Great Hill Equity Partners II LP v Novator One LP & Ors

The principal issue in this action is the meaning and effect of a clause in an option deed dated 10 March 2005 (“the option deed”) and made between the claimant (“GHP”) and the defendants. The clause in question is clause 6.5 (b) which provides:

Each of Florissant, Novator, KRC, Robson and Bachmann warrant and undertake to the Grantee and agree that until expiry of the Option Period or completion of the sale and purchase of all the Option Shares pursuant to the exercise of the Option in accordance with this Deed, whichever is the earlier –

(a)

…..

(b)

the Grantee shall have rights of pre-emption in respect of new issues of shares for cash by Florissant and in respect of any new shareholder loans so that the Grantee shall be entitled to its pro rata share to obtain and maintain a 23 per cent. (subject to adjustment to take into account the Grantee not taking up any rights of pre-emption under this clause (b)) interest in the issued Preferred Shares upon the exercise of the Option and be offered any such new shares or shareholder loans at the same price and on such other terms as are offered to other shareholders;

At the trial, GHP relied not only on clause 6 (5) (b) but also on an oral collateral contract alleged to have been made on 10 March 2005 shortly before the option deed was executed. GHP also contended that certain pre-contract statements made in the course of negotiations and draft Heads of Terms sent by one side to the other following the making of these statements were admissible evidence on the issue of construction. The defendants disputed this proposition but did not seek an exclusionary ruling before GHP called its evidence. In the event, the pre-contract evidence was admitted de bene esse, the question of its admissibility being left to be determined when final judgement was given.

When recording the relevant events leading up to the execution of the option deed I set out my findings on all of the evidence I heard. The admissibility of the challenged evidence is dealt with at a later stage.

GHP called Mr Michael Kumin, who was heavily involved in the pre-contract negotiations on behalf of GHP, and two partners of Reed Smith Richards Butler (“Richards Butler”), Mr Philip Taylor and Mr David Boutcher. The witnesses for the defendants were the 4^th and 5^th defendants, Mr Kenn Robson and Mr Andrin Bachmann, Mr Bruce McInroy, who represented the first defendant in the negotiations, Mr Gunnlaugur Erlendsson, in-house legal counsel for Novator Limited, the manager for the first defendant, and Mr Peter Smith, a partner in CMS Cameron McKenna (“Cameron McKenna”). All of the witnesses were truthful and on the whole recalled reasonably accurately the events they related. Mr Kumin was mistaken about his account of what he told the partners of GHP on 7 March 2005. Mr McInroy on occasion failed to deal with questions put in cross-examination as straightforwardly as he should have done but this was not done deliberately to conceal or mislead. And I think Mr Smith was mistaken to insist that in a conversation with Mr Taylor on 23 March 2005 he said that GHP had no right to participate in what is referred to below as the Keaton loan because the lender, Keaton Industries Corp (“Keaton”) was not a shareholder.

At the time the option deed was executed GHP was bidding against the other parties to the deed to take over QXL, a company listed on the London Stock Exchange whose principal business is to run an internet auction website similar to the model used by eBay, the well known market leader in this field. GHP’s bid vehicle was Tiger Acquisition Group Corporation Limited (“TAC”). The vehicle through which the opposing bid was being made was the third defendant (“Florissant”).

GHP’s bid came first when TAC announced an offer of 700 pence per share on 26 November 2004. The bid took Mr Robson and Mr Bachmann by surprise. They too had identified QXL as a potential target and had been taking steps to negotiate an agreement with a Polish company and its backers (“the Polish parties”) who claimed to have acquired 92% of QXL’s Polish subsidiary, QXL Poland sp z o o (“QXL Poland”). This claim was strongly disputed and there was on-going litigation in the Polish courts. QXL Poland accounted for around 75% of the value of the QXL group and the dispute was depressing the QXL share price. The strategy of Mr Robson and Mr Bachmann was to secure an agreement with the Polish parties that would significantly increase the chances of a bid for QXL succeeding.

When TAC’s bid was announced on 26 November 2004 Mr Robson and Mr Bachmann started to look urgently for a financial backer. Mr Robson was introduced to Novator Limited, an Investment Manager and Investment Advisor which was in the course of setting up a fund, Novator One, the first defendant. Novator Limited is owned by Mr Thor Bjorgolfsson, an extremely wealthy Icelandic businessman.

On 15 December 2004 two important agreements were concluded. The first was the Florissant Subscription and Shareholders Agreement (“the Florissant SSA”), the parties to which were KRC Communications Holding NV (“KRC”, a company owned and controlled by Mr Robson), Novator One and Mr Bachmann (“the Investors”) and Florissant and Mr Robson. The second was an agreement between Florissant and the Polish parties (“the Edelmira Agreement”).

The Florissant SSA was made in contemplation of an offer by Florissant for QXL at 800 pence per share (the Offer). Florissant was the intended bid vehicle. The whole of Florissant’s share capital was owned by KRC. Clauses 3.1 to 3.8 regulated what the Investors could and could not do in respect of the making and conduct of the Offer and, inter alia, allowed any Investor to veto purchases of QXL shares by Florissant during the Offer Period. Clause 4.1 provided that if the Offer went unconditional Florissant on the Payment Date would issue and the Investors would each subscribe for a specified number of Preferred Shares in Florissant, and Mr Bachmann and Mr Robson would in addition subscribe for a specified number of Ordinary Shares. The total of the payable subscription monies was £17 million.

The respective entitlements to distribution of profits and capital attached to Preferred Shares and Ordinary Shares in the event of a liquidation, dissolution or winding up, or further specified trigger events, are set out in clause 16.1. Under this provision, should any of the trigger events occur, all of the “proceeds of the event” are to be distributed first to the holders of Preferred Shares up to the nominal value of these shares and the share premium paid thereon, and the remaining amount is distributed to the holders of the Ordinary Shares and the Preferred Shares, proportional to their individual holdings. The Ordinary Shares carry no entitlement to vote.

Clause 4 is under the rubric “Issue and Subscription”. By clause 4.4 it was agreed that other than the subscription shares any new shares created in Florissant’s capital would be allotted or issued to the Investors pro rata and the grant of any right to require the allotment or issue of any new shares would be done so as to preserve the Investors’ pro rata holdings of existing shares in Florissant.

By clause 6.2, if the Offer lapsed or was withdrawn: (a) KRC and Mr Bachmann would pay 30% of the costs of the Offer and Novator One would pay 70%; (b) the Florissant SSA itself would lapse; and (c) and all actions taken thus far would be deemed not to have been taken, or would be reversed to the extent practicable or possible.

By clause 7, in the period before the Payment Date: (a) Florissant would not carry on any other business than was required to complete the Offer and the transactions contemplated by the Florissant SSA; and (b) information regarding Florissant had to be provided to the Investors but if the agreement lapsed, all such information had to be returned. The Payment Date was not less than 4 Business Days prior to payment to the QXL shareholders consequent on the offer going unconditional.

By clause 14.1 and 14.2 if Florissant wished to raise additional finance the Shareholders had the right to subscribe for any new shares or make any new shareholder loan pro rata to their respective shareholding. “Shareholders” is defined as “the holders of the Shares” and “Shares” means “all the issued shares in the capital of [Florissant], as outstanding from time to time. It is therefore plain that in contradistinction to clause 4.4 (which applies to shares or the right to require the allotment or issue of shares created before the Payment Date), clause 14.1 and 14.2 applies to shares issued or shareholders’ loans made after subscription, which would only occur if the Offer were successful.

Clause 4.4 and clause 14 are anti-dilution provisions. They confer a right on the Investors to maintain the proportionate value of their shareholdings ie the right to a proportionate share in the distributable assets and profits of the company and a proportionate number of votes. An increase in Ordinary Shares will affect the value of the Preferred Shares because after the holders of the Preferred Shares have received their preferential distribution, any surplus distributable funds are distributed to the holders of both the Preferred and the Ordinary Shares in proportion to their holdings. Shareholders’ loans too might affect the value of the shares held in the company if the loans provide for an extremely high rate of interest and/or provide for a liquidation preference or are convertible into equity.

The Edelmira Agreement provided that if Florissant’s contemplated bid for Florissant succeeded the dispute over the ownership of QXL Poland would be settled on pre-determined terms and Florissant and the Polish parties would transfer their respective shares in QXL and QXL Poland to a new company, BeleggingsmaatschappijEdelmira NV. It was also agreed that Florissant should have an exclusive right for at least 4 years to consummate the transactions contemplated by the agreement, so that if the first bid for QXL did not succeed, the Polish parties could settle only with Florissant during the 4 year period.

On 14 January 2005 Florissant announced a bid for QXL of 800 pence per share.

On 14 February 2005 TAC announced an increased bid of £10 per share, plus one “Litigation Unit” which gave a contingent entitlement to additional consideration of £10 per share in the form of unsecured Loan Notes. The contingency was a settlement of the QXL Poland dispute which accounted for or generated annualised revenue of at least a specified value.

By mid-February 2005, the man with day to day responsibility for the GHP bid, Mr Kumin, had decided that it would be a good idea if Florissant and GHP were to collaborate in their attempts to acquire QXL. On 17 February 2005 he spoke on the telephone to Mr Bruce McInroy, an advisor on investments employed by Novator Limited, and suggested that the two bidders should join forces. Mr McInroy’s reaction was equivocal. He said that he was unsure whether the proposed collaboration was permissible under the Takeover Code and the other rules governing bids for public companies. He reported Mr Kumin’s approach to Mr Robson and Mr Bachmann. All three felt that the Edelmira Agreement put Florissant in a strong position. In their view, GHP had much more to gain from a cooperative bid than did Florissant.

Following an amendment on 1 March 2005 to the Florissant SSA to provide for an increased subscription of £27.3 million, Florissant announced on 3 March 2005 an increased bid for QXL of 1400 pence per share. This bid was recommended by QXL’s independent directors. The next day the Takeover Panel announced that the bids for QXL were to be subject to an auction procedure to be conducted in the period 8 to 10 March 2005 with bidders being required to increase their bids by at least 25 pence per share and the final bid having to be notified to the Panel by 4.00 pm on 10 March 2005.

On 5 March 2005 Mr Kumin spoke again to Mr McInroy over the telephone. Mr Kumin proposed that TAC would withdraw its bid in exchange for a 50% stake in Florissant for GHP. Mr McInroy’s response was a scornful counter -offer of 5%. Each attempted to talk up his ability to outbid the other. The two men spoke again the next day and continued to negotiate. In response to an invitation from Mr McInroy that Mr Kumin should set out his proposed terms in draft Heads of Terms, GHP’s solicitors, Richards Butler, sent Cameron McKenna a set of draft Heads of Terms on 7 March 2005 headed “Subject to Contract” and which proposed that in exchange for lapsing its bid GHP should have an option to acquire 30% of the Preferred Shares in Florissant. Clause 4 of this document proposed, inter alia, that during the option period (a period commencing when the Offer became or was declared unconditional) no change should be made to Florissant’s share capital and that GHP should have the benefit of a number of the terms in the Florissant SSA. Clause 5 proposed that GHP should have the benefit and be bound by clauses 3.1 to 3.8 of the Florissant SSA, as if GHP were an Investor. (Richards Butler was already in possession of a copy of the Florissant SSA. They had been provided with it by Cameron McKenna under the provisions of the Takeover Code).

Mr Kumin spoke to Mr McInroy over the telephone after these draft Heads of Terms had been sent to Cameron McKenna. Mr McInroy told Mr Kumin that GHP could have anti-dilution protection but not the same rights as the Investors under clauses 3.1 to 3.8 of the Florissant SSA which went much further than anti-dilution rights. Mr Kumin said that he wanted GHP to have the protection of the same or similar rights over the funding of the Florissant bid as did Novator One. In particular, he wanted GHP to have the right to participate in any new issue of shares by Florissant from the signing of the option deed. He did not say he wanted this right whether or not the Florissant bid succeeded. Mr McInroy was non-committal; he did not expressly agree to Mr Kumin’s proposal but he did not say no. The context of the conversation was a request for GHP to have protective rights if the bid succeeded and the option was exercised. Both men expected the Florissant bid to succeed if the TAC bid lapsed.

Following this conversation Cameron McKenna sent Richards Butler a revised set of draft Heads of Terms. In this document the optioned shares were to be 15% of the Preferred Shares; the substance of the original clause 4 was now in clause 6 (although GHP’s entitlements during the option period were slimmed down); clause 7 provided that GHP was to have no right of veto over the conduct of the Offer; and clause 8 proposed that “The GHP Parties would have a pre-emption right in respect of new issues of shares for cash by Florissant. In other words, they would be offered their pro rata share at the same price as the other shareholders”.

On 9 March 2005 TAC announced an increased bid of 1000 pence per share, plus one New Litigation Unit giving a contingent entitlement to 1025 pence per share. On the same day, Mr McInroy and Mr Kumin spoke a number of times on the telephone. They agreed at an early point that the proposed option should be over 23 % of Florissant’s Preferred Shares. They also talked about Florissant buying QXL shares in the market up to a total of 29.9% of the issued shares in QXL following the announcement of the option deed. Such a move would assist the Florissant bid and made obvious commercial sense. Mr Kumin on the one side, and Mr McInroy, Mr Bachmann and Mr Robson on the other, knew that the announcement of the option deed was likely to lead to a drop in the QXL share price below the Florissant offer price because there was some risk that the Florissant offer would not go unconditional and because of the time-value of money -- payment under the bid being farther off than payment for market transactions. Mr McInroy told Mr Kumin that purchases of QXL shares in the market by Florissant were likely to be funded by a loan. It was obvious that such a loan would probably be made by one of the putative Florissant shareholders. Mr Kumin said that GHP wanted the right to participate in any such loan. Mr McInroy agreed. I find that he did not qualify his agreement to Mr Kumin’s proposal by saying that GHP could have such a right if the Florissant bid was successful and GHP exercised his option. However, both he and Mr Kumin were confident that the Florissant bid would succeed and Mr Kumin, as he accepted in the witness box, did not say to Mr McInroy that GHP wanted to be able to participate in such a loan in case the Florissant bid failed.

Following these conversations between Mr Kumin and Mr McInroy, Richards Butler sent a third draft of the Heads of Terms to Cameron McKenna at 23.34pm the same day. The optioned shares were now to be 23% of Florissant’s Preferred Shares; the previous clause 6 was now clause 5 which continued to apply “during the option period” and covered roughly the same ground as the previous clause 6 covered; the previous clause 7 was now clause 6; the previous clause 8 was now clause 7 which provided:

The GHP Parties would have a pre-emption right in respect of new issues of shares for cash by Florissant and in respect of any new shareholder loans. In other words, they would be offered their pro rata share at the same price as the other shareholders.

The Takeover Panel’s deadline of 4.00 pm on 10 March 2005 for a final offer meant that the proposed option deed had to be executed by this time if the full benefit of a withdrawal from the contest by GHP was to be achieved. There was a meeting at the offices of Richards Butler from 4.30 am to 10.00 am on 10 March 2005 attended by Mr McInroy, Mr Erlendsson, Mr Smith of Cameron McKenna and Mr Boutcher of Richards Butler and, for some of the time, Mr Taylor also of Richards Butler. Prior to this meeting, Mr McInroy had circulated a further revised set of draft Heads of Terms, in which he proposed no change to clause 7. The first four named spent a considerable period discussing a draft option deed which had been worked on by Mr Boutcher following the production of a first draft by a colleague. Mr Taylor joined the meeting when the negotiations over the deed were well advanced. On occasion Mr Kumin talked by telephone to Mr Taylor to find out how the meeting was going.

In the course of a broad, general discussion between Mr Boutcher, Mr Smith, Mr Erlendsson and Mr McInroy on what became clause 6.5 (b) in the option deed, Mr McInroy said that the term “new shareholder loans” applied to any loan by one of the option deed signatories and stated that GHP would have a right of participation in any loans made for the purpose of buying shares in QXL. He indicated that Florissant might purchase QXL shares in the market prior to the closing of its offer and said that such purchases might be financed by a loan in which case the loan was likely to be made by “Novator”. Later, Mr McInroy said that whatever happened, GHP would retain its pro rata 23% interest in Florissant and its bid. Mr Boutcher understood this to refer to anti-dilution protection of the interest GHP would receive if it exercised the option. The prevailing mood at the meeting was that the Florissant bid was going to succeed. Nothing was said about what was to happen if the bid failed.

After the meeting the attendees reported back to their principals. The option deed was executed just before the 10 March 16.00 deadline.

Under clause 2.1 of the option deed, GHP was granted an option exercisable at any time during the Option Period to require each of KRC, Mr Bachmann and Novator One (the Grantors) to sell a specified number of Preferred Shares in Florissant (the Option Shares) at £97.44 per share. The Option Shares were to be 23% of each seller’s holding of Florissant Preferred Shares. The Option Period began on the date the Offer (Florissant’s bid for QXL) became unconditional and ended on the Payment Date, this being a date not less than 4 Business Days before payment was due to the QXL shareholders under the Offer. Under clause 3 the Grantors were obliged to give GHP not less than 6 Business Days notice of the Payment Date and under clause 2.2, the option was exercisable by notice in writing not less than 4 Business Days before the Payment Date.

By clause 4.5 GHP agreed that it would procure that the TAC offer was not revised or extended and, if so agreed by the Takeover Panel, would procure that the TAC offer would lapse or be lapsed. And by clause 6.7, GHP undertook that following completion of the sale and purchase of the Option Shares (“Completion”) it would immediately accept Florissant’s offer in respect of any shares in QXL it owned at the time the option deed was executed and if it acquired any shares in QXL to offer to sell them to Florissant on the terms of the Offer.

By clause 5.1 all rights attached to the Option Shares were to accrue to GHP on and from the commencement of the Option Period.

Clause 6 is headed Warranties and Undertakings. By clause 6.1 (a) each of the Grantors warrants that at completion of the sale pursuant to the option it will be the beneficial owner of the Option shares set opposite his name in the Schedule to the deed. By clause 6.2 each of the Grantors undertakes that until the option is exercised or the Option Period expires, whichever is the earlier, it will not transfer or encumber its interest in any of the Option Shares. In clause 6.3 each of the Grantors and Florissant and Mr Robson warrant that at the Payment Date the Option Shares will represent 23% of the preferred share capital of Florissant and, other than as set out in the Florissant SSA, there is no option or right in favour of a third party to subscribe for any share or loan capital of Florissant.

In clause 6.5, in addition to the matters set out in sub-clause (b), there are undertakings and warranties that: (a) there shall be no variation made to the rights attaching to the Preferred Shares; (c )(d) and (e) GHP will be provided with information with regard to the Florissant SSA and the Edelmira Agreement, any breach of or changes to those agreements and the transactions contemplated by those agreements; (f) the Florissant SSA represents the entire agreement relating to the transactions referred to or contemplated therein; and (g) Novator and Mr Robson shall present to GHP in Boston details of their plans for the business of QXL if given reasonable notice to do so.

By clause 7 GHP is to be given the third party due diligence carried out by Novator One and/or Florissant for the purposes of the Florissant bid and in the event that the option deed lapses all documents and records belonging to Florissant furnished to GHP in anticipation of the Payment Date are to be returned to Florissant.

Alongside the option deed a second amendment to the Florissant SSA (“the 2^nd SSA”) was entered into by the parties to the Florissant SSA and GHP which was to be effective if the option were exercised and the sale of the Option Shares completed. The 2^nd SSA makes GHP a party to the Florissant SSA but does not provide that GHP is to be in the same position as the original parties to the Florissant SSA. Rather, the 2^nd SSA specifies precisely which provisions of the Florissant SSA are to be for GHP’s benefit. Thus, whilst clause 3.1 confers on GHP a number of specific rights under the Florissant SSA, clause 3.2 provides that GHP will not become an Investor or Shareholder generally, or otherwise benefit from the rights conferred by the Florissant SSA, “unless specifically stated in this Agreement or the Option deed.” Amongst the rights conferred by clause 3.1 are: (i) the right to benefit from and be bound by the provisions of clause 14 of the Florissant SSA “so that GHP shall have … pro rata pre-emption rights as set out in such clause 14 in respect of all new issues of shares in the Company and new shareholder loans to the Company” (3.1 (d)); and (ii) GHP is made a Party and Shareholder for the purposes of clauses 16.1 to 16.4.

On 11 March 2005, the day following the execution of the option deed and the announcement thereof, Florissant began buying QXL shares in the market at a price below the current Florissant bid price with a view to acquiring a 29.9% stake.

In the period 11 March 2005 to 16 March 2005 Florissant acquired approximately 28% of QXL’s issued share capital in the market at below the Florissant offer price. These purchases were paid for by a loan to Florissant of £7,147,563 from Keaton, a BVI company in which neither Novator One nor Novator Limited had an interest but which was beneficially owned by Mr Bjorgolfsson, who also owned Novator Limited. This loan (“the Keaton loan”) was arranged in a hurry. It was advanced in three tranches on 17, 18 and 21 March 2005. On 16 March 2005, Mr Erlendsson sent a draft “boilerplate” loan agreement to Mr Robson, Florissant’s Managing Director, and Mr McInroy which provided that the interest payable would be at 3% over LIBOR. Mr Robson told Mr McInroy that he agreed the interest rate. At this time he expected the Florissant bid to succeed and that, following implementation of the Florissant SSA, Florissant would be in a position to repay the loan within a relatively short period of time. Mr.Robson then went on holiday, leaving Mr Bachmann and a solicitor at Cameron McKenna, Mr Weeks, to sort out the final terms. In the event, no loan agreement was ever executed.

From about 20 March 2005 the QXL share price began to rise above the QXL offer price prompting concerns that other parties had entered the market to try to buy up QXL shares and that, contrary to the strong expectation on 10 March 2005, the Florissant bid might fail. On 29 March 2005 a regulatory announcement stated that a group of Israeli investors, the Izaki Group, had acquired 5% of the listed QXL shares at an average price of 1406.1 pence per share. On 30 March 2005 Mr Taylor sent Mr Smith an email stating that, subject to sight of the proposed loan agreement covering the loan, GHP wanted “to participate in its pro rata share of the Novator Shareholder loan”. This was a reference to clause 6.5 (b) of the option deed. GHP wanted to participate in the loan because it could see that the Florissant bid might fail, yet the value of the Florissant’s holding of QXL shares could well rise and in its view it was inevitable that the loan would be repaid by an issue of shares in Florissant.

Mr Taylor’s email elicited a dusty response. The defendants maintained and continue to maintain that GHP had no right under clause 6.5 (b) to participate in the Keaton loan.

On 6 April 2005, Florissant announced that its offer had lapsed because its acceptance condition, originally 90% but by now 75%, had not been satisfied. The intervention by the Izaki Group had scuppered the offer.

The Keaton loan was repaid as to principal and one instalment of interest on 1 August 2005, with the second and final interest instalments being paid on 1 September 2005. The money used to re-pay the loan was raised by KRC, Mr Robson, Mr Bachmann and Novator Equities Limited subscribing for Preferred Shares in Florissant under an Amendment Agreement to the Florissant SSA dated 19 July 2005. (This agreement gave Novator One the right to nominate one of its subsidiaries to subscribe for Preferred Shares in its place).

Well prior to the agreement dated 19 July 2005, it was agreed on about 23 March 2005 between Mr Robson, Mr Bachmann and Mr McInroy that KRC, Novator One and Mr Bachmann would subscribe for Preferred Shares in Florissant in order to finance the Keaton loan. There then followed some tough negotiations over additional rights for Mr Robson and Mr Bachmann which took several months to finalise. In the event, the number of Preferred Shares it was agreed on 23 March 2005 each party should be subscribed for was virtually identical to the number of shares they did subscribe for under the 19 July 2005 agreement.

On the 4^th day of the trial it was disclosed for the first time that on 26 September 2005 Novator One had paid £6,203,090.00 to Keaton in respect of the appreciation in the value of the QXL shares acquired by Florissant with the Keaton loan.

After the close of the evidence, GHP abandoned its alternative collateral contract claim.

GHP in its closing submissions contends that: (i) the Keaton loan was a convertible loan and was a “new shareholder loan” for the purposes of clause 6.5 (b) of the option deed; (ii) alternatively, the issue of shares in Florissant in July 2005 pursuant to the Amendment Agreement of the Florissant SSA was a “new issue of shares for cash by Florissant” for the purposes of clause 6.5 (b); (iii) clause 6.5 (b) entitled GHP to participate in that loan, alternatively that issue of shares; (iv) either of these entitlements would have led to GHP holding a proportionate stake in the Preferred Shares of Florissant; (v) even if the Keaton loan was not a convertible loan, GHP is entitled to damages on the basis that it was in the contemplation of the parties that the loan would become a convertible loan; (vi) the value of Florissant’s holding of QXL shares (Footnote: ¹) has increased very significantly and is now worth in excess of £100 million; (vi) the value of GHP’s putative stake in the share capital of Florissant, appropriately discounted, is accordingly at least £14 million; and (vi) GHP is therefore entitled to damages in this amount whether under its new shareholder loan claim or under its new issue of shares claim.

The defendants contend that clause 6.5 (b) is exclusively an anti-dilution provision intended to protect the value of the optioned 23% interest in Florissant’s Preferred Shares and that the right to participate in new shareholder loans or new issues of Florissant shares depends on the option being exercised. They also submit that: (i) the Keaton loan was not a “new shareholder loan” for the purposes of clause 6.5 (b) but instead was a bridging loan with no right to any “equity upside” (a right to have the loan re-paid in shares in Florissant or QXL); and (ii) the issue of shares in Florissant in July 2005 to finance the repayment of the Keaton loan was not a “new issue of shares” for the purposes of clause 6.5 (b).

In In BCCI v Ali [2001] 1 AC 251 at 259 Lord Bingham said:

In construing this provision, as any other contractual provision, the object of the court is to give effect to what the contracting parties intended. To ascertain the intention of the parties the court reads the terms of the contract as a whole, giving the words used their natural and ordinary meaning in the context of the agreement, the parties' relationship and all the relevant facts surrounding the transaction so far as known to the parties. To ascertain the parties' intentions the court does not of course inquire into the parties' subjective states of mind but makes an objective judgment based on the materials already identified. The general principles summarised by Lord Hoffmann in Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896, at 912-913 apply in a case such as this.

The first three of Lord Hoffmann’s principles referred to by Lord Bingham were in these terms:

(1)

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.

(2)

The background was famously referred to by Lord Wilberforce as the "matrix of fact," but this phrase is, if anything, an understated description of what the background may include. Subject to the requirement that it should have been reasonably available to the parties and to the exception to be mentioned next, it includes absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man.

(3)

The law excludes from the admissible background the previous negotiations of the parties and their declarations of subjective intent. They are admissible only in an action for rectification. The law makes this distinction for reasons of practical policy and, in this respect only, legal interpretation differs from the way we would interpret utterances in ordinary life. The boundaries of this exception are in some respects unclear. But this is not the occasion on which to explore them.

By way of clarification of principle 2, Lord Hoffmann said in BCCI :

I should in passing say that when, in Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896, 913, I said that the admissible background included "absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man", I did not think it necessary to emphasise that I meant anything which a reasonable man would have regarded as relevant. I was merely saying that there is no conceptual limit to what can be regarded as background. It is not, for example, confined to the factual background but can include the state of the law (as in cases in which one takes into account that the parties are unlikely to have intended to agree to something unlawful or legally ineffective) or proved common assumptions which were in fact quite mistaken. But the primary source for understanding what the parties meant is their language interpreted in accordance with conventional usage: "we do not easily accept that people have made linguistic mistakes, particularly in formal documents". I was certainly not encouraging a trawl through "background" which could not have made a reasonable person think that the parties must have departed from conventional usage.(Page 269)

  Lord Hoffmann’s principle 3 (called hereafter “the exclusionary principle”) was undoubtedly founded on Lord Wilberforce’s speech in Prenn v Simonds [1971] 1 WLR 1381 in which he held that evidence of pre-contract negotiations and draft agreements was inadmissible where the question before the court is the construction of a finally concluded written contract. At pp.1384-1385 Lord Wilberforce said:

On principle, the matter is worth pursuing a little, because the present case illustrates very well the disadvantages and danger of departing from established doctrine and the virtue of the latter. There were prolonged negotiations between solicitors, with exchanges of draft clauses, ultimately emerging in clause 2 of the agreement. The reason for not admitting evidence of these exchanges is not a technical one or even mainly one of convenience, (though the attempt to admit it did greatly prolong the case and add to its expense). It is simply that such evidence is unhelpful. By the nature of things, where negotiations are difficult, the parties' positions, with each passing letter, are changing and until the final agreement, though converging, still divergent. It is only the final document which records a consensus. If the previous documents use different expressions, how does construction of those expressions, itself a doubtful process, help on the construction of the contractual words? If the same expressions are used, nothing is gained by looking back: indeed, something may be lost since the relevant surrounding circumstances may be different. And at this stage there is no consensus of the parties to appeal to. It may be said that previous documents may be looked at to explain the aims of the parties. In a limited sense this is true: the commercial, or business object, of the transaction, objectively ascertained, may be a surrounding fact. Cardozo J. thought so in the Utica Bank  case. And if it can be shown that one interpretation completely frustrates that object, to the extent of rendering the contract futile, that may be a strong argument for an alternative interpretation, if that can reasonably be found. But beyond that it may be difficult to go: it may be a matter of degree, or of judgment, how far one interpretation, or another, gives effect to a common intention: the parties, indeed, may be pursuing that intention with differing emphasis, and hoping to achieve it to an extent which may differ, and in different ways. The words used may, and often do, represent a formula which means different things to each side, yet may be accepted because that is the only way to get "agreement" and in the hope that disputes will not arise. The only course then can be to try to ascertain the "natural" meaning. Far more, and indeed totally, dangerous is it to admit evidence of one party's objective - even if this is known to the other party. However strongly pursued this may be, the other party may only be willing to give it partial recognition, and in a world of give and take, men often have to be satisfied with less than they want. So, again, it would be a matter of speculation how far the common intention was that the particular objective should be realised. ….In my opinion, then, evidence of negotiations, or of the parties' intentions … ought not to be received, and evidence should be restricted to evidence of the factual background known to the parties at or before the date of the contract, including evidence of the "genesis" and objectively the "aim" of the transaction…” [pp1384-1385]

Mr Snowden QC for GHP submits that the following form part of the background to the option deed which would have been known to the reasonable man seeking objectively to interpret the subsequent contract. and are therefore admissible on the question of construction:

Proposition (5) is based on: (i) the fact that Florissant had no real capital until the subscriptions provisions in the Florissant SSA were fulfilled; and (ii) the putative Florissant shareholders’ aim was to make an investment in Florissant (an equity upside) not to earn a commercial rate of interest on a loan.

Propositions (4), (5) and (6) are crucial to Mr Snowden’s construction argument. They are founded on or arise out of what was said in negotiations between Mr Kumin and Mr McInroy over the telephone on 7 and 9 March 2005; and in developing (4) (and thereby (5) and (6), since all are closely inter-related) Mr Snowden relied on the wording of the various draft Heads of Terms recited above.

Mr Snowden submitted that since Prenn v Simmonds it has become clear that the boundaries to the exclusionary principle are not rigidly fixed and that it is open to the court to hold that the negotiations between Mr Kumin and Mr McInroy, and the terms of the draft Heads of Terms, are admissible. In support of this contention he cited The Karen Oltmann [1976] 2 Lloyds Rep 708 as an example of an exception to the exclusionary principle. There the question was whether the expression “after 12 months” in a Baltime charter meant “at the expiry of 12 months” of “at any time after 12 months”. Kerr J held that whilst the general rule was that the pre-contract exchange of telexes could not be referred to as an aid of construction, they could be looked at to see if the parties had negotiated on an agreed basis that the words bore only one of the two possible meanings. Mr Snowden did not contend that the parties to the option deed had given their own dictionary meaning to any of the words in clause 6.5 (b).

Mr Snowden next cited the decision of the Court of Appeal in Proforce Recruit v The Rugby Group [2006] EWCA Civ 69. The question below (Footnote: ²) was whether the claimant’s claim should have been struck out by the Master on the basis that the written contract sued on was not open to the construction the claimant was putting on it. The claimant was an employment and recruiting agency. Under the contract it had agreed to provide certain cleaning personnel and equipment to the defendant. The contract contained the words: During [the period of two years] ProForce will hold preferred supplier status.”The claimant contended that the words “Proforce will hold preferred supplier status” meant that during the two year period the defendant was obliged to offer to the claimant the first opportunity to supply contract labour and hire equipment at the defendant’s site in preference to other suppliers. The defendant contended that the words meant that to the extent the defendant maintained a list of preferred suppliers, the claimant would be on that list. The claimants sought to rely on evidence that in the lead up to the contract a representative of the defendant had suggested that if the claimants bought some machinery it might be given a “A Preferential Agreement” and that discussions continued in that vein until another of the defendant’s representatives offered the claimant “Preferred Supplier Status,” explaining that the claimant would have the opportunity to supply all labour and additional plant at the defendant’s site. On appeal from the Master I struck out the claim, holding that this evidence was inadmissible. The Court of Appeal overturned this ruling and held that the claim should go to trial. Mummery LJ said that the exploration of the surrounding circumstances was not as completely ruled out as had been held below. He cited The Karen Oltmann; paragraph 12.119 of Chitty on Contracts (29^th ed); and having referred to Lord Nicholls’ 2005 Chancery Bar Lecture published in (2005) 121 LQR 577 said:

34.

In the view of Lord Nicholls the statement of the rule that pre-contract negotiations are irrelevant is too rigid. He said that (see p583):

"…there will be occasions where the pre-contract negotiations do shed light on the meaning the parties intended to convey by the words they used. There will be occasions, for instance, when the parties in their pre-contract exchanges made clear the meaning they intended by language they subsequently incorporated into their contract. When pre-contract negotiations assist in some such way, the notional reasonable person should be able to take that evidence into account in deciding how the contract is to be interpreted."

35.

He continued :

"This would not be a departure from the objective approach. Rather, this would enable the notional reasonable person to be more fully informed of the background context. This would recognise that pre-contract negotiations are themselves part of the background of a contract and that, like other background material, they may be relevant when interpreting a contract. They differ from other background material in that, unlike other background material, they may afford direct evidence of the parties' actual intentions. That is not a reason for banning their use. That would be perverse. That would mean that in deciding the meaning intended to be conveyed by the language chosen by the parties the notional reasonable person would always be barred from having regard to what may be the best evidence of all. He must always conjecture, he must never know. The preferable approach is to recognise that pre-contract negotiations are relevant and admissible if they would have influenced the notional reasonable person in his understanding of the meaning the parties intended to convey by the words used.

Whether the notional reasonable person would have been so influenced in a particular case depends upon the facts of that case."

36 In my view, a trial is necessary in this case in order to hear all the pre-contract evidence from both sides in order to establish the facts of the case, including any evidence of pre-contract negotiations that is relevant and admissible for the purpose of ascertaining the meaning of the Preferred Supplier Status provision in the agreement.

Arden LJ held that it was reasonably arguable that the words in question bore the meaning the parties in common gave them in their communications leading up to the signing of the contract. In admitting the evidence of those communications the court would be hearing it for the purpose of identifying the meaning the parties in effect incorporated into their agreement in circumstances where the court was satisfied that on their true interpretation the terms of the agreement were to have this effect. There was therefore a sufficient prospect of success in distinguishing the situation before the court from the usual situation in which, in the course of negotiations the parties agree a matter which is to become binding on them (only) when a written agreement has been drawn up and signed.

Arden LJ then went on to say :

Evidence as to negotiations between the parties to a contract leading up to the making of that contract may be admissible for the purposes of interpretation in wider circumstances than I have indicated above, but it is unnecessary for me to go further than those circumstances for the purpose of this appeal. Lord Hoffmann recognises in the ICS case that the boundaries of the rule excluding evidence of pre-contractual negotiations on questions of interpretation is unclear. Moreover, Lord Nicholls has argued in the passage cited by Mummery LJ in para 34 of his judgment and elsewhere, that the rule should be relaxed. The exclusion of pre-contractual negotiations is not on the face of it consistent with the general principle that a contract should be interpreted in the light of its context. Nor, on the face of it, is the application of a meaning which is not that which the parties themselves gave to a term consistent with the general approach of contract law, which is to respect party autonomy. The results may be anomalous. If the judge's ruling in this case expresses the general position in law, the result would be that the parties' meaning would be adopted if they defined the term in their written contract but not if they only did so only in the course of pre-contractual negotiations. Moreover, in that latter event, the meaning given to the term by the court would prevail, and (if the court's meaning is one which is different from that on which both parties in fact proceeded) a party would be able to avoid its contractual obligations deriving from the parties' meaning. That may be the law but, if it is, it is not, on the face of it, an attractive result. There are considerations that may go the other way. Lord Hoffmann's holding is that the exclusionary rule is based on reasons of practical policy (see para (3) of the passage cited above from the ICS case). That policy would have to be carefully considered if evidence of pre-contractual negotiations is to be admitted in evidence in interpretation questions in the future on any wider basis than the law presently permits. In that sense there may be parallels to be drawn with the use of legislative history in the interpretation of statutes. In addition, careful consideration may have to be given to the aims to be achieved by contractual interpretation and the precise extent to which the law requires an objective interpretation, as set out in para. (1) of the passage cited above from the ICS case. It may be appropriate to consider a number of international instruments applying to contracts. It is sufficient to take two examples. The UNIDROIT Principles of International Commercial Contracts give primacy to the common intention of the parties and on questions of interpretation requires regard to be had to all the circumstances, including the pre-contractual negotiations of the parties (article 4.3). The UN Convention on Contracts for the International Sale of Goods (1980) provides that a party's intention is in certain circumstances relevant, and in determining that intention regard is to be had to all relevant circumstances, including preliminary negotiations. Consideration may also have to be given to the question whether some matters outside the text of a contract should be given less weight where (for example) the contract is one to which different persons adhere at different points in time, such as a company's constitution, than in the case of "one-off" contracts between two persons, as in this case.

Richards LJ agreed with Mummery LJ that the question of the extent to which pre-contract negotiations can properly be taken into account for the purpose of ascertaining the meaning of the contract was best resolved in the light of detailed findings of fact made at trial.

In my judgement, whilst Mummery and Arden LJJ recognised the possibility that the boundaries of the exclusionary principle might be redrawn in the future, the Court of Appeal did not change the law on the admissibility of pre-contract negotiations as an aid to the construction of a written contract which was intended to contain all of the agreed terms. If it is contended on proper grounds that the parties negotiated on an agreed basis or that there is an estoppel by convention, or that the contract should be rectified, evidence of pre-contract negotiations is admissible, but not otherwise. No such contentions were advanced by Mr Snowden.

I am also of the opinion that this is not a case where I should relax the exclusionary principle. On the contrary, these proceedings demonstrate all too clearly the wisdom of Lord Wilberforce’s approach.

The admissible background against which clause 6.5 (b) is to be construed is made up of: (i) the competing bids of both sides for QXL; (ii) the Florissant SSA, including in particular clauses 4.4 and 14 and 6.2 (b) and (c); (iii) the Edelmira Agreement; (iv) the proposed 2^nd SSA (which gave GHP the protection of clause 14 of the Florissant SSA but not that of clause 4.4); (v) the main purpose of the proposed and subsequently executed option deed, namely the grant to GHP of an option over 23% of the Preferred Shares in Florissant in exchange for TAC lapsing its bid; (vi) the fact that it is usual for agreements conferring options to buy shares to contain anti-dilution provisions, as was well known to Mr Kumin and Mr McInroy; (vii) the justified expectation of all parties in the lead up to and at the time the option deed was signed that the Florissant bid would very likely succeed if the TAC bid lapsed; (viii) the likelihood that Florissant would buy QXL shares in the market after the option deed was announced and that the finance for such purchases would be provided by a loan from Novator One or organised by Novator Limited.

Seen against this background, particularly (ii),(v),(vi) and (vii), the conversations between Mr Kumin and Mr McInroy concerning GHP’s wish to participate in the purchase of QXL shares in the market by Florissant and to participate in any shareholder loan made to finance such purchases do not provide a reliable basis on which the reasonable man could conclude that clause 6.5 (b) was to be construed as conferring on GHP an immediate right to participate in any shareholder loan or new issue of shares even if the option were not exercised. In particular, it would not have been apparent to any reasonable observer (just as it was not apparent to the defendants) that GHP’s interest in participating in any shareholder loan made to finance the purchase by Florissant of QXL shares in the market was in the event that the bid failed.

The changes in the wording of the draft Heads of Terms also bear out Lord Wilberforce’s view that such evidence should be excluded because it is only when the final agreement is executed that there is consensus. For example, whereas the obligations imposed by clause 5 of the last draft were to apply during the option period, in the deed, those obligations arose from the moment the deed was executed, it being common ground that clause 6.5 is to be construed as applying from the moment the deed was signed and not from the date the Florissant bid became unconditional.

In the result, a great deal of time was taken up at the trial adducing evidence that was of no help in deciding how clause 6.5 (b) was to be construed.

What then is the meaning of clause 6.5 (b)? Does it apply whether or not the option conferred by clause 2.1 is exercised, as submitted by Mr Snowden, or does it mean that GHP only has a right to be offered any new shares or shareholder loans if it exercises the option, as submitted by Mr Waksman QC for the defendants?

As I have said, it is common ground that clause 6.5 (b) applies as soon as the deed had been executed. In other words it is agreed that the period of time contemplated by the phrase “until the expiry of the Option or completion of the sale and purchase of all the Option Shares” in the first part of clause 6.5 begins with the signing of the deed. Having regard to the nature of the rights provided for in (a) and (c) to (g), I agree with this approach.

I turn to the words “so that the Grantee shall be entitled to its pro rata share to obtain and maintain a 23 per cent. (subject to adjustment to take into account the Grantee not taking up any rights of pre-emption under this clause (b)) in the issued Preferred Shares upon the exercise of the Option” [emphasis supplied]. In my opinion, these words express the exclusive purpose of (b) which is to protect against the dilution of GHP’s putative 23% stake in Florissant’s Preferred Shares which GHP will acquire if it exercises the option. What clause 6.5 (b) does is to protect the 23% stake against direct dilution resulting from the issue of new Preferred Shares, and from indirect dilution resulting from the issue of Ordinary Shares or the making of shareholders’ loans, as explained in paragraph 15 above. In effect, clause 6.5 (b) is providing GHP with substantially the same protection that clause 4.4 of the Florissant SSA gives to the putative Florissant shareholders.

This being the sole purpose of the sub-clause, it follows that the rights it confers are conditional on GHP exercising the option, which in turn is conditional on the Florissant bid succeeding.

I am fortified in this conclusion when I consider what the consequences would be if Mr Snowden be right. By clause 6.2 (b) and (c) of the Florissant SSA, if the Florissant bid lapses so too does the Florissant SSA lapse, and all actions taken are deemed not to have been taken, or are to be reversed to the extent practicable or possible, leaving KRC as the sole shareholder in Florissant. It follows that, if clause 6.5 (b) gives GHP the right to participate in a “shareholder loan” even if the Florissant bid fails, GHP will have a right to participate in a loan made by Novator or Mr Bachmann to Florissant, even though they never become shareholders of Florissant under the Florissant SSA. And if the loan was or became a convertible loan, which is a likely scenario, GHP would end up with a greater right to receive shares in Florissant than those putative Florissant shareholders who were not party to the loan.

Another consequence if Mr Snowden is right is that if the Florissant bid fails or if GHP chooses not to exercise the Option, the bid having succeeded, the rights conferred by clause 6.5 (b) will be “evergreen” i.e. there will be no limit to the period during which these rights are to operate. This is because if the bid fails the Option Period will never begin and therefore will never expire, and if the Option is not exercised although the bid succeeds, there will never be completion of the sale and purchase of the Option Shares. Thus, if Mr Snowden is right, even if the bid failed, GHP would have an endless right to participate in new shares issued by Florissant even though the “founder” putative shareholders would have no such right because of the operation of 6.2 (b) and (c) of the Florissant SSA. And if the bid succeeded, but GHP declined to exercise the option, it could at any time claim a pro rata share in any new share issue by Florissant, including the share issue made to the Investors under the Florissant SSA. I cannot accept that the parties are to be taken to have intended such an outcome.

It is also to be noted that Clause 7 of the option deed contemplates that the deed might lapse, and this could only arise if the Florissant bid failed or the option was not exercised. This is another pointer to the conclusion that GHP clause 6.5 (b) rights were conditional on the option being exercised.

Mr Snowden submitted that the immediate applicability of clause 6.5 (a) and (c) to (g) means that (b) must be immediately applicable so that the rights it confers cannot be conditional on the exercise of the option. He also laid great store by the words in brackets - subject to adjustment to take into account the Grantee not taking up any rights of pre-emption under this clause (b) - submitting that they only made sense on the basis that the parties envisaged that if there were shareholder loans resulting in an issue of Ordinary and/or Preferred Shares prior to the exercise of the option, GHP would have a right to participate in those issues of shares prior to the exercise of the option. I reject these submissions. The rights conferred by (a) and (c) to (g) are much simpler than the rights conferred by (b) and do not include the crucial words considered in paragraphs 67 and 68 above. The true construction of (b) is that it confers an immediate inchoate right which is perfected when and if the option is exercised. As to the words in brackets, these simply mean that if there were a new issue of shares or a shareholder loan which GHP does not take up which has the effect of diluting the value of its 23% interest in the Preferred Shares, then, to that extent, it will not get an undiluted 23% interest.

Mr Snowden also had a timing /impracticality point. He argued that the primary, if not only, purpose of new issues of shares or shareholders loans would be to finance purchases by Florissant of QXL shares in the market and it cannot be sensibly envisaged that GHP should be asked hypothetically or conditionally if they wanted to participate in such transactions prior to the exercise of the option, with the result that the transaction in question would only take place in part, or would be staggered. It is also impossible to envisage, he submitted, any viable process by which issues of shares or loans might be reversed in part upon GHP’s exercise of the option. I disagree. What is contemplated is that if GHP exercises the option, then, on the Payment Date, it would be entitled to participate in any previous share issue or shareholder loan. Clause 4.4 of the Florissant SSA is designed to operate in precisely the same retrospective manner. Under that provision, the Investors only receive their pro rata entitlement in any extra shares created on the Payment Date when they obtain their initial shares in Florissant under clause 4.1.

In my judgement, the retrospective operation of sub-clause (b) does not give rise to the practical problems envisaged by Mr Snowden. The putative shareholder(s) receiving the new issue of shares would deliver 23% to GHP when the option is exercised, just as they would in respect of the Option Shares. As for shareholder loans, Florissant’s sole shareholder, KRC, and all the putative shareholders under the Florissant SSA, were parties to the option deed. In agreeing to sub-clause (b) they were therefore agreeing that if one or more of them made a loan to Florissant before the option was exercised, GHP would be cut into the deal on the original terms if GHP sought this after having exercised the option. In my view, such a process is perfectly viable. This is what GHP attempted to do once it appeared the Florissant bid would probably fail. GHP did not succeed, not because of any practical difficulty in what it was trying to do, but because the defendants maintained that GHP had no right to participate in the Keaton loan.

With respect to him, I found Mr Snowden’s submissions on the “evergreen” point wholly unconvincing. He made no attempt to argue that the rights conferred by the clause 6.5 (b) would not endure without limit of time if his interpretation of the clause was correct. Instead, he maintained that on the facts of this case his interpretation gave rise to no commercial absurdity where Florissant was a single purpose entity and the loan in question was made and used to purchase QXL shares before the Florissant bid failed. He also said there would be no commercial absurdity if GHP exercised its sub-clause (b) rights after the first issue of shares or shareholders loans because those rights were part of the pro quid quo for the lapsing of the TAC bid and the rights would be correspondingly devalued because its pro rata proportion would be reduced as envisaged by the words in brackets in clause 6.5 (b). The trouble with these submissions is that they take quite insufficient account of the fact that if the Florissant bid failed, the founding putative shareholders in Florissant would have no rights to participate in any share issues or shareholders loans whereas, GHP, a johnny-come-lately optionee, would have such rights, and the rights would remain without limit of time. Nor do Mr Snowden’s submissions go any where near to persuading me that the parties intended that GHP could exercise the clause 6.5 (b) rights after the bid had succeeded and after GHP had elected not to exercise the option. Moreover, the clause is not to be interpreted in light of the events that had actually happened. The fact is that on Mr Snowden’s interpretation of the provision, GHP’s rights will endure endlessly if the bid fails or, even if the bid succeeds, where the option is not exercised, and this must inevitably raise serious doubts about the correctness of the interpretation he contends for.

My decision that the rights conferred by clause 6.5 (b) are conditional on GHP exercising the option means that it is unnecessary to decide the other issues in contention and I decline to do so: this judgement is already too long.

For the reasons I have given above, the rights conferred by clause 6.5 (b) are conditional on the option being exercised, and the Florissant bid having failed and the option not having been exercised, GHP’s claim is dismissed.