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You are here: BAILII >> Databases >> United Kingdom Supreme Court >> Lloyds TSB Foundation for Scotland v Lloyds Banking Group Plc (Scotland) [2013] UKSC 3 (23 January 2013) URL: https://www.bailii.org/uk/cases/UKSC/2013/3.html Cite as: 2013 SC (UKSC) 169, [2013] WLR (D) 19, [2013] 2 All ER 103, 2013 SCLR 569, 2013 GWD 4-111, [2013] UKSC 3, [2013] 1 WLR 366, [2013] WLR(D) 19 |
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Hilary Term
[2013] UKSC 3
On appeal from: [2011] CSIH 87: [2011] CSOH 105
JUDGMENT
Lloyds
TSB
Foundation
for Scotland (Respondent) v
Lloyds
Banking Group Plc (Appellant) (Scotland)
before
Lord Hope, Deputy President
Lord Mance
Lord Clarke
Lord Reed
Lord Carnwath
JUDGMENT GIVEN ON
23 January 2013
Heard on 27 and 28 November 2012
| Appellant Helen Davies QC Jonathan Barne (Instructed by Group Legal, Lloyds Banking Group plc) |
Respondent Richard Keen QC Jane Munro (Instructed by Simpson and Marwick) |
LORD MANCE (with whom Lord Reed and Lord Carnwath agree)
Introduction
Lloyds
TSB Group plc and now known as
Lloyds
Banking Group plc (and which I shall for simplicity call "
Lloyds
Bank"), and the respondent,
Lloyds
TSB
Foundation
for Scotland ("the
Foundation
"). The 1997 Deed replaced an earlier Deed executed in 1986 and varied by agreement between the parties in 1993. The 1986 Deed was one of four entered into upon the floatation of the TSB Group plc ("TSB") and intended to provide four charitable
foundations
with payments totalling 1% of the pre-tax profits of the TSB.
Lloyds
Bank covenanted to pay the
Foundation
the greater of "(a) an amount equal to one-third of 0.1946 per cent of the Pre-Tax Profits (after deducting Pre-Tax Losses)" for the relevant Accounting Reference Periods and "(b) the sum of £38,920". Clause 1 defined "Pre-Tax Profit" and "Pre-Tax Loss" as meaning
"in relation to any Accounting Reference Period …. respectively the 'group profit before taxation' and the 'group loss before taxation' (as the case may be) shown in the Audited Accounts for such period adjusted to exclude therefrom any amounts attributable to minority interests and any profits or losses arising on the sale or termination of an operation, such adjustment to be determined by the Auditors on such basis as they shall consider reasonable, which determination shall be conclusive and binding on the parties hereto".
The words "and any profits or losses arising on the sale or termination of an operation" were added to the 1986 Deed by the amendments mutually agreed in 1993, and were maintained in the replacement Deed mutually agreed and executed in February 1997. Clause 1 further defined "Audited Accounts" as meaning, in relation to any Accounting Reference Period, "the audited accounts of the Company and its subsidiaries for that period".
Foundation
on the basis of the
Lloyds
Bank group's audited accounts for 2009. Those accounts included in the consolidated income statement (the modern equivalent of a profit and loss account) a figure for "gain on acquisition" of over £11 billion, converting a loss of over £10 billion into a figure for profit before taxation of over £1 billion. This unrealised "gain on acquisition" related to the rescue of HBOS mounted by
Lloyds
Bank in 2008. It was described on p 160 of the accounts as reflecting the difference between, on the one hand, the book value of HBOS's assets written down by (in percentage terms) small "fair value adjustments" and, on the other hand, consideration given by
Lloyds
Bank of about half that written down fair value. Further insight into the envisaged and likely outcome may be provided by the Group Chief Executive officer's statement under the heading Results Overview on p 11 that
"we acquired the business at half book value in anticipation of the likely losses resulting from their troubled asset portfolios".
Lloyds
Bank itself, where the acquisition was accounted for at cost. At the dates of the various Deeds, it would have been contrary to both the law and accounting practice to include in a profit and loss account an unrealised item like "gain on acquisition". This remained the case until 1 January 2005, on and after which date a change in the law and accounting practice instituted at European Union level required listed companies to make such an entry in their consolidated (but not their individual) accounts, albeit with the different implications already mentioned by comparison with other items in the consolidated income statement.
Lloyds
Bank maintains that the "gain on acquisition" should be left out of account for the purposes of the 1997 Deed when ascertaining the group's profit or loss before taxation by reference to the audited accounts, while the
Foundation
maintains that it is no more than one of many items making up a bottom line figure for pre-tax profit or loss, with the result that the group made for those purposes a profit of over £1 billion, rather than a loss of over £10 billion, before taking into account minority interests.
The legal and accounting context
"Every profit and loss account of a company shall show the amount of the company's profit or loss on ordinary activities before taxation".
Schedule 4, para 12 read:
"12 The amount of any item shall be determined on prudent basis, and in particular -
(a) only profits realised at the balance sheet date shall be included in the profit and loss account; and
(b) all liabilities and losses which have arisen or are likely to arise in respect of the financial year to which the accounts relate or previous financial year shall be taken into account …."
Paragraph 91 of Schedule 4 of the Companies Act 1985 provided:
"Realised profits
91 Without prejudice to—
(a) the construction of any other expression (where appropriate) by reference to accepted accounting principles or practice, or
(b) any specific provision for the treatment of profits of any description as realised,
it is hereby declared for the avoidance of doubt that references in this Schedule to realised profits, in relation to a company's accounts, are to such profits of the company as fall to be treated as realised profits for the purposes of those accounts in accordance with principles generally accepted with respect to the determination for accounting purposes of realised profits at the time when those accounts are prepared."
The like principles applied to group accounts: section 230(1) of the 1985 Act. Their function was to "combine the information contained in the separate balance sheets and profit and loss accounts of the holding company and of the subsidiaries dealt with by the consolidated accounts but with such adjustments (if any) as the directors of the holding company think necessary": Schedule 4, paragraph 61.
Foundation
's rights were to be based. The problem which arose in October 1992 from the introduction of Financial Reporting Standard 3 was that exceptional income of this nature was from now on no longer to appear below, but as part of, "profit or loss on ordinary activities", although its tax treatment remained distinct – that is, because under para 24 of Financial Reporting Standard 3 ("FRS 3") issued October 1992 tax was to be computed on ordinary items as if the extraordinary profit or loss did not exist, and the result then compared with the notional tax charge on the profit or loss after the extraordinary items, with any additional tax charge or credit arising being attributed to the extraordinary items).
Lloyds
Bank came to sell Hill Samuel Bank and TSB Property Services. As the agreed statement of facts and issues records (para 14):
"The effect of the amendment was to restore the position in relation to profits or losses arising on the sale or termination of an operation to that which existed prior to the adoption of FRS 3."
The Deed was therefore understood by the parties in 1993 to focus on the line showing "profit [or loss] on ordinary activities". When the parties realised that exceptional items consisting of "profits or losses arising on the sale or termination of an operation" were required to be included in "ordinary activities" they agreed the 1993 amendment to make clear that they were not to count towards the "group profit before taxation" to which the Deed referred.
Foundation
submits that this confirms that any legal and accounting change whatever affecting the profit or loss shown in the accounts must be accepted, unless the parties met the change by agreeing a specific exclusion. I do not agree. I have some doubt whether the exclusion in respect of "any profits or losses arising on the sale or termination of an operation" was actually necessary, bearing in mind their extraordinary nature and entirely different tax treatment. But at least such profits or losses were realised and could in 1993 as a matter of law permissibly be included in the profit and loss account. Assuming on that basis that the exclusion was necessary, and it was certainly a sensible precaution, that says nothing about whether the Deed covers an unrealised "gain on acquisition" arising outside the group's ordinary trading activities, which at the time when it was made could not in law or foreseeably ever have been included in a profit and loss account.
"is recognised immediately in the consolidated income statement, notwithstanding that it reflects an unrealised gain. It is unrealised at the date of acquisition since the related net assets of the acquired entity, which give rise to the negative goodwill, have not been realised through use or sale (hence they are unrealised)".
It is as a result of this development in the legal and accounting position, unforeseen and unforeseeable in 1986, 1993 and 1997, that the present issue arises.
Lloyds
TSB Group as the financial crisis threatened mortgage lenders in September 2008. If the 1997 Deed does not require an unrecognised gain on acquisition of this nature to be taken into account in identifying the "group profit before taxation", it is circular to try to draw any inference from the fact that the parties did not renegotiate or amend the Deed. It would also be illegitimate to try to do so, since parties' subsequent conduct cannot, in Scots or English law, construe an earlier contract. In any event, it is clear that neither party actually foresaw the present issue until it arose after the acquisition of HBOS.
The factual background
Foundation
must have been aware, was that the payments made to the
Foundation
and to the three sister
Foundations
were made by way of covenants for (in total) about 1% of the group's annual pre-tax profits, because such covenants would represent a charge on income and be a more tax-efficient method of providing income than dividends. The covenant was thus seen as an alternative to the issue of shares and to any payment of dividends or their equivalent. If the profits of all group companies were remitted to the parent, and the parent distributed equivalent sums by way of dividends, there would have been a general equation with the covenanted payments. But, as the table produced by the Dean of Faculty demonstrated, there had over the years been considerable discrepancies in particular years between the group profit before tax and the actual dividend payments made by individual group companies. That is understandable. Individual companies in the group may have resolved to retain profits, rather than distribute them as dividends. Or they may have distributed dividends at a rate greater than the 1% total contemplated when the covenants in the Deeds were entered into.
Lloyds
Bank could correspondingly make available to pay away.
Analysis of the opposing cases
Foundation
's case rests in essence upon the use in clause 1 of the phrase "group profit before taxation" in inverted commas, coupled with the phrase "shown in the Audited Accounts". These words are said, in effect, to tie
Lloyds
Bank to any similarly phrased line which may from time to time be found in a future year's Audited Accounts, however fundamentally different the basis on which it is arrived at from any which existed or was in mind when any of the Deeds were executed. The present dispute relates, as stated, to the group's consolidated income statement in its audited accounts for 2009. This contains a line reading "profit before tax: 1,042[,000,000]". This, the
Foundation
says, should be taken without further examination or enquiry. The novel previous line, "gain on acquisition: 11,173[,000,000]", entered pursuant to the demands of Regulation 1606/2002 and IFRS 3, is to be ignored: this, although it represents an entry which could never have appeared in company accounts when the various Deeds were executed or any date until 2005 and which converts a realised loss of over £10 billion into an unrealised profit of over £1 billion. It is, for good measure, also a line which finds no place in the individual company accounts of
Lloyds
Bank, the group's parent company which actually acquired HBOS. In its accounts, the acquisition of HBOS is entered at cost, making it doubly clear the difference between the group "gain on acquisition" and any realised income by reference to which tax might be paid or dividends declared by
Lloyds
Bank.
Foundation
's case as reflecting an appropriately mechanical application of the combination of clauses 1 and 3. The description mechanical is appropriate, but the value of machinery depends upon its being correctly directed towards the right end. In this respect, the proper approach is contextual and purposive. That this is so needs today relatively little citation of authority. As Lord Wilberforce said in Prenn v Simmonds [1971] 1 WLR 1381, pp 1383H-1384B
"The time has long passed when agreements, even those under seal, isolated from the matrix of facts in which they were set and interpreted purely on internal linguistic considerations There is no need to appeal here to any modern, anti-literal, tendencies for Lord Blackburn's well-known judgment in River Wear Commissioners v Adamson (1877) App Cas 743, 763 provides ample warrant for liberal approach. We must, as he said, inquire beyond the language and see what the circumstances were with reference to which the words were used, and the object, appearing from those circumstances, which the person using them had in view".
Construing the words "actually paid" in Charter Reinsurance Co Ltd v Fagan [1997] AC 313, Lord Mustill stated that, in cases not involving a specialist vocabulary, "the inquiry will start, and usually finish, by asking what is the ordinary meaning of the words used" (p 384C-D) and that he had:
"initially thought that the meaning of the words ['actually paid'] was quite clear, and that the complexities and mysteries of this specialist market had hidden the obvious solution, and had led the courts below to abjure the simple and right answer and to force on the words meaning which they could not possibly bear" (p 384F-G).
But he went on (p 384G-H):
"This is, however, an occasion when a first impression and a simple answer no longer seem the best, for I recognise now that the focus of the argument is too narrow. The words must be set in the landscape of the instrument as whole".
Lloyds
Bank's individual company accounts (since the HBOS transaction was there accounted for on a cost basis) and which could never attract taxation. In the light of the legal position of the 1980s and 1990s and the Lord Ordinary's findings on the accountancy evidence (para 19 above), the change was wholly outside the parties' original contemplation, and something which they would not have accepted, had they foreseen it.
Foundation
itself would then be urging that approach.
Foundation
receives only the minimum sum of £38,920, rather than the £3,543,333 which on their case results from the unrealised gain (after taking into account £135 million attributable to minority interests in the group).
Consequences of the opposing cases
Lloyds
Bank of acquiring HBOS with such assets, which was about half the "fair value" figure. Either way, further profits could be made or further write-downs/impairment could fall to be recognised. So it will necessarily be possible to identify by reference to future accounts the amounts which will on
Lloyds
Bank's case logically have to be taken into account by way of profit or loss in future years, if the gain on acquisition in 2009 is ignored for the purposes of the Deed.
Foundation
's case involves striking irrationality. On the
Foundation
's case, the
Foundation
is entitled to have the unrealised gains on acquisition of HBOS taken into account in looking for an appropriate figure for "group profit before taxation" in the 2009 accounts. The Dean of Faculty suggested that this was not unfair because, if the unrealised gains did not in fact materialise, that would inure to the
Foundation
's detriment in the calculation of group profit or loss before taxation in future accounts. But that is very far from the invariable case. First, the
Foundation
is guaranteed a minimum of £38,920 in every year. In any year when the
Lloyds
Bank group makes a loss or insufficient profit, and therefore cannot absorb some element of the original "gain on acquisition" realised in that year at less than its original "fair value" to an extent which still yields the
Foundation
at least £38,920, the
Foundation
will have benefitted from the original "gain on acquisition", and suffered no equivalent detriment.
Foundation
to derive from an unrealised gain a benefit it could not derive from a realised profit. Yet this is precisely what the
Foundation
's case achieves. If HBOS was sold at a profit over and above the "fair price" which led to the "gain on acquisition" in the 2009 accounts, the
Foundation
would not be able to take advantage of that actual realised gain, but the exclusion in clause 3 of "any profits or losses arising on the sale or termination of an operation" would mean that it could keep the advantage of the covenanted payment due, on its case, at the earlier stage of the unrealised "gain on acquisition" of HBOS. Similarly, if the (probably much more likely) scenario arose of a disposal of all or part of HBOS at a price less than the "fair price" which led to the gain on acquisition, the exclusion would mean that the
Foundation
would not have to bring into account any part of the realised loss which had now replaced all or part of the unrealised "gain on acquisition" of HBOS. These incongruous consequences make to my mind completely untenable the
Foundation
's case that the phrase "group profit before taxation" must or can refer to a figure derived from an unrealised gain on acquisition.
Conclusion
Lloyds
Bank's construction would involve "re-writing" the Deed, when in fact it reflects the proper approach, of giving effect to the parties' original intentions in the radically different legal and accounting context which existed by 2009. The Inner House further failed to recognise the incongruity of the result for which the
Foundation
contends.
LORD HOPE (with whom Lord Reed and Lord Carnwath agree)
Lloyds
Bank, which accords with the landscape at the time when the words were written, must prevail over that for the
Foundation
.
Foundation
for 2009 under clause 3 of the Deed would be restricted to £38,920.
Foundation
must fail in its claim against the Bank in any event. But he dealt with the argument nevertheless and, having examined the authorities, he concluded that there was no such doctrine in Scots law: [2011] CSOH 105, 2012 SLT 13, para 89. The point was raised in the Inner House by way of a cross-appeal. As the First Division decided to reverse the Lord Ordinary on the issue of construction, it had to deal with it: [2011] CSIH 87, 2012 SC 259, para 22. In its view however there was no
foundation
for the equitable adjustment of contracts, as a generality, in Scots law. Lord President Hamilton recognised the existence of the doctrine, but he said it would be beyond the judicial power to develop it in a way that would assist the Bank in this case: para 29.
Foundation
. The contract had not been frustrated. Nor was it his case that the court had any general power to adjust or alter contracts to achieve what one or other of the parties might regard as an equitable result. His proposition was a narrow one, confined to a case where the alteration in the circumstances in which the contract came to be performed was affected in a material way by supervening events for which neither party was responsible. There had to be a supervening event which was not foreseen and was not foreseeable when the contract was made, and that event must affect the substance of the contract.
Foundation
, for its part, made it clear in its written case that it did not suggest that there was no concept of equitable adjustment in Scots law. It is to be found, for example, where the future performance of a contract is frustrated. The rule in Scots law is that the loss does not lie where it falls on the frustration of a contract. There must be, as McBryde, The Law of Contract in Scotland, (3rd ed, 2001), para 21-47 puts it, an equitable adjustment. That was what was done in Cantiere San Rocco SA v Clyde Shipbuilding and Engineering Co 1923 SC (HL) 105, [1924] AC 226, where it was held that the buyer was entitled to repetition of the instalment of the price that was paid on signature of the contract as, owing to the war, further performance of the contract had become impossible. As Lord Dunedin explained, at pp 126, 248-249, the remedy for frustration of the contract was given "not under the contract or because of breach of the contract inferring damages, but in respect of the equitable (of course I am not using the words in the technical English sense) doctrine of condictio causa data causa non secuta." It should be noted that the term causa data causa non secuta is used today not to describe a remedy as such, but rather to describe one particular group of situations in which the law may provide a remedy because one party is unjustifiably enriched at the expense of the other: Shilliday v Smith 1998 SC 725, 728, per Lord President Rodger.
Foundation
were to succeed on the interpretation argument its obligations under the Deed could not be implemented. But Lord President Cooper, Frustration of Contract in Scots Law (1946) 28 Journal of Comparative Legislation, at p 1, saw frustration of the contract as a by-product of a wider question
"how the relations of two parties should be equitably readjusted by the Court when the one has been unintentionally enriched at the expense of the other."
He made it clear at pp 4-5 that in his opinion the principle of frustration was capable of being expanded in the future into other areas. In James B Fraser & Co Ltd v Denny, Mott & Dickson Ltd 1944 SC (HL) 35, 41, [1944] AC 265, 272, Lord Macmillan (who was counsel for the unsuccessful shipbuilding company in Cantiere San Rocco) said that the doctrine of frustration was so inherently just as inevitably to find a place in any civilised system of law:
"The manner in which it has developed in order to meet the problems arising from the disturbances of business due to world wars is a tribute to the progressive adaptability of the common law."
In Muir v McIntyre (1887) 14 R 470 it was held that a tenant was not bound to pay the full rent where, due to no fault of his own, almost the whole of the accommodation on the farm was destroyed by a fire. Lord Shand at p 473 said that the principle on which the tenant was entitled to an abatement of his rent was "founded on the highest equity".
Foundation
contends it means. The obligation that, so construed, it sets out is not impossible of performance. Can it really be said that it would be appropriate to resort to an equitable doctrine in order that the Deed should mean something else? None of the examples of equitable adjustment that are to be found in the reported cases go that far. And it is hard to see how this the enrichment can be regarded as unjustified, if including the sum for negative goodwill results from the meaning that must be given to the covenant.
Foundation
. As the Dean of Faculty pointed out, the unrealised gain on acquisition was due to
Lloyds
TSB Group's decision to acquire HBOS in January 2009 by which date IFRS 3 had already been issued. The situation which has resulted from this was described by the Bank's expert Mr Simmonds as "unthinkable" when the covenant was entered into. But the acquisition was a voluntary act. It was not something that was beyond the control of either party.
LORD CLARKE
Foundation
. It then seemed to me that the Deed set out a clear formula which was intended to apply to the relevant circumstances over very many years, that the parties must be taken to have recognised that there would be likely to be changes in accounting standards over the years and that the purpose of the formula was to leave it to the auditors in each year to set out the "group profit before taxation" and the "group loss before taxation" in the Audited Accounts. It appeared to me that, in these circumstances, since it was clear that the group profit before taxation was the item described as "Profit before tax" in the Audited Accounts for 2009, it followed that the figure of just over £1 billion shown against that item was the "'group profit before taxation' shown … in the Audited Accounts" for the relevant period and that, following the formula set out in clause 2(1) of the Deed, the amount payable by
Lloyd
's Bank to the
Foundation
was £3,543,333. That seemed to me to be the result on the natural meaning of the deed.
Lloyds
Bank to the
Foundation
is based on the minimum figure of £38,920 set out in clause 2(1)(b) of the Deed. As Lord Mance explains, the difference between the parties depends upon whether the figure of just over £11.1 billion shown in the accounts as "Gain on acquisition" should be taken into account in arriving at the "group profit before taxation". If it is not taken into account the profit of just over £1 billion is turned into a significant loss of over £10 billion so that only the minimum amount is payable under the Deed.
"… no-one suggests that that the lease cannot or should not apply in the changed circumstances. We have to promote the purposes and values which are expressed or implicit in the wording, and to reach an interpretation which applies the wording to the changed circumstances in the manner most consistent with them."
I agree that that is a sensible approach both to that problem and to the problem we have here. I note that in Bank of Credit and Commerce International SA v Ali [2002] 1 AC 251 Lord Clyde said, at para 79:
"Generally people will say what they mean. Generally if they intend their agreement to cover the unknown or the unforeseeable, they will make it clear that their intention is to extend the agreement to cover such cases."
Lloyds Bank.