Can an agent act for a competitor of his original principal?

To what extent is an agent entitled to act for a competitor of his original principal?  This important question was considered by the Court of Appeal in Rossetti and Anor v Diamond Sofa Company Ltd ([2012] EWCA Civ 1021) in a judgment issued on 27th July. 

This case was an appeal from a decision of Cranston, J., determining certain preliminary issues.  As such, the judgment does not contain a full analysis of all the legal issues.   The Master of the Rolls, Lord Neuberger, delivered the main judgment with which Lords Moses and Rimer agreed. 

Facts
Diamond is a company whose operation is based in Thailand, where it manufactures leather upholstery.  Diamond entered into an agreement with a company called SML.  SML was set up to represent Asian furniture manufacturers and to assist them in penetrating the UK market. 

In February 2004, Diamond and SML orally agreed that SML would act as Diamond’s exclusive agent in connection with the sale of leather upholstery in the UK and Irish markets.  During negotiations, SML informed Diamond that SML was already acting for two other manufacturers of upholstery: Linkwise and ArtPeak.  SML indicated that the furniture range of each of the two companies did not clash with that of Diamond. 
The agency agreement was entered into for one year initially and, because SML proved to be “remarkably successful” at acting on Diamond’s behalf, the agency agreement was continued beyond the initial duration (Lord Neuberger quoting from Cranston J’s judgment at [2011] EWHC 2482 (QB), para 20).

In 2008, the agency agreement came to an end consensually, and Diamond appointed another company, RML, as agent.  RML had in fact been set up by the individuals behind SML to take over the clients of SML.  By this time, however, the parties were beginning to fall out.  Diamond determined the agency agreement on 4 June 2008. 

Decision of the High Court (Queen’s Bench)
In the subsequent dispute, Diamond indicated that it had terminated the agreement because RML had acted for two direct competitors of Diamond, Cassaredo and Creative.  Cranston J., held that there was no express term about SML or RML acting for competing principals but that there was an implied term at the outset of the contract that SML would continue to act for Linkwise and ArtPeak.  He also held that this implied term was varied by a course of dealing between the parties, and in particular that Diamond knew that SML had assumed agencies for Cassaredo and Creative and Diamond had not objected.  Cranston J., found, however, that nothing in the course of dealing meant that there was an implied term in the agency agreement enabling SML or RML to place orders with other principals at the expense of Diamond. 

Court of Appeal decision
Fiduciary Duties in General
Lord Neuberger began his judgment with an explanation of the agent’s fiduciary duty.  Quoting Millett LJ in Bristol and West v Mothew ([1998] Ch 1, 18A-B), he referred to the “single-minded duty of loyalty” that an agent owes to a principal: he “…must not place himself in a position where his duty and his interest conflict, and he “may not act for…the benefit of a third party without the informed consent of his principal.”  He referred to another leading case, Kelly v Cooper ([1993] AC 205, 214D) in which Lord Browne-Wilkinson had said that “it is normally said that it is a breach of an agent’s duty to act for competing principals.”  He had also been referred to Hospital Products Ltd v United States Surgical Corporation ((1984) 156 CLR 41, 97) in which Mason J. stated that where a fiduciary duty arises out of a commercial contractual arrangement, that duty “if it exists at all, must accommodate itself to the terms of the contract so that it is consistent with, and conforms to, them.” 

Acting for a competitor
Lord Neuberger identified two types of cases in which an agent may act for a competitor (paras 22 and 23).  The first is where both principals agree.  In such a case the agent must show that the principal not merely consented, but that the consent was given on a fully informed basis (Quoting Tuckey LJ in Hurstanger Ltd v Wilson [2007] EWCA Civ 299, [2007] 1 WLR 2351, para 35, approving a passage from Bowstead & Reynolds on Agency, now at para 6-039 of the 19th edition.)  The second type of case is where the principal must have appreciated that the nature of the agent’s business is to act for numerous principals.  The most obvious example of this type is the estate agent, whose business is to act for a number of principals at the same time. 

Lord Neuberger concluded that there was no reason to conclude that, in this case, the normal non-compete rule did not apply (para 24).  Diamond had not agreed that SML could act for competitors.  Diamond had been told that, although SML acted for Linkwise and ArtPeak, there would be no clash of products.  This supported the conclusion that Diamond would not have expected SML to act for competitors, and had certainly not agreed to this.  An attempt to place SML/RML within the same class as residential estate agents was unsuccessful.  Reference was made (at para. 27) to a conclusion in Bowstead and Reynolds (footnote 294 of para 6-945) that “estate agents are only imperfectly agents and are known to act for many principals.”  He also referred to an article by Joshua Getzler ((2006) LQR 122) in which Getzler supported the House of Lords decision in Hilton v Barker Booth & Eastwood ([2005] UKHL 8, [2005] 1 WLR 567).  Lord Walker in that case referred to the “content of the contractual duty of full disclosure being rooted in the fiduciary relationship” between principal and agent. 

Nor did SML/RML acquire the right to act for competitors after 2004.  Oral evidence established that Diamond was aware that RML was acting for Casserado and Creative.  Diamond was, however, led to believe that those companies’ products did not clash with their own.  Whilst there was informed consent to RML acting for Creative and Casserado in relation to non-clashing products, there was no informed consent in relation to clashing products. 

Lord Neuberger’s inescapable conclusion (at para 48) is worth quoting: “…the sensible and proper course for SML to have taken if it wished to act for a manufacturer of furniture which competed with that made by Diamond, was to inform Mr Charoenyos, [the managing director of Diamond] and to obtain his consent.  By not taking that course, SML, and then RML, took the risk that, when it appreciated what had occurred, Diamond would stand on its strict legal rights, and that is what has happened.” 

Lessons for Scots law?
The case also includes discussion of claims under the Commercial Agents (Council Directive) Regulations 1993, commented on below.  For the moment however, it is important to ask how relevant the Court of Appeal’s conclusion on acting for the principal’s competitor is to the Scots lawyer.  The ability of an agent to act for a competitor of his principal was considered in the Scottish case of Lothian v Jenolite (1969 S.C. 111).    The court decided that it was not necessarily the case that every agency contract has an implied condition that the agent is not entitled to act for a competitor.  Lord Milligan stated (at 117):

“The proposition which the defenders invite us to affirm is that in all agency cases there is an implied condition that the agent will not without the permission of his principal act, even in an outside matter, in such a way as to bring his interests into conflict with those of his principal.  There is admittedly no case in which such a proposition has been affirmed, and the proposition is a sweeping one which, if it is sound, would undoubtedly affect a very large number of cases where an agents acts for two or more principals.  There would normally be no objection to such a condition or term being expressly included in a contract of agency…but it is a different matter to imply such a condition when it does not appear expressly in the contract.  It is, moreover, more difficult to imply a condition in a written contract than a verbal contract…The introduction of the condition would…make the contract a different contract altogether, and moreover it was a condition to which the parties could readily have given expression if that was their intention….The many authorities quoted by the defenders establish that, while actually performing his principal’s business, an agent is not entitled to take advantage of his position and make a profit for himself, but, as I have said, no authority was quoted for the much wider proposition for which the defenders now contend.”   

Notably, Jenolite had not appointed Lothian as full-time agents, nor exclusive agents, whereas in Rossetti SML/RML were exclusive agents in the UK. 

Could Rossetti v Diamond Sofa be used as a persuasive authority in a Scottish case?  Part of the difficulty here is that the pursuers in Lothian framed their claim too broadly.  Clearly, an agent is not completely prohibited from acting for a competitor of the principal in every case.  There is no implied term to that effect.  Having said that, the judges in Lothian did not depart from the general rule that an agent must not let his own interests compete with those of his principal.  Lord Milligan twice referred to the phrase “even in an outside matter”, in other words, the pursuer’s contention, if correct, would have prevented an agent from acting for a different principal even where the agent was selling goods which did not compete with those of his original principal.  That, of course, was not correct either.  The issue probably remains an open one in Scots law.   In a Scottish case in future, those
acting for a principal could frame a legal proposition narrower than that argued in Lothian.  It seems likely that a Scottish court would find that, where the agent acts for a direct competitor of his principal, selling for that competitor the same type of goods as the agent is instructed to sell for his original principal, that conduct will constitute a breach of the agent’s fiduciary duty.  The court may be more likely to reach that conclusion where the agent is appointed an exclusive agent, given that in such a case the original principal will have no other outlet for the sale of his goods.  Rossetti may indeed be a useful case to cite in support of an argument to that effect.     

Commercial Agents (Council Directive) Regulations 1993
The change from SML to RML provided food for thought for the application of the Commercial Agents (Council Directive) Regulations 1993.  Although little was said on this point, Lord Neuberger concluded that the transfer was probably novation rather than assignment.  This is an important point: under regulation 15 the periods of notice differ depending on the duration of the agency agreement.  The length of the agency agreement may also be taken into account in calculation of compensation under reg 17 – the Extra Division of the Inner House in King v Tunnock (2000 S.C. 424) emphasised not only the duration of Mr King’s agency, but also the fact that his father had held the agency before him.   Lord Neuberger concluded (at para 55) from the terms of regulation 18(c) that where a principal agrees to instruct a new agent in place of an existing agent, in circumstances where the existing agent has transferred the agency business to the new agent, the new agent is to be treated as having taken an assignment of the existing agent’s rights and duties.  His conclusion on this point is important.  The English language version of reg 18(c) uses the word “assigns.”  Lord Neuberger did not, in this case, give that word its normal English legal meaning, which would have had the effect of limiting it to cases of true assignation in English law.  Rather, he gave it a purposive interpretation, noting (at para 55):

“…the fact that the common law might treat the new agency as a new contract is neither here nor there.  This conclusion appears to me to comply with the commercial purpose of the Regulations.” 

This is a notable example of the interpretation of the regulations in a purposive manner, consistent with the protective nature of the original Directive. 

Given that this case sought only to determine preliminary issues, there is no analysis of the amount of compensation RML is due under reg 17.  A fully litigated claim for compensation may yet be to follow. 

   

Thoughts on frustration of contract in Scots law

One of the classes on offer during Innovative Learning Week was a class called "Blogging in private law."  The class discussed the recent case of Lloyds TSB Foundation For Scotland v Lloyds Banking Group plc ([2011] CSOH 105 and [2011] CSIH 87), a case which we understand is being appealed to the Supreme Court.  This case caused us to reflect on the principles of frustration in Scots contract law.  Although neither party in the case has, thus far, argued that the contract has been frustrated, arguments raised by the bank on  equitable adjustment led the class to look back at the development of frustration. Here is a blog on the case of Tay Salmon Fisheries Company Ltd v Speedie (1929 SC 593) drafted by one of the students in the class, Martin Smail:

 "In light of the recent Lloyds TSB Foundation for Scotland case being appealed to the Supreme Court, it seems an appropriate time to take a look back at an early example of frustration in contract – the case of The Tay Salmon Fisheries Company Ltd v Speedie (1929 SC 593).

The Tay Salmon Fisheries Company was the tenant of a lease to fish for salmon in Fife. During the period of the lease, the President of the Air Council (under statutory authority) created by-laws in the fishing area to allow that area to be used as a practice zone for the RAF. The result of the by-laws was that no ‘vehicle, animal, vessel, aircraft or thing’ was permitted to be in the practice zone at certain times, with a breach of this resulting in a fine. Subsequently, the Fisheries Company was unable to fish because of the time it took them to drop and lift their fishing nets, ultimately rendering their rights under the lease unusable. Despite the fact that the ‘zone’ was only in use for part of the time that the Fisheries Company used their fishing rights, it was their (cumbersome) fishing style that led them to raise an action again Mr Speedie arguing that they should be released from the lease.

It was held by the Lord President (Clyde) that the lessor (Mr Speedie) was in breach of the warrandice clause under the contract to provide possession of the fishery to the Fisheries Company. His Lordship stated that the result of the by-laws was to make the fishery ‘unworkable’ and ‘incapable of possession’. In respect of the fact that the bombing zone was not in constant use, it was stated that it was ‘impracticable’ for the Fisheries Company to have to lift their nets at short notice, to their cost and endangerment and therefore that they were ‘deprived of the possession of the fishery under the lease’.

The case was said to resemble the principle of rei interitus (i.e. where the subjects of a lease are completely destroyed) although this did not sit very well in the judgments. The result of this was that the principle had to be applied almost by analogy because the facts of the case did not fit with the general application of the rei interitus principle. The important pivot (again) on which this point was decided was that the Fisheries Company fished in a way that meant that they could not practicably use the lease. Therefore it was ultimately deemed to be useless to them and that the only result of this was that warrandice provided by the lessor was breached, the result of which could only be ‘liberation of the tenant from the bonds of the lease’.

An interesting approach was taken by Lord Sands whose discomfort with the breach of the warrandice (and the application of the rei interitus principle) as a result of the actions of a 3rd party is almost palpable. He states that it is not the lessor’s duty ‘to protect against outside interferences’ and his approach therefore is purely from a commercially practical point of view. He states that the case raises not a question of loss of profits but instead ‘of possible loss’ which is the reason why the Fisheries Company decided not to continue to fish when the by-laws were enacted. He places the burden of proof on the Fisheries Company to show that the use of the fishery was impracticable and that the ‘character of the fishery’ was ‘entirely altered’. He seems satisfied by the evidence given by pursuers that dropping and lifting their nets at such short notice and so many times a week was ‘commercially quite impracticable’. This was not only due to the cost and man-power that would be expended but also because, had the nets not been taken in on time, then there is a chance that the Fisheries Company would have contravened the by-laws and incurred a penalty as a result. His sidestep in having to answer the breach of warrandice or rei interitus question led him to say that that ‘free exercise of the right of salmon fishing’ has been ‘rendered incapable of profitable use’ – a much  more general commercial law approach than one purely borne out of contract law found in the other judgments.

I agree with Lord Sands approach more than I do with the other judgments in the case as I do not feel comfortable with the fact that a breach of warrandice can occur as a result of a supervening action of a third party. Lord Sands’ commercially practicable approach makes more sense and avoids the tricky question of whether a party can be liable for breach of contract when the real cause of the breach is a factor external to the contract itself. 

I feel that the decision that was arrived at (although by different means) by the judges was the correct one. It should serve as a warning to parties undertaking such leases to expect the unexpected (i.e.consider taking out business interruption insurance, trade insurance or even legal expenses insurance) and when they hear aeroplanes overhead to take cover and check their contract again…."

Aberdeen City Council wins Supreme Court interpretation appeal: Aberdeen CC v Stewart Milne Group Limited [2011] UKSC 56

Earlier today the Supreme Court issued its judgment in the Aberdeen City Council v Stewart Milne Group Limited appeal ([2011] UKSC 56).  The Court had little difficult in reaching a unanimous decision in favour of the Council, upholding the decisions of both Lord Glennie in the Outer House ([2009] CSOH 80) and of the Inner House ([2010] CSIH 21, and see blog at http://www.law.ed.ac.uk/ecclblog/blogentry.aspx?blogentryref=8414). 

This case involves the interpretation of commercial missives in terms of which the Stewart Milne Group had purchased land for development from Aberdeen City Council.  The dispute centred around whether the sellers were entitled to an overage payment on the purchase price in terms of clause 9 of the missives, and the extent of that overage payment (this is referred to as a “Profit Share” in the missives and an “uplift” in the Supreme Court judgment). Clause 9 of the missives reads: In addition to the purchase price detailed in Clause 2 hereof, the Purchasers and the Sellers have agreed that the Sellers shall be entitled to a further payment ("the Profit Share") upon the Purchasers purifying the suspensive conditions contained in Clause 4 hereof and issuing a notice to the Sellers intimating to the Sellers that the Purchasers wish to purchase the relevant part of the profit-share as defined in the Schedule to which the Sellers are entitled. The Sellers' entitlement to the relevant part of the profit-share will also be triggered by the Purchasers disposing either by selling or by granting a lease of the whole or any part of the subjects."

The Profit Share was defined as follows: 

“the Profit Share … means 40% of 80% of the estimated profit or gross sale proceeds or lease value lest [sic] the Allowable Costs as herein defined.”

Stewart Milne sold the subjects to a company within the Stewart Milne Group at a price that appears to have been well below market price, namely £483,020.  They argued that the profit share payable to the Council should be calculated by reference to this low, non-market price.  As this amount was less than the allowable costs that were to be deducted from the sale price in terms of the missives, they argued that no uplift was payable. 

The Council argued that, had the subjects been sold on the open market, the price would have been £5,670,000, i.e. more than 11 times the price at which the Subjects were actually sold.  Not surprisingly, the Council argued that the profit share should be calculated by reference to the open market price at the time of sale.

Lord Hope, after identifying the relevant contractual drafting, began his substantive discussion by noting that the drafting of the provisions was not without defects (para 9).  Outlining several minor errors he noted (at paras 9 and 10):

“These infelicities appear to be due more to untidy drafting rather than to differences in matters of substance. I mention these drafting points because they may make it easier to attribute the problem that we have to deal with to oversight rather than to a deliberate choice when the agreement was being drafted.”

The appellants (Stewart Milne) sought to rely on the literal meaning of the clauses in question, whilst the respondents made reference to the commercial purpose of the agreement, which was, they argued:
“…to enable the respondents to participate in a share of the development value of the subjects.  This was to be arrived at by assuming an open market transaction carried out at arms length, whatever the event was that gave rise to the respondents’ right to a share of the uplift.  Effect should be given to that purpose when construing the words of agreement.”

Lord Hope then carefully sought to identify what the agreement appeared to have in mind (para 15).  Clause 9 provided that the profit share was triggered in different ways.  He continued (para 16):
“But the context tends to indicate that they have one thing in common.  This is that the base figure is to be taken to be the amount which the subjects would fetch in a transaction that was conducted at arms length in the open market.  This is expressly provided for in the case of a buy out, in which event a valuation of the subjects must be undertaken.  This is also provided for expressly in the case of a lease.  No mention is made of a valuation exercise in the case of a sale.  But a sale at arms length is usually taken to be the best evidence of the value of the subjects in the open market.  On this view there was nothing more to be said about the base figure in the event of a sale, other than that it was to be the gross sale proceeds.”  
Continuing his analysis of the type of commercial deal which was envisaged by the parties he explained (para 17):

“As the choice between these three methods lay entirely in the hands of the appellants and clause 9.7 precludes the respondents’ entitlement to any further Profit Share in the future, it is a reasonable assumption that these methods were expected to produce the same base figure, albeit by different routes or methods of calculation.  Otherwise it would be open to the appellants to avoid the basis for the calculation in the case of a disposal by lease by disposing of the subjects to an associated company at an undervalue and arranging for the lease to be entered into by that company.  Basing the calculation on the open market value was, on a fair reading of the agreement, the commercial purpose that these various methods were intended to serve.”

Thus Lord Hope considered the contract as a whole, seeking to place the events which actually took place (i.e. a sale) in the scheme provided by the contract as a whole for the different types of event which would trigger an uplift (i.e. a buy-out, a sale or a lease). 

Nowhere in the contract was it stated that the gross sale proceeds were only to be used in the event of a sale at arms’ length in the open market (para 18).  He posed the question: “Was this a deliberate choice, or was it simply an oversight?” (para 18).  The answer to this question was to be found “…by examining how the agreement can be given effect on the assumption that it was an oversight” (para 18).  The problem for the Council was that the “…wording of the definition does not, in terms, confine the method to be used in the case of a sale to the gross sale proceeds” (para 19).  Drawing on the definitions contained in the contract, he concluded (para 20):

“It seems to me therefore that there would be no difficulty in implying a term to the effect that, in the event of a sale which was not at arms length in the open market, an open market valuation should be used to arrive at the base figure for the calculation of the profit share.”  

Although this resembles the test for implication of terms, Lord Hope does not seem to actually a imply a term.  This view is borne out by his opening sentence where he indicates that the issue is one of construction (rather than implication).  He differs on this point from the rest of the Court who clearly preferred implication of terms as a solution. 

At this stage the work of our own Dr Martin Hogg formed a point of reference for Lord Hope.    Described as a “much respected senior lecturer”, Lord Hope summarised (at para 21) Dr Hogg’s criticisms of the Inner House decision in the case ((2011) Edin L R 406 at 420):

“Why, he asks, where a party has been feckless in allowing a clause susceptible of a commercial disadvantageous sense to form part of the contract, should it be protected by the court giving the contract a commercially sensible interpretation rather than allowing the party simply to suffer the results of its commercial fecklessness?  Why should commercial good sense be attributed to a party which has not shown it in the drafting of the contract?  At pp. 421-421 he recommends a departure from what he refers to as a naïve focus on subjective intention in favour of an objective approach to the interpretation of contracts.  That would minimise the temptation which some courts have shown to improve upon the bargain reached by the parties in the name of commercial good sense.”

Lord Hope, however, did not agree that this was such a case (para 22).  It is worth pausing here to consider this argument.  None of us, of course, knows what the actual agreement on this point was.  This being the case, we must balance various policies.  On the one hand we have what, objectively, the parties are likely to have agreed.  A test of commercial good sense is likely to help us reach that goal.  On the other, and this may be where Dr Hogg is coming from, a party who uses imperfect drafting should, arguably, suffer the loss.  But is the latter policy so significant that it should outweigh the former?  Is it not more important, objectively, to reach what is most likely to have been the actual agreement of the parties?  Drafting is not an exact science.  After all, we already use the contract as a whole to understand the meaning of particular clauses.  Surely any other approach is an overly technical one to apply to a less than scientific exercise? 

  
Lord Hope indicated that the context should be used to understand the intention of the parties, which was that the base figure for the calculation of the uplift was to be the open market value of the subjects at the date of the event that triggered the obligation (para 22):

“In other words, it can be assumed that this is what the parties would have said if they had been asked about it at the time when the missives were entered into.  The fact that this makes good commercial sense is simply a makeweight….The only question is whether effect can be given to this unspoken intention without undue violence to the words they actually used in their agreement.  For the reasons I have given, I would hold that the words which they used do not prevent its being given effect in the way I have indicated.”

Again the language is redolent of implied terms without actually going as far as implying a term.  The language in this paragraph is nuanced.  The major issue is the intention of the parties, objectively measured.  The test of good commercial sense is available, and in this case it matches the objective intention of the parties.  It is available, but relatively unimportant in the context of this case.  This is reflected in the use of the word “makeweight” (of the possible definitions of ‘makeweight’ in the Paperback Oxford English Dictionary, “an unimportant person or thing that is only included to complete something” seems the most apt).  This case can therefore be contrasted with the recent English appeal to the Supreme Court, Rainy Sky SA v Kookmin Bank ([2011] UKSC 50)case.  In that case the commercial good sense test was used in order to decide between two competing interpretations.  The commercial good sense test has not had as significant a role to play in this appeal.
 
Lord Hope’s reference to “undue violence” is reminiscent of Lord Glennie’s reference in Lloyds TSB Foundation for Scotland v Lloyds Banking Group plc ([2011] CSIH 105, and see blog at http://www.law.ed.ac.uk/ecclblog/blogentry.aspx?blogentryref=8710, the appeal in this case has been heard by the Inner House but no judgment has, as yet been issued).

The legal team acting for the appellants sought to raise an argument which they had attempted to raise at a late stage in the Inner House but had been refused leave by that court to do so.  Although the respondents’ objected to this further attempt, Lord Hope nevertheless identified “the overriding aim” as “to do substantial justice as between the parties” rather than to become involved in “niceties of procedure” (para 14).    This argument (set out in para 25) was that the uplift had not been triggered at all on these facts, being triggered only by a sale by the related company in due course at an open market value.  Lord Hope stated that this alternative argument “created more problems than it solves” (para 24) and in actual fact supported the respondents’ case.
 
Lord Clarke in a short speech (with which Lady Hale, Lord Mance and Lord Kerr agreed) identified the nub of the issue, namely that a literal reading of Clause 9.4 suggested that that the uplift was calculated by reference to the actual sale proceeds.  He characterised this case not as one in which “there are two alternative available constructions” but rather as one in which “notwithstanding the language used, the parties must have intended that, in the event of an on sale, the appellants would pay the respondents the appropriate share of the proceeds of sale on the assumption that the on sale was at a market price” (para 31). 

Lord Clarke agreed with Lord Hope as regards the relevance of the context, which showed that the parties intended the open market value as a base figure for calculation of the profit share (para 32). He, however, favoured implied terms as a solution rather than construction (paras 32 and 33):

“…it can be assumed that this is what the parties would have said if they had been asked about it at the time when the missives were entered into…If the officious bystander had been asked whether such a term should be implied, he or she would have said “of course.”  Put another way, such a term is necessary to make the contract work or to give it business efficacy.  I would prefer to resolve this appeal by holding that such a term should be implied rather than by a process of interpretation.  The result is, of course, the same.”    

Lord Clarke was clearly in no doubt as to outcome, indicating that counsel for the appellants was (para 32):  “…not able to advance any commercially sensible argument as to why the parties would have agreed a different approach in the event of an on sale.”

 A few brief comments can be made summarising the impact of this case as a whole.  Most significantly, the case is a victory for common sense and, indeed, justice.  To give to clause 9 the interpretation argued by the appellants makes no sense in the context of the contract as a whole.  It gives a highly unusual effect to sale, understood as one of three events triggering the profit share.  No explanation was offered by the appellants as to why computation of uplift on sale should be so radically different from the other methods.  This illustrates how important it is for us to have a good grasp of the way in which contracts of this type are drafted.  Lord Hope provided us with a model in this respect, being at pains to interpret the clauses of the contract as a whole.  Secondly, it reminds us that other parts of the law of contract offer a solution to cases of this type, in this case, the implication of terms.  The use of a different solution is perhaps not surprising given that this case differed from many of the cases decided recently.  Here the problem was not the “classic” one of an ambiguity giving rise to alternative interpretations.   Thirdly, Lord Hope’s characterisation of commercial good sense as a “makeweight” is interesting.  Clearly it was not the most significant interpretative method used in the case.  Rather, it is the fact that a specific clause must be understood in the context of the contract as a whole which informed the interpretative exercise here.  Dr Hogg is indeed correct – we should guard against courts substituting their own ideas of commercial good sense for that of the parties.  That is not what occurred here.  Finally, prompted by Dr Hogg’s arguments, we should reflect on the extent to which the rules of interpretation should be “shaped” by the policy of punishment of the “feckless” drafter (if at all). 

 

International Commercial Arbitration: The Edinburgh Centre for Commercial Law and Hogan Lovells

Members of the Edinburgh Centre for Commercial Law were delighted to welcome Michael Davison from Hogan Lovells as a speaker this week.  Hogan Lovells offer an internship scheme as a prize for the two top students in the International Commercial Arbitration Masters course (details of the prize available from the course organiser, Dr Simone Lamont-Black).  Michael has become a great friend and colleague having delivered lectures here for the last three years and acted as a speaker at an Arbitration Conference held at the Law School in June 2010.

Undaunted by fog which closed London City Airport, according to Michael, "nothing would stop this Edinburgh boy from coming home."  This involved a lengthy and unplanned journey by taxi across London and by train to Edinburgh.  He arrived unruffled, even in the face of a front row comprising leading lights of the Scottish arbitration world, including (in the order in which they were sitting): Iain Murray, Lord Dervaird; Brandon Malone, McClure Naismith; Andrew MacKenzie, Scottish Arbitration Centre; Hew Dundas, Chartered Arbitrator; and David Bartos, advocate; Hew and David being co-authors (together with Professor Fraser Davidson) of the first commentary on the Arbitration (Scotland) Act 2010.  To raise the pressure even more, the Lord President had joined the occupants of the front row.

Michael provided a thorough and thought-provoking analysis of the new ICC Rules of Arbitration.  His perspective as a practitioner was highly valuable, particularly for the many students of the LLM class in the audience.  A particular focus was the scheme for appointment of an Emergency Arbitrator (Article 29(1)).  Arbitration is often compared adversely with litigation, and particularly by contrasting arbitration with the speed with which injunctions or interdicts can be obtained.  The emergency arbitrator scheme goes some way towards narrowing this gap.  The President of the ICC Court appoints an emergency arbitrator usually within two days of the Secretariat's receipt of the application (Appendix V, Article 2(1)).  Given the fact that the parties to the dispute cannot choose the identity of the arbitrator, no doubt the courts will remain an attractive route to those who value the identity of the decision-maker highly. 

Listeners noted the broad discretion surrounding the manner in which the Emergency Arbitrator conducts proceedings (Appendix V, Article 5(2)).  The emergency arbitrator issues an order, not an award (Appendix V, Article 6(4)).  His or her order may be modified, terminated, or annulled by the arbitral tribunal (Article 29(3)).  Listeners also noted the eye-watering 40,000 US dollars required to be paid by the applicant up front (Appendix V, Article 7(1)). Michael provided some thought-provoking comments on the lack of sanctions for failing to comply with an order.  This may be a significant weakness, particularly given that an emergency arbitrator cannot later act as an arbitrator in the same dispute (Appendix V, Article 2(6).)

In an extremely comprehensive paper, Michael took us through questions of jurisdiction and joinder, multiple claims, and multiple contracts.  Of particular interest are the case management rules.  All of this was presented against the backdrop of Michael's extensive practical experience, which he presented in a highly amusing way.  The arbitration world, according to Michael, is peopled with larger-than-life characters, from shipping magnates to Russian oligarchs.  All in all, the lecture was both highly informative and highly amusing (a rare combination indeed).

We in the Centre for Commercial Law would like to express our thanks for the contribution which Michael and his colleagues at Hogan Lovells have made over the last three years.  There is surely no better advert for a career in arbitration than Michael.  He, and his fellow practitioners who contribute to the teaching of International Commercial Arbitration at Edinburgh Law School (many of the occupants of the front row) provide the practical angle on the subject which is so highly valued by our Masters students.  We hope that our relationship with Hogan Lovells and indeed with our friendly practitioners will continue to bear fruit, particularly as the Arbitration (Scotland) Act 2010 becomes established.           

Supreme Court of Singapore on apparent authority: Skandinavska Enskilda Banken AB (Publ) v Asia Pacific Breweries (Singapore) Pty Ltd and Anor

The English Court of Appeal case of First Energy v Hungarian International Bank ([1993] 2 Lloyd’s Rep 194) poses particular problems for those seeking to understand the law of apparent authority in agency.  The House of Lords in Armagas Ltd v Mundogas SA ([1986] A.C. 717) suggested that there is no such thing as a “self authorising agent.”  For apparent authority to operate, the representation as to the agent’s authority must come from the principal and not from the agent.  Steyn L.J. in First Energy, however, recognised that an agent may be clothed by his principal with the authority to make representations of fact.  Those might include the extent of the agent’s own authority.  In First Energy the third party was aware that the agent was not authorised.  As such, this was a case in which apparent authority could not arise.  The Court of Appeal nevertheless found in favour of the third party, who was able to claim damages from the principal. The case therefore robs the requirements of apparent authority of much of their force.

All may not be lost, however.  The case of Skandinavska Enskilda Banken AB (Publ) v Asia Pacific Breweries (Singapore) Ptd Ltd and Anor (([2011] S.G.C.A. 22) has already been commented on in this blog for useful statements made in the Supreme Court of Singapore on vicarious liability in agency.  This case also provides a useful illustration of the limited nature of First Energy as an authority.  

The Court in Skandinavska noted that each of the judges in First Energy considered their ruling to be consistent with Armagas, and this led them to conclude that First Energy could be distinguished from Armagas only on the facts ([2011] S.G.C.A. 22).  The Court identified three factors that were significant in the exercise of distinguishing the two (para 47):

(a) Whereas in Armagas the third party could easily have checked the agent’s authority, this would have been more difficult in First Energy in view of the agent’s senior role;
(b) Whereas in Armagas the agent was found not to have any authority to enter into a three year charterparty, in First Energy the agent was held to have apparent authority that board approval had been obtained;
(c) Whereas the agent in Armagas had limited authority, the agent in First Energy had wide ranging authority, including the authority to communicate his principal’s approval of the transaction in question.   

The Court’s approach to this issue is encapsulated in para 51 of the judgment:

“It is clear from the foregoing examination of The Raffaella [[1985] 2 Lloyd’s Rep 36 at 42-43].
and First Energy that in both cases, the court’s decision was based on a specific finding of fact that the principal concerned had held out its agent as having authority to make, in relation to the transaction in question, representations of the class or kind of representations that the agent actually made, even though the agent knew he had no actual authority to enter into the transaction itself. In particular, it was made abundantly clear in First Energy that Mr J, as the senior manager of HIB’s Manchester office, had overall responsibility of that office. In such circumstances, it made good commercial sense that a customer of HIB’s Manchester office should be able to rely on what was conveyed to him by Mr J. In contrast, in the present case, Chia was merely the finance manager of APBS, a title which does not connote the possession of any specific authority. The senior management of APBS, including the APBS Board, was also within easy reach of the Appellants. In the circumstances of the case, the Judge found as a fact that APBS had not held out to the Appellants, whether by its actions or by Chia’s position as Finance Manager, that Chia had any authority to make on its behalf any representations of the class or kind of representations that Chia actually made. The Judge’s finding is purely one of fact; therefore, unless the Appellants are able to show that this finding of fact is plainly wrong or is against the weight of the evidence, their appeals based on apparent authority must fail.”

This case correctly emphasises that it is only where the agent occupies a senior position in the principal’s business that the solution in First Energy is relevant.  Only in those circumstances is a third party justified in relying solely on the agent’s representation of the extent of his own authority. 

 

The solicitor’s warranty of authority

A third party is protected against unauthorised activity of agents in different ways.  If the criteria are established, he may be able to raise an action against the principal for damages on the basis of apparent authority.  If the principal, notwithstanding the agent’s lack of authority, chooses to adopt the transaction, then it becomes binding through ratification.  A less familiar action is the action that the third party has against the unauthorised agent: breach of warranty of authority.  In an opinion issued on 23 September, Lord Glennie analysed this action as it applies to solicitors (Cheshire Mortgage Corporation Limited v Grandison and Blemain Finance Limited v Balfour Manson [2011] CSOH 157).  Outcomes in cases of this type are highly fact-dependent.  On the facts of this case, it was held that the solicitor warranted only that he was authorised, not the identity of his clients.   

The fraud which took place in these cases was similar to that which occurred in another case which was commented on in this blog last year: Frank Houlgate Investment Co Ltd v Biggart Baillie LLP 2010 SLT 527, see http://www.law.ed.ac.uk/ecclblog/blogentry.aspx?blogentryref=8030.  The scam is simple but effective, as is illustrated by the facts of the first case.  By impersonating an actual couple (the rather appropriately named Mr and Mrs Cheetham), the fraudsters secured a loan of £355,000 secured over the real Mr and Mrs Cheethams’s home.  The fraudsters were able to provide a number of documents including drivers’ licences and utility bills, all suggesting that they were the real Mr and Mrs Cheetham.  On the day the offer letter was issued, the fraudsters consulted Mr Longmuir, a solicitor, instructing him to act on their behalf.  Not surprisingly, the fraudsters did not have the title deeds to the property which the mortgage was to be taken out over.  Extracts were produced by them, under explanation that the original deeds had been lost.  Their dealings progressed in the normal way, the loan was made and a standard security was executed and submitted for registration over the property.  Shortly after the loan had been made, the fraudsters disappeared, leaving the mortgage company unable to recover the loan and unable to rely on the pretended standard securities.  The mortgage company raised actions against the two sets of solicitors who had acted on behalf of the fraudsters.  They argued that the solicitors in acting for their clients warranted not only that they were duly authorised, but also the identity of their clients.  In other words they argued that the solicitors warranted to the mortgage company that their clients were who they said they were.  As is invariably the case in unauthorised agency, “…the issue is fought in each case between two innocent parties” (para [5]). 

Lord Glennie began his analysis of the law with the English case, Collen v Wright [1857] 8 E&B 647, quoting from Willes J at 657:

“I am of the opinion that a person, who induces another to contract with him as the agent or a third party by an unqualified assertion of his being authorised to act as such agent, is answerable to the person who so contracts for any damages which he may sustain by reason of the assertion of authority being untrue….The obligation arising in such a case is well expressed by saying that a person, professing to contract as agent for another, impliedly, if not expressly, undertakes to and promises the person who enters into such a contract, upon the faith of the professed agent being duly authorised, that the authority which he professes to have does in point of fact exist.”

This action is contractual in nature.  Lord Glennie referred to the judgment of Buxton LJ in SEB Trygg Liv Holding AB v Manches [2006] 1 WLR 226 at para 60 who identified the existence of a collateral contract between agent and third party.  There is, of course, no contract between these parties: the action rests on an implied contract, a legal fiction.  This author has argued that the relationship between the two parties is better analysed in Scots law as a unilateral promise or undertaking (‘Unauthorised Agency in Scots Law’ in D. Busch and L. Macgregor, The Unauthorised Agent: Perspectives From European and Comparative Law, (2009)).  This more accurately reflects the one-sided nature of the dealings between agent and third party. The agent undertakes to the third party that he is authorised.  The third party does not place himself under any similar obligation to the agent.  This analysis is not possible in English law given the lack of an enforceable unilateral promise in that legal system.  Consideration, although not part of Scots law, could potentially help us to analyse the fictitious contract which exists.  Lord Glennie stated  (at para [56]):

“…the acts which amount to consideration may also indicate the acceptance necessary to turn the representation or unilateral promise by the agent into a contract between the agent and third party collateral to that purportedly entered into between the third party and the agent’s professed principal.”  

It is unclear whether Lord Glennie in using the phrase “unilateral promise” means the exchange of promises which lies at the heart of contracts in English law, or the Scottish idea of a binding unilateral promise.  If the latter, this may provide a hint of support for a promissory analysis.  The contractual analysis is highly unsatisfactory: agent and third party clearly have no intention to form a contract.  An implied promise more neatly suits the factual context.  

  
Lord Glennie explained that outcomes are highly dependent on the facts (para [56]):  “…one cannot simply assume the existence of a warranty of authority in all cases.  It is necessary in each case to look at the relationship between the parites, and to examine closely what was said, expressly or impliedly, by the agent in the context of that relationship, how what was said could reasonably have been understood by the other party (the test, as always in contract, being objective.)”

Quoting Lord Drummond Young in Houlgate, he confirms the limited scope of the warranty (at para [57], quoting from para [27] of Lord Drummond Young’s judgment:

“Thus the representation relates to the person for whom the supposed agent purports to act.  It does not relate to the capacity in which that person, the supposed principal, will enter into the transaction, or as to the property that person holds, or as to that person’s title to property.”

Finally, Lord Glennie confirms that liability is strict: it makes no difference to the agent’s liability that he honestly believed himself to be authorised (para [58]).

Going back to the facts, Lord Glennie sought to establish whether the warranty in this case could extend to the principal’s identity.  He emphasised the high degree of contact between the mortgage company and the fraudsters before the solicitor became involved (para [62]). “Of particular importance, to my mind, is the fact that, by the time the borrowers’ solicitors became involved, the lenders knew who they were (or thought they were) dealing with.  They had made the decision in principle to lend to those individuals.  The solicitors were instructed by the borrowers for a limited purpose, namely to help draw up the relevant loan and security documentation and to liaise with the Mellicks, solicitors instructed by the lenders, to that end. (para [63])”
This led him to conclude (at para [64]) that “[i]n those circumstances, it is, in my opinion, difficult to see any room for any implied representation by the solicitors as to the identity of the borrowers for whom they were acting, other than that they were acting for the people with whom the lenders were already engaged in a process of finalising a loan transaction.”  

Researches of counsel suggested that there is no reported Scottish case in which a party has been held liable for breach of warranty of authority.    Judicial analysis nonetheless exists in cases such as Anderson v Croall (1903) 6F 153, Rederi Aktibolaget Nordstjernan v Christian Salvesan & Co [1903] 6 F 64, Irving v Burns 1915 SC 260 and Scott v JB Livingstone & Nicol 1990 SLT 305.  To that list of cases to which Lord Glennie was referred could have been added statements made by Lord MacKay in RBS v Skinner (1931 SLT 382 at 387) on the requirement of reliance of the third party on the warranty. 

This case usefully sets out the requirements of a successful case of breach of warranty of authority.  The action is undoubtedly unusual: contractual damages are available in a situation in which there is, in reality, no contract.  The law of agency contains other similar anomalies.  In apparent authority contract again supplies the measure of the damages even there is no contract between principal and third party though (the agent having been unauthorised).  No doubt the contractual measure is appropriate for the commercial situations in which this action operates.  Agency law could be accused of over-use of legal fictions.  Perhaps we need to be more creative and analysis the tri-partite legal relationships which exist in agency in different, non-contractual, ways. 
On a practical level, banks and building societies may now need to rethink the checks they carry out on borrowers.  An action against the borrower’s solicitors is clearly not the easy option.  Lord Glennie did not entirely close the door on this possibility, however.  The outcomes of cases of this type are highly fact-dependent.  In these particular cases, the fraudsters had become well-known to the mortgage company before the fraudsters’ solicitors became involved.  Lord Glennie seems to suggest a remote possibility that, had the facts differed, the outcome too might differ.    

The agent’s fiduciary duties: FHR European Ventures LLP & Ors v Mankarious & Ors

FHR European Ventures LLP & Ors v Mankarious & Ors [2011] EWHC 2308 (Ch) provides a useful illustration of the way in which the English courts treat the acceptance by an agent of secret commission as a breach of the agent’s fiduciary duty towards the principal.  It sheds light on the extent of knowledge which the principal must possess before he can truly be held to have “consented” to the retention of such a payment by the agent.  It also focuses on the wider impact on the agent, airing issues such as whether the agent can recover from the principal an allowance for skill and effort in obtaining the profit which he has to disgorge to the principal and the impact on commission earned in other, unconnected transactions.  Finally, it illustrates the fact that in English law the agent holds such funds on constructive trust for the principal.

The party who was alleged to have retained the secret profit was Mankarious, who had established a business venture, Cedar Capital Partners (‘Cedar’).  He had acted on behalf of a consortium in their purchase of a hotel in Monte Carlo, for a price of 215 million euros.  After the consortium had purchased the hotel it was discovered that the agent had accepted a commission payment from the sellers of the hotel amounting to 10 million euros.  The consortium brought the relationship with the agent to an end immediately, and refused to pay any of the agent’s outstanding invoices relating to work which the agent had carried out on the consortium’s behalf.  The action was raised by the consortium against the agent requiring disgorgement of the alleged secret commission to the consortium, and seeking resolution of other issues between the parties such as payment of outstanding invoices.  

Mr Justice Simon began his discussion of the applicable law with reference to what has become a highly influential case on fiduciary duties in English law, Bristol and West BS v Mothew ([1998] 1 Ch 1).  He quoted from the case, including the following words, encapsulating the idea of the agent’s fiduciary duty (at 18, quoted by Mr Justice Simon at para 74):

“The distinguishing obligation of a fiduciary is the obligation of loyalty. The principal is entitled to the single-minded loyalty of his fiduciary.  This core liability has several facets.  A fiduciary must act in good faith; he must not make a profit out of his trust; he must not place himself in a position where his duty and his interest may conflict; he may not act for his own benefit or the benefit of a third person without the informed consent of his principal.  This is not intended to be an exhaustive list, but it is sufficient to indicate the nature of fiduciary obligations…where the fiduciary deals with his principal.  In such a case he must prove affirmatively that the transaction is fair and that in the course of the negotiations he made full disclosure of all facts material to the transaction.”       

Authorities on the nature of the principal’s consent were reviewed.  Significantly, it was confirmed that the burden of proving full disclosure rests on the agent (para 78, quoting from Bowstead & Reynolds, Agency, para 6-057).  It was also acknowledged that the factual nature of these enquiries mean that it is difficult to use cases as precedents (para 81).  Finally on this issue, the court considered whether, where the agent has more than one principal, disclosure to one principal can constitute disclosure to all.  This raises the issue of authority: one principal may have actual or apparent authority to receive such information from the agent on behalf of the other principals. 

The agent can be made an allowance for the skill and effort which he expended in obtaining the profit which he has to disgorge.  This principle was recently explored by  the Court of Appeal in Imageview Management v Jack [2009] EWCA Civ 63 at [56].  Imageview, the subject of an earlier blog entry available here:
http://www.law.ed.ac.uk/ecclblog/blogentry.aspx?blogentryref=7912.  In that case, the court had approved the statement of this principle in Snell’s Equity, 31st edition, §7-131:

“…a fiduciary who has acted in breach of fiduciary duty and against whom an account of profits is ordered, may nevertheless be given an allowance for skill and effort in obtaining the profit which he has to disgorge where ‘it would be inequitable now for the beneficiaries to step in and take the profit without paying for the skill and labour which has produced it.’ [The quotation is from the judgment of Wilberforce J in Phipps v Boardman [1964] 1 WLR 993, 1018)].  The power is exercised sparingly, out of concern not to encourage fiduciaries to act in breach of fiduciary duty.  It will not likely be used where the fiduciary has been involved in surreptitious dealing…although, strictly speaking it is not ruled out simply because the fiduciary can be criticised in the circumstances.  The fiduciary bears the onus of convincing the court that an accounting of his or her entire profits is inappropriate in the circumstances.”

On the facts it was held that the agent owed duties to each of the principals severally, meaning that the fully informed consent of each one would have been required before the agent could have retained the secret profit.  Unless this consent was obtained “it could not receive and retain the 10 million euros commission from the Vendors.” 

The evidence suggested that the certain of the members of the consortium may have been aware or suspected that the agent was receiving commission from the sellers. Mr Justice Simon held (at para 104) that it was “…incumbent on the Cedar to inform BoS, not only that it was receiving a Commission payment but the amount, 10 million euros.  It was an exceptionally large sum in proportion to the rewards that Cedar was likely to be able to negotiate from its acquisition work for the purchasers…and it was a significantly larger percentage than would have been expected.”  The agent failed to discharge the burden of proving that each of the companies in the consortium had the requisite knowledge. 

Nor was this the type of case in which it would be appropriate to make an equitable allowance to the agent (para 108).  Numerous opportunities had arisen for the agent to inform the principals, but none of these were taken.  The agent was, however, entitled to retain the commission from work performed in relation to another three hotels, presumably on the basis that these other transactions were severable from the tainted transaction (Lord Hunter in Graham & Co v United Turkey Red Co 1922 S.C. 533 at 553, relying on English authority, indicates that a similar priniciple of severability exists in Scots law). 

Although this case is useful for Scots lawyers, a few issues should be borne in mind about the differences between Scots and English law.  Where the agent is in material breach of the agency agreement and yet seeks payment for his skill and effort, the situation moves from a contractual one to an enrichment one.  Given the differences between enrichment law in Scotland and England, this means that, in a Scottish case, a pursuer would be well advised to use Scottish rather than English cases as precedents. The same issue was considered in the case of Graham & Co v United Turkey Red Co (1922 SC 533).  The breach in that case was acting for another principal when that was specifically prohibited by the written agency agreement.  Although the agent was entitled to commission for the period during which he was not in breach, he was not entitled to commission once he placed himself in material, or “flagrant,” breach (per Lord Ormidale at 548).  According to Lords Salvesan and Ormidale, that was not, however, the end of the line for the agent.  He could claim remuneration even after he had placed himself in material breach (at 546 and 549 and see Ramsay & Son v Brand (1898) 25 R. 1212 and Steel v Young 1907 S.C. 360).  As an enrichment remedy, this claim would only be open to the agent (as contract-breaker) if the principal had opted to rescind in response to the agent's material breach.  The onus lay upon the agent to establish that he was entitled to commission (per Lord Salvesan at 546).  If he successfully established that the principal had gained from his services during this time, the measure of recovery would not be quantum meruit the agent, but rather quantum lucratus the principal (i.e. measured not by reference to what the agent deserves, but rather by reference to the principal's enrichment (per Lord Salvesan at 546 and Lord Ormidale at 550).  Thus it is the law of unjustified enrichment and not the law of contract that potentially offers the agent a remedy for remuneration where he has placed himself in material breach of contract.  It should also be noted for the avoidance of doubt that there is no implied term that an agent is not entitled to work for another principal: only an express term can limit the agent’s activities in this way (Lothian v Jenolite 1969 SC 111).

The fact that it was held in this case that the agent held the secret profit on constructive trust for the principals has already been noted.  Whether a constructive trust exists in Scots law, and would apply to the agent in this type of situation is a controversial issue, and one that cannot be analysed here.  Those seeking enlightenment on the constructive trust in Scots law should consult two articles by Professor George Gretton:  Constructive Trusts: Part I (1997) Edin.L.R. 281 and Part 2 (1997) Edin.L.R. 408.   

 

The line between an (enforceable) liquidated damages clause and an (unenforceable) penalty clause

A recent decision from the Inner House,  Hill and Anor v Stewart Milne Group and Gladedale (Northern) Ltd [2011] CSIH 50 sheds light on liquidated damages clauses and when they may amount to unenforceable penalties. 

The alleged penalty was contained in a minute of agreement and provided that, where the construction of the subjects in question had not been completed by both defenders by a Longstop Date, a penalty of £5,000 per month would be payable to the pursuers.  The Inner House, in a decision delivered by Lord Brodie, reminded us of the tension taking place in cases concerning clauses of this type:

“The context is the law's attempt to resolve the tension between competing principles: on the one hand, as Lord Justice Clerk Inglis put it in Craig v M'Beath (1863) 1 M 1020 at 1022, "it is not legal to stipulate for punishment" and, on the other, as Lord Blackburn said in Caledonian Rly Co v North British Rly Co (1881) 8R (HL) 23 at 31, "a bargain is a bargain". Hence the uncontroversial rules that Lord Macfadyen summarised in paragraph [15] of his Opinion in City Inn Ltd v Shepherd Construction Ltd 2002 SLT 781:
"For a contractual provision to be regarded as imposing a penalty, and therefore as being unenforceable, it must, in my opinion, stipulate for payment by one party to another of a sum of money which (a) is payable on the occurrence of a breach of contract committed by the former party (EFT Commercial Ltd v Security Change Ltd 1992 SC 414), and (b) does not constitute a genuine pre-estimate of the loss likely to be suffered by the latter party as a result of the relevant breach of contract, but is instead unconscionable in respect that it is designed to operate in terrorem, or oppressively or punitively (Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co [1915] AC 79, per Lord Dunedin at 86, para 2; Clydebank Engineering and Shipbuilding Co v Castaneda (1904) 7F (HL) 77; AMEV UDC Finance Ltd v Austin (1987) 68 ALR 185)."”

The case contains analysis of whether the defenders were actually in breach.  This argument arose because the defenders were under an obligation to use all reasonable endeavours to ensure completion by the Longstop Date.  Thus, the pursuers argued, although reaching the Longstop Date without the development having been completed might suggest that a breach had occurred, this may not be the case.  The defenders could only be in breach if they failed to use reasonable endeavours to achieve this outcome.  The Inner House, describing this as a “nice question” (para [14]) indicated that they did not require to come to a decision on this point given their decision on the second issue before them.

Looking then at the second issue, i.e. whether the provision was, in fact, a penalty, the Inner House noted that the Sheriff Principal had erred in his analysis of the onus of proof.  It is for the party who has asserted that a provision is a penalty to establish, by evidence and averment, that it is “…exorbitant and unconscionable and designed to operate in terrorem” (para [15]).  The primary question was therefore whether the defenders had made sufficient specific averments to support their proposition (para [15]).  Here the defenders had provided little more than a statement that the provision was a penalty and therefore unenforceable.  This was insufficient to discharge the onus which lay on them. 

The Sheriff Principal had also been wrong when he found the pursuers’ case to be irrelevant on the grounds that the loss they had suffered had not been caused by the defenders’ breach:

“Moreover, stipulating for pre-estimated damages is recognised as a useful means of allowing the need for proof of a loss caused by breach and accordingly, the party founding on such provision does not need to prove such loss: Clydebank Engineering supra at 83 and Dunlop Pneumatic Tyre supra at 95.”

They later summarised the law on this point by saying:
“Whether a party suing on a liquidated damages provision in the contract had in the actual event suffered damage in consequence of the breach was irrelevant.”

A liquidated damages clause is, of course, enforceable if it represents a genuine pre-estimate of loss.  A clause is only unenforceable as a penalty if it seeks to impose a penalty that is not such a pre-estimate of loss. 

Finally, the Inner House confirmed that whether a provision falls to be regarded as an unenforceable penalty is to be determined by reference to the position at the date of conclusion of the contract and not at the date of the breach (para [18]).  It is at the date of formation that the parties have the opportunity to estimate their potential losses in the event of a particular breach and set the level of the liquidated damages accordingly:

“The proper approach for the Court was to consider whether the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach: Dunlop Pneumatic Tyre supra at 87.”

The Sheriff Principal had approached this case by placing the onus of proof on the pursuers (the parties who were not arguing that it was a penalty) and had also found against the pursuers on the basis that they had failed to prove that the breach had caused them loss.  As explained above, the Sheriff Principal’s decision was wrong on both of these points and was overturned by the Inner House.  All in all, this is a succinct judgment outlining both the method to be used in determining whether the clause is a (valid) liquidated damages clause or an (invalid) penalty clause, and outlining the mechanics of dealing with a clause of this type in litigation. 
 

 

Vicarious liability: Skandinavska Enskilda Banken AB v Asia Pacific Breweries (Singapore) Pte Ltd

The vicarious liability of an agent is an issue which has not been analysed in much depth by the Scottish courts.  Some argue that there is no such thing as vicarious liability in agency: merely that the agent is treated as an employee and the established rules relating to employment applied to an agent (P. S. Atiyah, Vicarious Liability, (1967), p.100).  This approach arguably fails to take into account the role of the agent’s authority in assessing the principal’s liability.  The recent case of Skandinavska Enskilda Banken A.B. (Publ.) v Asia Pacific Breweries (Singpore) Pte Ltd and anor [2011] S.G.C.A 22, decided by the Court of Appeal of Singapore, contains extremely useful analysis of the policy factors underlying vicarious liability (available here: http://www.singaporelawwatch.sg/remweb/legal/ln2/rss/judgment/12453.html?utm_source=rss%20subscription&utm_medium=rss

More significantly, the court applied the “sufficient connection” test for vicarious liability developed in the leading English House of Lords case of Lister v Hesley Hall Ltd ([2001] UKHL 22, [2002] 1 A.C. 215)
in a commercial context.  The court recognised that there may be very different policy factors underlying a decision in a commercial as opposed to a domestic or private situation (Lister was a case which concerned the employer’s vicarious liability where an employee had sexually abused vulnerable children in his care.) 
 

Skandinavska also contains very useful analysis of apparent authority in agency, and comments on the difficult case of First Energy v Hungarian International Bank [1993] 2 Lloyd’s Reps 194).  The apparent authority angle is not discussed here, but may appear in this blog in the future.

    
In Skandinavska, the Court of Appeal identified the two main policy reasons underlying vicarious liability as, firstly, effective compensation for the victim and deterrence of future harm (para 76).  Crucially, the Court suggested that in some factual contexts the person best placed to prevent the tort may be the victim himself or a third party (para 81).  They opened the door for other policy reasons to be relevant to the determination of vicarious liability, not all of which could be identified outside the facts of a particular case (para 81).  They suggested that the following was an accurate representation of the law (taken from Bokhary P.J. in Ming An Insurance Co (/HK) Ltd v Ritz-Carlton Ltd [2002] 3 H.K.L.R.D. 844 at para [25], approved by the Singapore Court of Appeal at para 81):

“By “close connection” is meant a connection between the employee’s unauthorised tortious act and his employment which is so close as to make it fair and just to hold his employer vicariously liable….[V]icarious liability [is imposed] when, but only when, it would be fair and just to do so.” 

   
The difference in factual context, i.e. a commercial as opposed to a domestic or private situation was noted (at para 88):

 “…the case of a commercial fraud perpetrated by an employee of a trading company against international banks which could have prevented the fraud by taking basic precautions presents quite a different situation.”

The court then analysed the agent’s authority on the facts of the specific case, which was extremely limited in financial matters.  As such they held that it would not be reasonable for the principal to have expected the agent to carry out the fraud in question, in fact, the sequence of events was “entirely unforeseeable” (para 91).  The Court decided to let the loss caused by the agent's fraudulent act fall on the third party who had purported to contract with the agent on behalf of the principal/employer, and not the principal as the agent's employer.  The Court made the following comment about the role of banks (para 93):

“Banks play a vital role in the economic life of a community as deposit-taking institutions and suppliers of investment capital for the economy.  There is, therefore, a greater need for banks, (as compared to trading companies such as APBS) to act responsibly and not take undue risks with their depositors’ funds so that the public will have confidence in the banking system.”

As a Singapore case, Skandinavska is, of course, persuasive rather than binding.  The Court of Appeal’s approach must surely be correct: vicarious liability ought to take into account the realities of the commercial situation.  These may be very different from those which applied in Lister, where the harm caused was physical rather than financial, and the victim of the delictual conduct a vulnerable person.   

 

Dissolution of Partnerships – Scottish and English Differences

A recent English High Court case, Boghani v Nathoo [2011] EWHC 2101 (Ch) provides an interesting illustration of the differences between Scots and English partnership law caused by the fact that the Scottish firm has separate legal personality whilst the English firm does not.  The decision also sheds light on the meaning of s.38 of the Partnership Act 1890, the interpretation of which has caused difficulties in the past.

The parties to the dispute had been in a partnership at will and had run the Splendid Hotel Group from 1993 until April 2011.  The firm had been dissolved by notice from Boghani to Nathoo.  At the time of dissolution, two major hotel development projects, known as the ICH Development and the Hilton Development, remained uncompleted.  The partners had been unable to agree how the developments should be disposed of in the winding up of the firm’s affairs.  Boghani argued that they should be marketed for a period of three months and then disposed of to the highest bidder, which might include one of the partners.  Nathoo disagreed, arguing that they should be completed first, and then disposed of. 

The terms of s.38 of the Partnership Act were fundamental to the dispute.  These are as follows:

“After the dissolution of a partnership the authority of each partner to bind the firm, and the other rights and obligations of the partners, continue notwithstanding the dissolution so far as may be necessary to wind up the affairs of the partnership, and to complete transactions begun but unfinished at the time of the dissolution, but not otherwise."

Nathoo argued that s.38 obliged the parties to complete the developments until the court, in its discretion under s.39, determined otherwise. Boghani argued that the section did not have this effect.  He argued that, before dissolution, the partners were under no unconditional obligation to complete the development, and also that completion was not necessary for the partnership to wind up its affairs.  In any event, he argued that the court should exercise its discretion and order the sale on the terms he proposes. 

The issue depended, the Chancellor of the High Court indicated, on what the words “necessary” and “complete” meant in the context of s.38 (para 31).  At the time of dissolution, the partnership was bound by valid contracts with developers requiring them to complete the transactions.  Did such binding obligations under the development contracts mean that it was indeed “necessary” for the firm to complete performance?  The Chancellor thought that it was relevant that many firms would not have the funds to complete every contract at the point of dissolution (para 31).  He interpreted “necessary” as meaning necessary for the purposes of winding up the partnership.  It followed, therefore, that completion of these developments was not necessary for the purposes of dissolution of the partnership (para 33).  Evidence had been led to the effect that other parties were interested in taking on the obligations of the firm in those developments.  Both of the partners individually had also indicated that they would be willing to do so.  This being the case, completion of the developments by the firm was not “necessary” in terms of s.38.   

       
Nathoo did not obtain the order in the terms requested, i.e. ordaining the firm to complete the developments.  The Chancellor indicated that, if the developments were to be completed, it could only be on a consensual basis.  Absent that agreement, either party would be free to bid for the developments against any outside bidders who may also be interested in the developments (para 34).  Boghani’s application, which requested decree that the partners were not under any continuing obligation, whether under s.38 or otherwise, to complete the developments, was also refused (para 35).  To do so would be “at worst incorrect and at best misleading” – the firm remained under obligation to complete the developments notwithstanding dissolution (para 35).
Paragraphs 19 to 27 of the decision contain some interesting and useful discussion of the meaning of s.38.  Reference is made inter alia to two Scottish decisions: a Scottish appeal to the House of Lords, Inland Revenue v Graham’s Trustees (1971 SLT 46) and an Outer House decision from Lord Reed, Duncan v MFV Marigold PD145 [2006] CSOH 128; 2006 SLT 975.  In the former case, on the death of one of the partners, the firm had ceased to exist.  The argument raised was that s.38 permitted the surviving partners to continue the lease of a farm which had been held in the name of the firm.  That argument failed.  The Chancellor quoted from Lord Reid’s speech (at page 48):

"What is meant by transactions begun but unfinished when the partnership was dissolved? If the common law had been clearly settled before 1890, I would interpret this section in light of the earlier law. But it appears that there was then little authority on this matter. So this section should if possible be construed so as to reach a reasonable result. It was argued that "transactions" means bargains. But that would deprive this provision of all content, for it is clear that surviving partners have no right to bind the assets of the dissolved firm by making new bargains or contracts. Their right and duty is to wind up its affairs. In my view this must mean that the surviving partners have the right and duty to complete all unfinished operations necessary to fulfil contacts of the firm which were still in force when the firm was dissolved.  Otherwise the position would be intolerable. Suppose the firm was employed to build a bridge and the bridge was half finished when the firm was dissolved. The surviving partners must be bound to finish the work, for otherwise they could hold the employer to ransom by refusing to proceed unless he made a new contract more favourable to them, and conversely the employer could refuse to allow the work to proceed unless the surviving partners made a new contract more favourable to him. That could not be right."

The Chancellor also quoted Lord Upjohn from that same case, where he indicated that s.38 would not often be required in England, given that the obligations under contracts would bind the outgoing partner and his estate under the general law:

 "Thus, for example, if a firm contracts to build a bridge, that contract is not affected by its dissolution. The remaining partners and the outgoing or the estate of a deceased partner will normally remain both entitled and jointly and severally liable under the general law to complete the bargain. Section 38 makes it plain that the continuing partners can in doing so bind the ex-partners or their estates. But I can well understand that in Scots law, without giving it any different a construction, it may be necessary to invoke the section more often than under English law because of s.4(2) of the Partnership Act, and the partnership having come to an end as a legal person on dissolution, the contract presumably must come to an end. But, nevertheless, this section makes it plain that the ex-partners will remain entitled and bound to carry out the contracts made in the name of the partnership and must complete all those contracts and other matters which are in medio when the partnership was a going concern. But their rights under s.38 are limited by the provision that they may only do so so far as it may be necessary to wind up the affairs of the partnership and, this is the important passage, to complete transactions begun but unfinished at the time of the dissolution, and this is equally true of course of contracts in English law but, as I have said, it is less likely to be necessary to invoke that section."

The Lord Chancellor referred to Lord Reed’s decision in Duncan v MFV Marigold, noting that he had referred to both of the House of Lords speeches quoted above, and, quoting him:

“On any view, however, s.38 cannot warrant the continuation of the business for more than a temporary period…[it is] necessary to examine the facts in order to determine whether a given transaction arose from the conduct of the business of the dissolved partnership by former partners for the purpose of winding up the affairs of the partnership and was "necessary" for that purpose, or whether it was attributable to some other relationship between the partners."

Having analysed this authority, the Chancellor summarised the legal position under s.38 as follows:

“In my view the terms of s.38 as explained in the authorities to which I have referred, in particular Inland Revenue v Graham's Trustees, demonstrate the following propositions:

(1) The obligations of partners to third parties continue notwithstanding the dissolution of the partnership.
(2) In England, if not in Scotland, the satisfaction of those obligations by performance, release or novation or the payment of damages will not usually involve reliance on the terms of s.38.
(3) S.38 does not entitle the surviving partners to engage in new bargains or contracts so as to bind a deceased or former partner.
(4) Even in relation to transactions, not being new bargains or contracts, begun but unfinished at the time of dissolution s.38 applies only if and to the extent that the completion of such transactions is necessary to wind up the affairs of the partnership.
(5) S.38, if applicable, confers a power; it does not impose any additional duty.”

It would be interesting to analyse the source and development of s.38.  The 1890 Act was a codifying statute.  As such, it was not intended to be an exhaustive statement of the law, but rather a statement of the central principles in a series of general propositions.  Lord Reed touched on this point in Duncan v MFV Marigold at para 26.  No doubt, as Lord Reid pointed out in Inland Revenue v Graham’s Trs, there was little case law on the operation of s.38 prior to the entry into force of the 1890 Act.  Arguably, however, the ability of the partner in this respect is simply the common law ability of an agent to continue transactions even if the principal dies or becomes bankrupt.  In theory, an agent cannot act for a non-existent principal.  But the common law permitted the agent to do so in order to complete unfinished transactions.  This idea is analysed in a significant agency case, Pollok v Paterson Dec 10, 1811, F.C. at 375, where the origins of this idea in Roman law are analysed.  Analysis of the the agency law principles underlying s.38 may help to shed further light on this difficult section of the Partnership Act 1890. 

 

 

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