estimated Net Sale Proceeds” of the East Block.

One matter in particular in the valuation report calls for attention. At paragraph 3.2.7, King Sturge recorded:

“3.2.7

The site for the Medical Centre has already been sold on a 999 year lease at a peppercorn rent and therefore does not form a valuable asset to the remaining property. You should however ensure that no existing occupiers have their rights infringed which could affect the stability of the income from the remaining units.”

It emerged from evidence at the trial that the proposed site for the medical centre was a car park area located at the rear of the East Block. TRG entered into a contract with a medical practitioner to design and build a medical centre on that site for him in return for an advance payment (which by agreement between them took the form of the transfer to TRG of another property owned by him at 67 Albert Road, Southsea, which Mr Murphy valued at about £300,000) together with a further obligation to make a payment of £129,000 when the works were complete. According to Mr Murphy’s evidence, the cost of designing and building the surgery would be roughly equivalent to the value of 67 Albert Road and the further payment of £129,105, so that in broad terms the development of the medical centre would be financially neutral so far as the overall value of the development of the East Block was concerned.

I turn now to address a number of issues which have arisen between the parties concerning the proper interpretation of the calculation of the “Surplus” which is set out in the EFA. Unsurprisingly, TRG contends for a wide interpretation to be given to the various elements in the calculation which are minus items, while Investec argues for a narrow interpretation of such elements. The most important point in dispute is whether the Bank Debt amendment, in the definition of “Surplus”, sets out a minus item at all, such as to require the deduction of the full amount of the “Bank Debt” in the calculation, as well as the deduction of “Completion Costs” and so on.

The parties were in agreement as to the proper approach to the construction of the EFA as a matter of law. On familiar principles, an objective approach is to be applied. A useful summary of the law is given by Lawrence Collins LJ in Chartbrook Ltd v Persimmon Homes Ltd [2008] EWCA Civ 183 at [85]-[86], as follows:

“85.

The starting point is not controversial. Interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract. Subject (a) to the requirement that the background should have been reasonably available to the parties, and (b) the exclusion of previous negotiations of the parties and their declarations of subjective intent, it includes anything which a reasonable man would regard as relevant and which would have affected the way in which the language of the document would have been understood by a reasonable man: Lord Hoffmann in Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896 at 912; BCCI v Ali [2002] 1 AC 251, 269; and also Mannai Investment Co Ltd v Eagle Star Life Assurance Ltd [1997] AC 749, 779.

86.

If a semantic analysis of words in a commercial contract leads to a conclusion which flouts business common sense, it must be made to yield to business common sense: Antaios Cia Naviera v Salen Rederierna AB [1985] AC 191, 201, per Lord Diplock. This does not mean, however, that the language can be rewritten in order to make the language conform to business common sense: Co-operative Wholesale Society Ltd v National Westminster Bank plc [1995] 1 EGLR 97.”

The particular significance of the application of an objective approach to construction of the EFA in the present context is that the subjective understandings of Ms Biagi and Mr Murphy, on the one side, and of Eversheds and Investec on the other, regarding the interpretation of the definition of “Surplus” in the EFA are not relevant to the proper interpretation of the EFA to be arrived at by the Court. I have found that Ms Biagi considered the effect of the insertion of the Bank Debt amendment to be to create a further minus item in the calculation of “Surplus”, and that she discussed that with Mr Murphy. However, that remained their subjective understanding, which was not communicated at the time to Investec, and does not control the proper interpretation to be given to the definition of “Surplus” in the EFA. Similarly, Eversheds’ letter of 14 February 2007 (para. [65] above) was written on the basis of the subjective understanding of the writer, a solicitor in Eversheds’ litigation department, formed well after the making of the EFA, that the true meaning of the Bank Debt amendment in the definition of “Surplus” was to create a minus item in the calculation. But, again, that does not control the proper interpretation of the EFA.

I have found that Ms Canning’s understanding of that amendment, which she inserted into the definition of “Surplus”, was that it did not create a further minus item but only provided clarification and comfort for TRG that the exit fee would not be payable until after the whole development was sold or re-financed and the entirety of the sums due to Investec under the Facility Letter were repaid. But Ms Canning did not communicate that understanding to Ms Biagi, so again it is not something which controls the proper interpretation of the EFA.

In construing the EFA, I have to have regard to the words used by the parties in the EFA, and give them the objective meaning which would be given them by a reasonable person located in the factual context in which the parties were positioned at the time of making their agreement.

The parties also agreed that another part of Lawrence Collins LJ’s judgment in Chartbrook Ltd v Persimmon Homes, at [129]-[130], correctly states a further principle relevant to the construction of a contract:

“129.

The other most directly relevant decision at first instance is Jones v Bright Capital Ltd [2006] EWHC 3151 (Ch). The issue was as to the meaning of a paragraph in a defence in a claim about pension rights, which had been incorporated as a term of the settlement of those proceedings. Sir Andrew Morritt C referred to the argument for the claimant that correspondence was admissible to show that the parties had used words in a special sense or to show the commercial business genesis or object of the agreement. He cited Prenn v Simmonds, Investors Compensation Scheme Ltd v West Bromwich Building Society, and The Karen Oltmann, and went on (at [24]):

‘In my view each of the letters in questions is admissible on the issue of construction. They show the genesis and subject matter of paragraph 38(3) of the defence which became a term of the Compromise. They show the connection between the actuary’s calculations and that paragraph and explain the figures and other terms which appear in it. None of them is relied on as indications of subjective intention and on the face of them they are not objectionable on that account. The mere fact that they were written in the course of inter-solicitor correspondence seeking to agree a redundancy package is not, in my judgment, a sufficient objection.’

130.

He then went on to say that none of the letters added a great deal on the issue of construction (at [25]), but (at [41]) used them to determine what he described as “the subject matter of discussion” to show that what the parties were negotiating about was extra scheme pension (attracting pension increases) rather than a flat rate annual payment. A literal reading of the document would not have led to that result. This was not a “private dictionary” case. The use of the correspondence was justified on the basis that it showed the genesis and object of the provision and provided a ground for treating the parties as having negotiated on an agreed basis.”

Accordingly, in interpreting a contract, regard may be had to the content of the parties’ negotiations to establish “the genesis and object” of a provision. This seems to me to be a relevant part of the factual matrix, since if the parties in the course of their negotiations are agreed on a general objective which is to be achieved by inclusion of a provision in their contract, that objective would naturally inform the way in which a reasonable person in the position of the parties would approach the task of interpreting the provision in question. I return to consider the relevance of this further principle at paragraphs [82]ff below.

Certain of the difficulties in interpreting the EFA stem from the fact that it was adapted from a standard form agreement suitable for a simpler development situation, in which one property would be acquired for development using funds provided by Investec and Investec would share in the profits from that development. In such a case, working out the profit on the transaction in which Investec should share would be a comparatively straightforward task. But in the present case the situation was more complicated, and the standard form agreement had been modified in an effort to deal with this.

TRG had acquired the properties in the East Block piecemeal over a period of about a year and a half before the transaction with Investec, using monies borrowed from other sources. The immediate reason TRG required funding in July 2004 was to take advantage of an opportunity to buy the West Block from Portsmouth CC. At the same time, TRG wished to re-finance its investment in the East Block. Its commercial objective was to treat the West and East Blocks as a potential unified development. But it was also contemplated by both parties from the outset that, if good opportunities arose to sell off individual properties within that development, TRG might do so.

There were, therefore, differences from a more usual, simple development transaction to which the standard form of EFA would apply. Two were of particular significance. First, part of the development to which the agreement was to apply had been acquired some time before Investec participated in the investment, but the profit sharing arrangement was to apply to the whole of the development. That required some method for working out the profit element in which Investec would share in relation to the previously acquired properties. Secondly, the parties had to consider what should happen if TRG sold off part of the overall development, rather than treating it as a single whole. These features of the present case are reflected in a somewhat uneasy tension in the EFA which was entered into by Investec and TRG.

The most significant matter in dispute between the parties concerns the effect of the Bank Debt amendment in the definition of “Surplus” in the EFA. TRG submits that the amendment creates a further minus item to be taken into account in the calculation of the “Surplus”. Investec submits that, on proper construction, the amendment does not create a further minus item, but merely stipulates that no “Surplus” can arise for sharing by way of an exit fee until the Bank Debt has been repaid.

In my judgment, Investec’s submission is correct. It is convenient to deal with indicators in the factual matrix which support this conclusion before turning to the detail of the provisions of the EFA.

As regards the factual matrix, the principle identified in paras. [75]-[76] above is significant, for two reasons. First, in documents passing between the parties from an early stage the general object of the provision for an exit fee in respect of the mezzanine loan to be provided by Investec was stated to be to provide Investec with “A profit share of 35% of the net profit after all costs …” (see the indicative offer of 10 August 2004: para. [9] above) and “35% of the profit” (see the facility letter of 15 September 2004, signed by TRG on 23 September 2004: para. [13] above). The profit sharing nature of the proposed exit fee arrangement was confirmed in the letter from Glinert Davis to Investec of 24 September 2004 (para. [15] above).

In the context of a property development transaction, the profit which it is hoped will be made is given in broad terms by deducting the price at which the developer acquired the property (which will very often be paid out of monies borrowed by the developer) and the costs of work carried out in developing it (which will also often be paid out of monies borrowed by the developer) from the final price at which the developer sells the property. One does not deduct from the final sale price the price for which the developer acquired the property and then also deduct the amount of the borrowing which enabled it to pay that price. That would involve an impermissible element of double-counting on the minus side of the profit calculation. Similarly, one does not deduct from the final sale price the developer’s costs of development works and then also deduct the amount of the borrowing which enabled it to meet those costs. That again would involve an impermissible element of double-counting on the minus side of the profit calculation. There was nothing said or done in the negotiations up to the making of the EFA which indicated any departure from this common objective to create an agreement which provided for a 35% profit share for Investec out of the three year loan transaction. This is an important part of the factual background against which the EFA falls to be construed.

The commercial logic of this focus on the intended profit sharing nature of the EFA is brought out by consideration of the figures in the contemplation of the parties in July to October 2004 in relation to this particular transaction. TRG indicated to Investec that it contemplated a profit of the order of about £8m or £9m, based on an acquisition price of about £16.4m, rental income of about £1.1m p.a., interest payments in respect of the senior and mezzanine loans of about £900,000, and an anticipated value of the portfolio by the end of the three year term of the loans of about £24m: see paras. [8]-[11] above. The original borrowing from Investec would be £14.75m. On those figures there would be no “Surplus” at all to be shared under the EFA, if both the acquisition price of about £16.4m and the borrowing of £14.75m fell to be deducted from the final value of the portfolio of £24m.

In the light of all this, one would require very clear language in the EFA to indicate that the parties intended to depart from the natural approach to be adopted to working out the profit in relation to a property development to be shared with Investec, and to deprive the profit sharing arrangement of what the parties contemplated in their negotiations up to the making of the EFA should be its practical effect. The Bank Debt amendment is not expressed in language which gives any clear indication that the parties did intend such a departure.

Secondly (as a matter of lesser weight), in relation to the detail of what passed between Ms Biagi and Ms Canning between 15 and 22 October 2004, by Ms Biagi’s markings on the draft of the EFA supplied to Ms Canning on 15 October 2004 (para. [26] above), Ms Biagi identified two principal concerns which she had in relation to the drafting of the EFA, namely that she did not consider that “Net Rental Income” should be brought into the calculation of the exit fee and that provision needed to be included to ensure that the principle as to the final position Investec would be in was recognised without TRG being liable to pay £500,000 on each part sale from the portfolio. I have found that Ms Canning explained in their conversation (paras. [30]-[34] above) that “Net Rental Income” was an appropriate plus item, in light of the fact that “Interest” was included as a minus item. Ms Canning also accepted in that conversation that it was not the intention that TRG should pay £500,000 on account of the exit fee each time part of the portfolio was sold and that the draft EFA should be amended to remove that possibility. Ms Biagi did not suggest in either her manuscript proposals on the draft EFA or in that conversation that the definition of “Exit Fee” in the draft EFA (which became the definition of “Surplus” in the final version of the EFA) required to be amended to bring in “Bank Debt” as a further minus item. In this context, it is my view that a reasonable person in the position of the parties would have understood that the general object to be served by inserting the Bank Debt amendment was to emphasise for the benefit of TRG that no exit fee would be payable until the whole Bank Debt was repaid, and thereby to provide comfort that there would be no obligation on TRG to pay £500,000 in relation to each part sale of the portfolio before that time.

I turn to the terms of the EFA itself. There are, in my view, three indications that in the definition of “Surplus” the Bank Debt amendment was not intended to create a further minus item in the calculation there set out.

First, absent the Bank Debt amendment, the definition of “Surplus” already provides for deduction of the “Completion Costs” as a minus item. “Completion Costs” are defined as follows:

“the purchase price, stamp duty, Land Registry fees, valuation fees, legal fees and disbursements and agent’s fees reasonably and properly incurred by the Borrower in connection with the acquisition of the Property”

In relation to the development of the portfolio, the “Completion Costs” to be deducted comprised the purchase price and other related costs of acquisition of the portfolio, the great bulk of which were funded – as regards the West Block - directly by Investec and – as regards the East Block – indirectly by Investec, since its loans covered the refinancing of the borrowing which TRG had incurred to acquire the East Block properties. If, by virtue of the Bank Debt amendment, the Bank Debt fell to be treated as a further minus item, that would involve a double counting of the borrowing from Investec as a deduction, which in my view would be commercially absurd and could not on any reasonable view have been intended: see para. [83] above.

Secondly, absent the Bank Debt amendment, the definition of “Surplus” already provides for “Interest” (i.e. interest paid by TRG to Investec under the Facility Letter) to be treated as a minus item. Therefore, if, by virtue of the Bank Debt amendment, the “Bank Debt” (i.e. the total sums payable to Investec under the Facility Letter) also fell to be treated as a further minus item, that would involve a double counting of the interest due to Investec under the Facility Letter as a deduction. That would again be wholly illogical, and the parties cannot reasonably be thought to have intended such a result.

Thirdly, the Bank Debt amendment is included in the text of the definition of “Surplus” in parenthesis and between “Net Sale Proceeds”/“Estimated Net Sale Proceeds” and “Net Rental Income”, which are all plus items which fall to be aggregated before the list of specified minus items (commencing with “Completion Costs”) begins. The fact that the amendment is in parenthesis suggests that it has a status different from the main plus and minus items in the calculation, which goes some way to indicate that it is not itself intended to be a minus item. The fact that it is included between two plus items, and apart from the list of minus items, again tends to indicate that it is not itself intended to be a minus item.

Against all this, if the language used in the Bank Debt amendment made it very clear that it was intended that the Bank Debt should be regarded as a further minus item, I would have treated that language as the decisive indicator of the parties’ intentions. But it does not. The drafting is clumsy and its positioning in the definition of “Surplus” is confusing, but as a matter of ordinary language, the Bank Debt amendment is capable of being read as bearing the temporal meaning for which Investec contends. Since that is a possible, natural interpretation of the words used, it is appropriate to have regard to all the reasons given above to conclude on an objective basis that this was the proper meaning which the parties intended the Bank Debt amendment to have.

I should add that in reaching that conclusion I have also taken account of the fact that (quite apart from the Bank Debt amendment) the effect of clauses 6.1 and 6.3 of the EFA was to provide that no exit fee would be due under the EFA until the whole of the portfolio was sold (which would naturally be expected to involve the repayment of the Bank Debt, since Investec held the first charge over the portfolio in respect of its lending) or until after service of a Crystallisation Notice (which could only take place after the end of the three year term, when the Bank Debt would fall to be repaid, or in the event that the Bank Debt was repaid before then). In the light of these provisions, it might be said that in any context in which a profit would arise (and hence where there might be a question of an exit fee having to be paid), it would be otiose for the Bank Debt amendment to provide that the “Surplus” could only be calculated after (in a temporal sense) the repayment in full of the Bank Debt. Therefore, it might be said, some different meaning should be given to the Bank Debt amendment, in line with TRG’s submissions. The difficulty with this, in my view, is that the other indicators as to the true meaning of the Bank Debt amendment to which I have referred above are so powerful that they plainly outweigh this rather tangential argument in favour of a different construction for that amendment.