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You are here: BAILII >> Databases >> The Judicial Committee of the Privy Council Decisions >> Krys & Ors v KBC Partners LP & Ors (British Virgin Islands) [2015] UKPC 46 (19 November 2015) URL: https://www.bailii.org/uk/cases/UKPC/2015/46.html Cite as: [2015] UKPC 46 |
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Michaelmas Term
Privy Council Appeal No 0089 of 2014
JUDGMENT
Krys
and others (Respondents)
v
KBC
Partners
LP
and others (Appellants) (British
Virgin
Islands)
From the Court of Appeal
of the Eastern Caribbean Supreme Court (British Virgin
Islands)
before
Lord Mance
Lord Sumption
Lord Reed
Lord Toulson
Lord Hodge
JUDGMENT GIVEN ON
19 November 2015
Heard on 17 June 2015
Appellants Ian Mill QC Philip Jones QC Tom Weisselberg QC (Instructed by Brown Rudnick LLP) |
|
Respondents
(Kenneth David Head (Instructed by Jones Day) |
|
|
Respondent (New
World Christopher Pymont QC Ciaran Keller (Instructed by Signature Litigation LLP) |
LORD SUMPTION: (with whom Lord Reed, Lord Toulson and Lord Hodge agree)
1.
Part VI
of the
Partnership
Act 1996 of the British
Virgin
Islands
provides for the creation of limited
partnerships
on the footing that the
partnership
business is conducted by the general
partner,
and the limited
partners
are not liable for
partnership
obligations unless they participate in
its management. This appeal arises out of a dispute about the distribution of
partnership
assets upon its dissolution.
2.
Value
Discovery
Partners
LP
(“
VDP”)
was a BVI limited
partnership
formed
in 2004. Its purpose was expressed in its articles of
partnership
(clause 1.2)
to be:
“to carry on business and in
particular but without limitation to identify, research, negotiate, make and
monitor the progress of and sell, realise, exchange or distribute investments
which shall include but shall not be limited to the purchase, subscription,
acquisition, sale and disposal of shares, debentures, convertible loan stock
and other securities in unquoted companies and in certain quoted situations,
and the making of loans whether secured or unsecured to such companies in
connection with equity or equity-related investments, with the principal
objective of providing the Limited Partners
with a high overall rate of return.”
(1) The Principal
Limited Partner
was New World
Value
Fund (“NWVF”), a company registered in
Gibraltar whose ultimate beneficial owners were Boris Berezovsky, a
controversial Russian politician and businessman who died in 2013, and his
Georgian business associate Arkady Patarkatsishvili, who died in 2008. NWVF
contributed assets
valued
at US$320m to the
partnership,
substantially the
whole of the initial capital. These assets consisted of ordinary shares in
various
companies carrying on business in the Balkans and the former CIS
states. They were divided into categories, corresponding to business areas,
which are referred to in the articles as “Strategies”.
(2) The General Partner
was a company called Salford Capital
Partners
Inc (“Salford”), which was
controlled by a Mr Eugene Jaffe, a professional fund manager. Salford was
entitled under the articles to a management fee of 2% of the aggregate capital
contributions of the limited
partners.
(3) In addition, there
were two Special Limited Partners,
KBC
Partners
LP
and SCI
Partners
LP,
referred to in the articles as Special Limited
Partner
I and II respectively.
KBC
and SCI were BVI limited
partnerships
owned by Mr Jaffe which made nominal
capital contributions of $100 each. Their role was to represent his interests
and those of a number of individuals working for Salford or otherwise concerned
in the management of
VDP.
4.
It is clear from the terms of the articles that the principal purpose of
the partnership
was to manage the investments contributed by Messrs Berezovsky and
Patarkatsishvili through NWVF with a
view
to selling them off within the
partnership
term and achieving the maximum return. It is apparent from the
evidence that the disposal of the investments was expected to be difficult,
partly because of their location in a part of the world where business
conditions are notoriously difficult, and partly because their sale
value
was
likely to be undermined if their connection with Messrs Berezovsky and
Patarkatsishvili became known. NWVF and
VDP
were structured in such a way as to
conceal that connection as far as possible.
5.
Clause 1.5 of the articles provided that the partnership
should
terminate on 1 July 2008, subject to clause 11.2, which provided for this date
to be extended for successive periods by the General
Partner
“in order to
permit an orderly liquidation of the
Partnership
Assets”. An extension was
conditional on the General
Partner
notifying the limited
partners
in writing
that it was of the
view
that an orderly liquidation of the
partnership’s
assets
was not possible by the existing date of termination. The management fee
payable in respect of the extended period was reduced to 0.4%. In no case were
the extensions to exceed four years in total. In other words, the last possible
date of termination was 1 July 2012. In the event, the duration of the
partnership
was successively extended, but none of the
partnership
assets had
been sold when the
partnership
was finally terminated on the long-stop date 1
July 2012. It is now in liquidation.
6.
The present appeal arises out of proceedings brought in the BVI by the
joint liquidators to determine the distribution of the partnership’s
assets in
the liquidation. The joint liquidators are neutral on this issue, and have
taken no substantial part in this appeal. The real issue is between NWVF, which
had contributed substantially all the capital, and the two Special Limited
Partners
KBC
and SCI, which represented the interest of those contributing
management skills. Shortly stated, the question is whether the Special Limited
Partners
are entitled to recover a sum referred to in the articles as “Carried
Interest” in circumstances where the assets had not been sold at the time of
termination. The Court of Appeal, overruling the trial judge, held that they
were not.
7.
Carried Interest is in substance a bonus or success fee payable to
interests associated with the management for selling the investments. The
articles provide for two kinds of “Carried Interest”. “Senior Carried Interest”
is related to the management of the assets as a whole and is payable to KBC
(“Special Limited
Partner
I”) at 24% of the net profits and gains realised on
the sale of the investments. “Strategy Carried Interest” is related to the
management of the assets comprised in individual “Strategies” and is payable to
SCI (“Special Limited
Partner
II”) at 6% of the profits and gains realised on
sale. The combined effect of the provisions for Carried Interest is that
individuals associated with the management stood to gain 30% of any profits or
gains made on the sale of the investments.
8. Clause 11.5 deals with liquidation. Clause 11.5.3 provides:
“Upon termination or liquidation
of the Partnership
… no further business shall be conducted except for such
action as shall be necessary for the winding-up of the affairs of the
Partnership
and the distribution of the
Partnership
Assets amongst the
Partners.”
Clause 11.5.4 provides for the treatment of the assets of
the partnership
on liquidation after termination:
“Upon termination of the
Partnership,
the liquidating trustee or trustees may sell any or all of the
Partnership
Assets on the best terms available or may, at its or their
discretion, distribute all or any of the
Partnership
Assets in specie. … The
remaining proceeds and assets (if any) shall be distributed amongst the
Partners
on the basis set out in clause 8.”
Clause 8 provides for distributions, some of which may be
made at any time at the discretion of the General Partner,
and some of which
may be made only upon termination. Among those which can be made only upon
termination are sums allocated under clauses 7.2.2 and 7.2.3, which deal with
Carried Interest.
“7.2 Allocation of Remaining Income and Gains
7.2.1 Except as provided in clause
7.1, all Net Income, Net Losses, Capital Gains and Capital Losses of the
Partnership
shall be allocated between the
Partners
only following the sale of
all Investments of the
Partnership
or at such other time as may be agreed by
the General
Partner
and the Limited
Partners.
7.2.2 Subject to clause 7.1, if
following the sale of all Investments of the Partnership
the Annual Rate of
Return of the
Partnership
exceeds 0%, then cumulative Net Income, Net Losses,
Capital Gains and Capital Losses of the
Partnership
shall be allocated between
the
Partners
by allocating the portion of each such amount equal to the Senior
Carried Interest multiplied by such amount to the Special Limited
Partner
I,
the portion of each such amount equal to the Strategy Carried Interest
multiplied by such amount to the Special Limited
Partner
II, and the balance of
such amount to the Principal Limited
Partner.
7.2.3 Subject to clause 7.1, if
following the sale of all Investments of the Partnership
the Annual Rate of
Return of the
Partnership
is 0% or less and the Annual Rate of Return of at
least one Strategy exceeds 0%, then the cumulative Net Income, Net Losses,
Capital Gains and Capital Losses of each Strategy shall be allocated between
the
Partners
as follows:
(a) for each Strategy for
which the Annual Rate of Return exceeds 0%, such amounts shall be allocated
between the Partners
by allocating the portion of each such amount equal to the
Strategy Carried Interest multiplied by such amount to the Special Limited
Partner
II, and the balance of such amounts to the Principal Limited
Partner;
and
(b) for all other
Strategies, 100% to the Principal Limited Partner.
7.2.4 Subject to clause 7.1, if
neither clause 7.2.2, nor clause 7.2.3 applies, then Net Income, Net Losses,
Capital Gains and Capital Losses of the Partnership
shall be allocated 100% to
the Principal Limited
Partner.
…
7.3.8 If a decision is made to
distribute any Partnership
Assets in specie in accordance with clause 8.6,
those assets shall be deemed to be realised for the purposes of computing Capital
Gains, Capital Losses and Capital Proceeds at their
Value.
…
8.1 Priority of Distributions
Subject to clauses 8.2, 8.3, and
8.7, Net Income, Capital Proceeds and other assets of the Partnership
shall be
distributed in the following order of priority (after payment of the expenses
and liabilities of the
Partnership):
(a) first, in payment of the Management Fee …
(b) second, to the
Principal Limited Partner
in amounts allocated to it pursuant to clause 7.1.6
and not characterised as Capital Contributions;
(c) third, to the Principal
Limited Partner
in repayment of its Capital Contributions;
(d) to Special Limited
Partner
I and Special Limited
Partner
II in repayment of their Capital
Contribution pro rata to the amount of their respective Capital Contributions;
(e) fifth, if clause 7.2.2
has been applied, then to the Partners
in the net positive amounts allocated to
them pursuant to such clause;
(f) sixth, if clause 7.2.3
has been applied, then to the Partners
in the net positive amounts allocated to
them pursuant to such clause;
(g) seventh, if clause
7.2.4 has been applied, then to the Partners
in the net positive amounts allocated
to them pursuant to such clause;
(h) eighth, if clause 7.1.7
has been applied, then to the Partners
in the net positive amounts allocated to
them pursuant to such clause.
The amounts distributable to a
Partner
under sub-clauses (c), (d), (e), (f) and (g) above shall be decreased,
in descending order, by amounts previously distributed to such
Partner
pursuant
to clauses 8.2.2, 8.2.3, 8.2.4, 8.2.5, 8.2.6 and 8.3.
8.2 Timing of Distributions
8.2.1 Subject to the provisions of
this clause 8.2 and Clauses 8.5 and 8.8, Net Income, Capital Proceeds and other
assets of the Partnership
shall be distributed in respect of the amounts under
sub-clauses (a), (b), (c) and (d) of clause 8.1 (and in that order) at any time
by the General
Partner
acting reasonably and in good faith, and in respect of
the amounts under sub-clauses (e), (f), (g), and (h) of clause 8.1 (and in that
order) at the end of the term of the
Partnership
or at such other time as may
be agreed by the General
Partner
and the Limited
Partners.
8.2.2 Unless otherwise
specifically permitted hereunder, distributions of Net Income, Capital Proceeds
and other assets of the Partnership
may be made at any time, and in any manner,
with the agreement of the General
Partner
and the Limited
Partners.
In each
such case, the General
Partner
and the Limited
Partners
shall each have an
absolute right to refuse consent with or without cause.
8.2.3 Distributions up to the
amount of the Preliminary Carried Interest attributable to the relevant
Investment(s) may be made to the Special Limited Partner
II upon the
satisfaction of the following conditions:
(a) all Investments
representing a Strategy have been sold and the aggregate Acquisition Costs of
Investments that have been sold is equal to or exceeds 30% of Invested Capital
of the Partnership;
and
(b) the Annual Rate of Return on Investments that have not been sold is not less than 20%.
(c) Except as provided below, distributions made pursuant to this Clause 8.2.3 shall be made on a pro rata basis from the Carried Interest Accounts for the Investments that have been sold.
8.2.4 Distributions up to the
amount of the Preliminary Carried Interest attributable to the relevant
Investment(s) may be made to the Special Limited Partner
II upon the
satisfaction of the following conditions:
(a) all Investments
representing a Strategy have not been sold and Investments have been sold whose
aggregate Acquisition Costs is equal to or exceeds 50% of Invested Capital of
the Partnership;
and
(b) the Annual Rate of Return on Investments that have not been sold is not less than 20%.
Distributions made pursuant to this clause 8.2.4 shall be made on a pro rata basis from the Carried Interest Accounts for the Investments that have been sold. …
8.3 Carried Interest Accounts
8.3.1 Subject to clauses 8.3.7 and
8.3.8 be1ow, upon the sale of any Investment after 1 July 2007 or upon the sale
of any Investment that gives rise to Capital Proceeds in excess of 20,000,000
(twenty million) US Dollars, 30% of the Net Investment Return of the Investment
(if any), less any amounts of Investment Income relating to such Investment
previously deposited under clause 8.3.2, shall be deposited in a separate bank
account (a ‘Carried Interest Account’) of the Partnership
that corresponds to
the Relevant Strategy and shall only be distributed or transferred in
accordance with this clause 8.3. A Carried Interest Account shall be opened and
operated for each Strategy. …
8.3.3 Except as provided in clauses
8.3.4 and 8.3.6, the only distributions or transfers that may be made from
Carried Interest Accounts are distributions to the Limited Partners
pursuant to
clauses 8.1(d), (e), (f) or (g) (and in that order), clause 8.2.3 or 8.2.4. …
8.3.6 If following the sale of all
Investments of the Partnership
and distribution of all assets of the
Partnership
other than amounts in Carried Interest Accounts, if any, the
Capital Contributions of the Limited
Partners
are not fully repaid in
accordance with clause 8.1(c), then such amounts in the Carried Interest Accounts
shall be distributed to the Limited
Partners
until their respective Net Capital
Contributions are 0 (zero) and the balance of the amounts in the Carried
Interest Accounts (if any) shall be distributed in accordance with clauses 8.1(d),
(e), (f) or (g) (and in that order). …
8.6 Distributions Other Than Cash
Prior to the final liquidation of
the Partnership,
the General
Partner
shall make all distributions under clause
8 in cash. Upon the final liquidation of the
Partnership,
the General
Partner
has the right to make distributions in the form of non-marketable securities.”
10. The effect of these complex provisions can be summarised as follows:
(1) Clauses 8.2.3 and
8.2.4 provide for what amount to interim payments of Carried Interest. As and
when investments are sold during the term of the partnership,
distributions up
to the amount of the “Preliminary Carried Interest” (6% of the net investment
return attributable to the investments which have been sold) may be made to SCI
if the conditions set out in clauses 8.2.3 or 8.2.4 are satisfied. These
conditions prescribe a minimum proportion of the assets of the
partnership
or
of individual strategies which must have been realised and a minimum rate of
return which must have been achieved.
(2) Clause 7.2 provides
for the distribution of Carried Interest once all the investments have been
sold: see clause 7.2.1. In that event, the income and gains are to be allocated
in accordance with clauses 7.2.2 and 7.2.3, both of which are expressly
predicated on there having been a sale of all the investments. Under clauses
7.2.2 and 7.2.3, a share of the income and gains is distributed to the Special
Limited Partners
according to a formula dependent on the Annual Rate of Return
over the period during which the investments were held, calculated by reference
to (among other things) the proceeds of their sale.
(3) Apart from the
interim payments authorised by clauses 8.2.3 and 8.2.4, clauses 7.2.2 and 7.2.3
are the only clauses providing for a distribution of income and gains to the
Special Limited Partners.
Clauses 8.1(e) and (f) are contingent on clauses
7.2.2 and 7.2.3 having been applied. If there has not been a sale of all the
investments, neither of them applies. In that event, 100% of the income and
gains is allocated to the Principal Limited
Partner
under clauses 7.2.4 and
8.1(h).
(4) The combined effect
of clauses 8.1(e)-(g) and 8.2.1 is that any distributions due under clause 7
are distributed “at the end of the term of the Partnership.”
11.
There having been no sales, on the face of it the Special Limited
Partners
are entitled to nothing more than the return of the nominal capital
contributions of $100 each. Since distributions have to be made in the course
of the liquidation at the end of the term of the
partnership,
there is no scope
for a distribution in their favour by reference to a sale made after the
partnership
has terminated.
12.
The Special Limited Partners
object to this conclusion on the ground
that “sale” has an extended meaning in clause 7, embracing any disposal of the
investments, including their disposal after termination in the course of
liquidation or their distribution in specie to the Principal Limited
Partner.
The requirement of clause 8.2.1 that distributions under clause 8.1 be made at
the end of the
partnership
term means, they say, “at or after” that time.
13.
These contentions were supported by a variety
of ingenious arguments,
but the Board is unable to accept them. “Sale” has a well understood meaning.
It means a transfer of property to another party for a money consideration. It
could not extend to a distribution to the Principal Limited
Partner
in specie.
In the first place, the articles refer throughout to other modes of disposal
such as “distribution” or “exchange” when these are intended, but clauses 7.2.2
and 7.2.3 refer only to a “sale”. Secondly, a number of clauses distinguish in
terms between “sale” and “distribution”, treating them as alternatives, notably
clause 11.5.4. Thirdly, since the ultimate object of the
partnership
is to
realise the investments for the benefit, primarily, of the Principal Limited
Partner
who contributed them, a sale cannot sensibly be thought to include a
distribution in specie to that
very
partner
in the course of a liquidation. The
Special Limited
Partners
relied in support of their case on clause 7.3.8, which
they argued constituted a general definition under which a distribution in
specie counted as a sale. But in the Board’s opinion that provision has a more
limited effect. It treats a distribution in specie as a realisation only for
the purpose of enabling the assets to be
valued
for the purpose of computing
Capital Gains, Losses and Proceeds. It does not create or assume any
entitlement to amounts based on these
values
which is not to be found in the
operative provisions of clauses 7 and 8.
14.
Under clause 11.5.4 it would be open to the liquidator to liquidate the
assets of the partnership
by sale instead of by distribution in specie,
although this seems unlikely to happen in the present case given the difficulty
that Salford has encountered in selling. However, a sale in the course of
liquidation after termination could not give rise to a distribution “at the end
of the term of the
Partnership”
for the purpose of clause 8.2.1. Clause 8.2.1
does not of course envisage a distribution at that
very
moment. It means a
distribution in the course of the liquidation but (as with a liquidation under
the Companies Acts) by reference to the state of affairs at its commencement.
This assumes that a “sale” has already occurred before that time.
15.
Underlying the Special Limited Partners’
arguments on construction there
is a consistent theme. They say that the apparent result of the language of the
articles is extraordinary, since it leaves them with nothing more than their
nominal capital contributions if they fail to sell all the investments, however
valuable
the investments remaining in their hands, however much they may have
succeeded in selling and however much the liquidator or NWVF may realise after
termination. Even if the Board regarded these consequences as absurd, such
arguments have limited force in the face of the clear language of the articles.
16.
However, the information available to the Board discloses no reason for
regarding the terms appearing from the language of the articles as commercially
unwise, let alone as “absurd”. This is an unusual partnership
made against an
unusual background. It is far from clear by what standards of commercial
normality any particular provisions are to be measured. There is little to be
gained by imagining more or less far-fetched examples of cases in which the
articles of
partnership
would operate harshly if construed according to the
ordinary meaning of the words, especially when those examples assume
investments of a different kind from those which
VDP
actually held. The salient
points are (i) that substantially all the assets of the
partnership
were
contributed by NWVF, and (ii) that Carried Interest is in effect a success fee
earned by the Special Limited
Partners
by selling the investments. Against this
background there is nothing surprising about the contingent character of the
interest of the Special Limited
Partners.
Nor is there anything uncommercial
about a construction which leaves them upon termination with nothing but their
original nominal capital contribution if Salford has failed to sell all the
investment when the long-stop date of termination arrives. The Special Limited
Partners
submit that the all or nothing basis on which Carried Interest is
apparently earned under clause 7.2 is so unreasonable that some other meaning
must be found. The Board would not be disposed to accept this even if the
premise were correct. But it is not correct. Even if Salford failed to sell all
of the investments, the Special Limited
Partners
would still have been entitled
to distributions up to the amount of the Preliminary Carried Interest if they
had sold enough of them to satisfy the conditions in clauses 8.2.3 and 8.2.4.
Moreover, Salford will have earned the Management Fee even if it has sold
nothing. At the trial, evidence was led by them to suggest that their
management fee was an inadequate reward by the standards of this kind of asset
management business, unless supplemented by the distribution of Carried
Interests. But evidence of this kind is almost invariably unhelpful, as it is
in this case. It is equally consistent with alternative explanations.
LORD MANCE: (dissenting)
18.
This appeal involves a one-off issue of interpretation of convoluted
articles of partnership
in
Value
Discovery
Partners
LP
(“
VDP”).
Its resolution
might appear to be unimportant, except to the
Partners
in
VDP
and those behind
them. I have therefore hesitated whether to express my dissent. I have
concluded that I should, because I regard the Board’s approach as inconsistent with
the principle that contracts should be construed as a whole, with their
principal objective in mind and without excessive reliance on a literal reading
of individual words or phrases. Further, the approach leads to a conclusion
which is both capricious and unfair to the two Special Limited
Partners
who are
the appellants and irrationally favourable to the Principal Limited
Partner
which is the only active respondent (and which I shall call simply the
respondent) on this appeal. The judge at first instance, Bannister J, correctly
recognised this, and I find myself in large measure in accord with his
characteristically clear judgment, although its reading of the articles was
incorrect in one or two particulars. As in In re Sigma Finance Corpn
[2009] UKSC 2, [2010] 1 All ER 571, para 12, so here, the contrary conclusion
reached in the Eastern Caribbean Court of Appeal and by the majority in my
opinion “attaches too much weight to what the courts perceived as the natural
meaning of the words …, and too little weight to the context … and to the
scheme … as a whole”. The Board has not in my opinion applied the lessons
illustrated by this case and others such as Aberdeen City Council
v
Stewart
Milne Group Ltd [2011] UKSC 56, where the United Kingdom Supreme Court held
that a reference to the “actual sale proceeds” must in context refer not to the
actual sale to an associated company which had occurred, but to a hypothetical
sale on the open market at a market price (see especially per Lord Clarke at
paras 30 to 31).
19.1 The partners
in
VDP
consist in a General
Partner,
Salford Capital
Partners
Inc (“SCP”), the
Principal Limited
Partner,
New World
Value
Fund Ltd (“NWVF”) and Special
Limited
Partners
I and II, now
KBC
Partners
LP
(“
KBC”)
and SCI
Partners
LP
(“SCI”).
19.2 Except where
otherwise expressly provided, the conduct and control of the Partnership’s
business, operations and affairs were
vested
exclusively in the General
Partner,
SCP (clause 4.1.1). The two Special Limited
Partners
have no such
role, but were
vehicles
by which the General
Partner’s
individual employees (in
respectively London and the Central and Eastern European areas where
Investments were to be made) were to be rewarded for positive performance, as
hereafter appears.
19.3 The principal
objective of the Partnership
is defined in clause 1.2 as that “of providing the
Limited
Partners
with a high overall rate of return”.
19.4 To achieve that
principal objective, the purpose of the Partnership
is defined by clause 1.2 as
being “to carry on business and in particular but without limitation to … sell,
realise, exchange or distribute investments …”.
19.5 Investments are defined to include but not to be limited to “shares, debentures, convertible loan stock, options, warrants or other securities of and loans (whether secured or unsecured) made to any body corporate or other entity”. They were to be acquired in accordance with an Investment Strategy defined as:
“investment in restructuring and consolidation opportunities in Central and Eastern Europe, as well as special situations worldwide, with particular emphasis on the Food and Beverage and FMCG industries in the Balkans and CIS.”
Individual investments with common characteristics were under clause 4.7.1 to be grouped, each group being called a “Strategy”.
19.6 The Partnership
has
(again under clause 1.2) power, through the General
Partner,
to “execute … all
contracts and other undertakings and engage in all activities and transactions
as may in the opinion of the General
Partner
be necessary or advisable in order
to carry out the foregoing purposes and objectives, subject to and in
accordance with the provisions of these Articles and the Investment Strategy”.
Clause 4.1.1 underlines this, by expressly conferring on the General
Partner:
“full power and authority …
(a) to carry out the
purposes of the Partnership;
(b) to perform all acts,
and to enter into and to perform all contracts and other undertakings, which
the General Partner
may in its sole discretion deem necessary or advisable, or
which are incidental, to or for the carrying out of the purposes of the
Partnership;
…
(d) to evaluate and
negotiate investment opportunities and to purchase, subscribe for, exchange or
sell or otherwise dispose of Investments for the account of the Partnership;
…
(f) to manage, hold and
control Investments on behalf of the Partnership
….”
19.7 The Principal
Limited Partner
contributed at the outset all the
Partnership
investments with
an initial
value
of US$320m, these being in fact investments previously
acquired on its behalf by the General
Partner.
The Special Limited
Partners
each provided nominal Capital Contributions of US$100, and the objective in
providing the Special Limited
Partners
with a high overall rate of return was
to incentivise the General
Partner’s
employees to achieve the like result for
the Principal Limited
Partner.
The General
Partner
was to receive a management
fee (of in effect US$6m per annum in the initial two year
Partnership
periods
ending 1 July 2008, reducing to US$1.4m during any extended periods up to the
final Extended Termination Date of 1 July 2012: see para 19.13 below).
19.8 For the Special
Limited Partners,
the high overall rate of return envisaged consists, broadly
speaking, in shares in net returns of 24% (by way of Senior Carried Interest)
in the case of Special
Partner
I and 6% (by way of Strategy Carried Interest)
in the case of Special Limited
Partner
II (ie 30% in all). The remaining 70% of
any positive return was to be for the benefit of the Principal Limited
Partner
(see further paras 19.14 to 19.16 below).
19.9 With limited
exceptions, there were to be no distributions of net return while Partnership
Investments were being actively managed, but only thereafter when that ended.
(A purpose of this was, according to the evidence of Mr Jaffe of the General
Partner,
SCP, again to incentivise the individual employees whose interests
were represented by the Special Limited
Partners
to continue to create the high
overall return which was the
Partnership’s
principal objective.)
19.10 Provision was
however made for the Special Limited Partners’
30% interest by payments into
Carried Interest Accounts. Thus, subject to some qualifications, upon the sale
of any investment made after 1 July 2007 or giving rise to capital proceeds in
excess of US$20m, 30% of the Net Investment Return of the investment was to be
deposited in a Carried Interest Account corresponding to the Relevant Strategy
(clause 8.3.1); and, likewise, apart from investment income covered by clause
8.2.6 (ie received after an Extended Termination Date: para 19.21 below), 30%
of any investment income after 1 July 2007 was to be deposited in a Carried
Interest Account corresponding to the Relevant Strategy (clause 8.3.2).
19.11 By way of exception
to para 19.10 above, clauses 8.2.3 and 8.2.4 provide for Distributions, up to
the amount of Preliminary Carried Interest (defined as 6% of the Net Investment
Return attributable to relevant investments sold), to Special Limited Partner
II out of a Carried Interest Account while
Partnership
Investments are still
being actively managed in the following limited circumstances:
19.11.1 under
clause 8.2.3, if all Investments representing a Strategy were sold, their
Acquisition Costs were equal to or exceeded 30% of Invested Capital of the
Partnership
and the Annual Rate of Return on unsold investments was at least
20%; or
19.11.2 under clause 8.2.4, if all such Investments representing a Strategy were not sold, but Investments were sold with Acquisition Costs of at least 50% of Invested Capital and the Annual Rate of Return on unsold Investments was again at least 20%.
Mr Jaffe explains the
background to these limited exceptions. Those interested in Special Limited
Partner
II were local Central or Eastern European employees, who might, if all
or half the Investments in a Strategy were sold, cease to be involved in the
General
Partner
or Special Limited
Partner
II before the
Partnership
came to an
end. Hence, the interim or preliminary provision made for their reward.
19.12 Otherwise, clause 8.3.3 provides (with presently immaterial exceptions) that:
“the only distributions or
transfers that may be made from Carried Interest Accounts are distributions to
the Limited Partners
pursuant to clauses 8.1(d), (e), (f) or (g) (and in that
order), clause 8.2.3 or 8.2.4.”
Clause 7.1.7 adds that:
“Net Income, Net Losses, Capital
Gains and Capital Losses arising from a Carried Interest Account shall be
allocated to the Partner
or
Partners
to whom the original amount deposited in
such Carried Interest Account is distributable in accordance with clause 8.3
and in the ratio of such distributions.”
19.13 The Life of the
Partnership
extends under clause 11.1 to a Termination Date of 1 July 2008,
capable under clauses 11.2.1 and 11.2.2 of
various
extensions by the General
Partner
alone or with the Limited
Partners’
consent to 1 July 2011, basically
“in order to permit an orderly realisation of the
Partnership
Assets” and
capable in that event under clause 11.2.3 of further extension to an Extended
Termination Date as follows:
“If the Termination Date is
extended by the General Partner
pursuant to clause 11.2.1 in order to permit an
orderly liquidation of the
Partnership’s
Assets, then not less than 90 (ninety)
days prior to such Termination Date the General
Partner
must notify the Limited
Partners
in writing that the General
Partner
is of the
view
that orderly
liquidation of the
Partnership
Assets is not possible by such Termination Date
due to market conditions for the sale of certain Investments and provide the
Limited
Partners
with a written summary of its reasons for such a
view.
If the
General
Partner
so issues such a notification, then the General
Partner
and the
Limited
Partners
undertake in good faith to discuss the options for disposal of
the
Partnership
Assets. Following such discussions, the General
Partner
may
acting reasonably and in good faith extend the Termination Date (with such
extended Termination Date referred to as the ‘Extended Termination Date’) by
such time as is necessary to complete the orderly liquidation of the
Partnership
Assets but in no event more than 4 (four) years. The General
Partner
shall notify the Limited
Partners
of such extension by not less than 30
(thirty) days prior to the Termination Date.”
It is common ground that the
Partnership
was extended under these provisions to 1 July 2012.
19.14 The articles contain
distinct provisions regarding the allocation of profits and losses between partners
during the life of the
Partnership
(clauses 7.1 and 7.2) and the timing of
distributions in respect of profits and losses so allocated (clause 8.2.1).
Thus, clause 7.1 covers, principally, the allocation to the General
Partner
of
its Management Fee and to the Principal Limited
Partner
of 100% of Interim
Investment Income in respect of each Accounting Period, while clause 7.2 covers
the allocation of remaining income and gains, by providing that:
“Except as provided in clause
7.1, all Net Income, Net Losses, Capital Gains and Capital Losses of the
Partnership
shall be allocated between the
Partners
only following the sale of
all Investments of the
Partnership
or at such other time as may be agreed by
the General
Partner
and the Limited
Partners.”
19.15 The word “only” in
clause 7.2 emphasises that this is both a triggering provision and a provision
for the allocation which follows when the trigger is pulled. The stipulated
trigger is “sale of all Investments of the Partnership”.
If this occurs, and:
19.15.1 there is a
positive Annual Rate of Return for all such Investments (clause 7.2.2), then
24% thereof is allocated by way of Senior Carried Interest to Special Limited
Partner
I and 6% by way of Strategy Carried Interest to Special Limited
Partner
II or, alternatively,
19.15.2 if there is
no positive Annual Rate of Return for all such Investments, but there is for
one or more Strategies, then 6% is allocated by way of Strategy Carried
Interest to Special Limited Partner
II (clause 7.2.3).
19.15.3 In each
case, clauses 7.2.2 and 7.2.3 provide for the remaining Net Income, Net Losses,
Capital Gains and Capital Losses to be allocated 100% to the Principal Limited
Partner.
19.16 Clause 7.2.4 further provides:
“Subject to clause 7.1, if
neither clause 7.2.2 nor clause 7.2.3 applies, then Net Income, Net Losses,
Capital Gains and Capital Losses of the Partnership
shall be allocated 100% to
the Principal Limited
Partner.”
19.17 Clause 8.1 headed
Priority of Distributions lists a “waterfall” of priorities, starting in clauses
8.1(a) to (d) with the General Partner’s
Management Fee, the Interim Investment
Income allocated to the Principal Limited
Partner
and the Limited
Partners’
respective Capital Contributions and continuing thereafter in clauses 8.1(e), (f)
and (g) with references to “net positive amounts” allocated to “the
Partners”
if clauses 7.2.2, 7.2.3 or 7.2.4 respectively has been applied. (The final
provision, clause 8.1(h), again refers to “net positive amounts” allocated to
the
Partners
under clause 7.1.7, consisting of net earnings on deposits in
Carried Interest Accounts distributable to the
Partners.)
19.18 Clause 8.2.1
provides for the timing of Distributions under the waterfall provisions of
clause 8.1. Distributions under clauses 8.1(a) to (d) may be made at any time
by the General Partner
acting reasonably. In contrast, amounts due under clauses
8.1(e), (f), (g) and (h) are payable “at the end of the term of the
Partnership
or at such other time as may be agreed by the General
Partner
and the Limited
Partners”.
The “end of the term” must here refer to the Termination Date of the
Partnership,
as defined by clause 11.2. Clause 11.5.4 (para 19.19 below) also
indicates this. The reference to “such other time as may be agreed” again
suggests that the parties cannot have regarded the termination or liquidation
of the
Partnership
and its Investments as critical to the making of distributions
under clauses 8.1(e), (f), (g) and (h).
19.19 The articles address
the distribution of assets unsold at the Termination Date at various
points,
particularly in clauses 11.5.4 and 8.6. Clause 8.6 provides, under the heading
“Distributions Other than Cash”:
“Prior to the final liquidation
of the Partnership,
the General
Partner
shall make all distributions under clause
8 in cash. Upon the final liquidation of the
Partnership,
the General
Partner
has the right to make distributions in the form of non-marketable securities.”
Clause 11.5.4 provides:
“Upon termination of the
Partnership,
the liquidating trustee or trustees may sell any or all of the
Partnership
assets on the best terms available or may, at its or their
discretion, distribute all or any of the
Partnership
assets in specie.”
It also specifies that, after
payment of or allowance for all present or future Partnership
debts,
obligations and liabilities and all liquidation costs that:
“The remaining proceeds and assets
(if any) shall be distributed amongst the Partners
on the basis set out in clause
8.
Partners
receiving a distribution of
Partnership
Assets in specie shall be
bound by the provisions of any agreements relating to such
Partnership
Assets,
to the extent such agreements so provide.”
19.20 In short, the articles
contemplate that the waterfall provided in clause 8 will on termination of the
Partnership
be capable of operation by distributions made in specie, if the
General
Partner
or liquidating trustee so decides. Clause 7.3.8 completes the
picture by providing for the basis on which assets distributed in specie are to
be
valued:
“If a decision is made to
distribute any Partnership
Assets in specie in accordance with clause 8.6,
those assets shall be deemed to be realised for the purposes of computing
Capital Gains, Capital Losses and Capital Proceeds at their
Value.”
“Value”
is defined by recital
(6) as
“such value
as shall be
determined by the General
Partner
acting in its reasonable discretion and in
good faith and in applying the
Valuation
Procedures (taking into account local
market conditions.”
The Valuation
Procedures are
defined by reference to the British
Venture
Capital Association’s Reporting and
Valuation
Guidelines of July 2003. Further, the definition of “Capital Proceeds”
“available for distribution … or … distributed by the
Partnership”
expressly
includes “the
Value
of any Investments distributed in kind, and for purposes of
determining the Annual Rate of Return on an unsold Investment, the
Value
of
such unsold Investment”.
19.21 Clause 8.2.6 also addresses the situation where at the Extended Termination Date not all the Investments have been sold. It provides that, when that occurs:
“then the Annual Rate of Return
of all unsold Investments of the Partnership
as of the Termination Date shall
be calculated as of such date …”
Clause 8.2.6 goes on to provide
that distributions shall be made as from such Termination Date as follows: if
the Annual Rate of Return of such Investments exceeds 0% at the Extended
Termination Date, then “Investment Income received by the Partnership
after the
Termination Date” shall go first to reduce the Net Capital Contributions of the
Principal and Special Limited
Partners
to nil and thereafter be paid as to 24%
as Senior Carried Interest to Special Limited
Partner
I and as to 6% as
Strategy Carried Interest to Special Limited
Partner
II, with the balance going
to the Principal Limited
Partner,
but if the Annual Rate of Return of such
Investments is 0% or less, then such Investment Income received after the
Termination Date shall go wholly to the Principal Limited
Partner.
19.22 None of the
Partnership
Investments was sold or it appears realised as at the Extended
Termination Date of 1 July 2012. Nevertheless, the
Partnership
appears, from the
information the Board was given, to have been highly successful in terms of
increasing the overall
value
of its Investments. That is what this litigation
is about. The Investments will either be or have been disposed of to third
parties or distributed in specie during the
Partnership’s
liquidation. A
computation of the cumulative Net Income, Net Losses, Capital Gains and Capital
Losses will show a highly positive Annual Rate of Return. The Special Limited
Partners
claim their respective portions of a 30% share of this. The Principal
Limited
Partner
claims the entirety of it, after covering (if not already paid)
each of the Special Limited
Partners’
US$100 Capital Contributions.
20.
The respondent Principal Limited Partner’s
case, accepted by the Court
of Appeal and by the majority, is that the Special Limited
Partners’
claim to
all or any part of a 30% share in net positive returns is limited to situations
where distributions can be made:
20.1
to Special Limited Partner
II of a share of up to 6% of Net Investment
Return out of a Carried Interest Account in the limited circumstances defined
by clause 8.2.3 or 8.2.4 (para 19.11 above):
20.2 upon the sale to
third parties for cash of all the Investments of the Partnership,
to the Special
Limited
Partners
in their respective percentages of 24% and 6% of any positive
Annual Rate of Return on all such Investments or any particular Strategy
pursuant to clause 7.2.2 or 7.2.3 (para 19.16 above);
20.3 in respect of any
Investment Income received on unsold Investments which showed a positive Annual
Rate of Return upon termination of the Partnership
at an Extended Termination
Date, then, after repaying any outstanding Net Capital Contributions, to
Special Limited
Partners
I and II in respect of their respective percentages of
24% and 6% of such Investment Income Return (para 19.21 above).
21.
Both Special Limited Partners’
claim to shares of any positive Annual
Rate of Return on the
Partnership’s
overall Investment record would thus
depend essentially upon the General
Partner
arranging the sale - in a strict
legal sense involving the transfer of property for monetary consideration - of all
the
Partnership’s
investments. Special Limited
Partner
II’s claim to a 6%
share in the limited circumstances defined by clause 8.2.3 or 8.2.4 is
described and clearly contemplated as a preliminary share, arising from interim
achievement.
22. The respondent’s interpretation depends upon:
22.1 reading the phrase
“sale of all Investments of the Partnership”
in clause 7.2 as referring to sale
in the strict legal sense mentioned in the preceding paragraph, and as imposing
this as a strict pre-condition to the operation of clauses 7.2.2 or 7.2.3 both
when they are applied in isolation and when they are applied as a result of
references back to them in later clauses, such as clause 8.1 read with clauses
8.2.1 and clause 11.5.4. This limb of the respondent’s case rests essentially
upon a repeated comparison between the “well understood” narrow legal concept
of “sale of all Investments of the
Partnership”
in clause 7.2 and fuller
terminology expressly embracing realisation and exchange, found elsewhere in
the articles, eg in clauses 1.2, 4.1.1 and 11.5.4.
22.2 reading clause 7.2.4
as directed not merely to situations where no positive Annual Rate of Return
has been achieved bringing clause 7.2.2 or 7.2.3 into operation, but also as
directed to a situation where there has not been “sale of all Investments of
the Partnership”.
Indeed, the respondent goes further and submits (written
case, para 50) that the latter purpose is in reality the only purpose of clause
7.2.4, since there could never be any positive return to be distributed to the
Principal Limited
Partner
under clause 7.2.4 and clause 8.1(g), if the Annual
Rate of Return of the
Partnership
was 0% or less;
22.3 treating the phrase
“at the end of the term of the Partnership”
in clause 8.2.1 as the date by
which any sale of all the
Partnership
investments must have occurred for the
waterfall provisions in clauses 7.2.2 or 7.2.3 read with clauses 8.1(e) and (f)
to apply; and
22.4 treating the
references in clauses 7.3.8, 8.6 and 11.5.4 to distribution of Partnership
assets and proceeds amongst the
Partners
in specie upon termination of the
Partnership
in accordance with clause 8, and to
valuation
of assets so
distributed, as explicable on the marginal basis that such distributions might
be made to satisfy outstanding management fees or capital contributions.
23.1 “It is clear from the
terms of the articles that the principal purpose of the partnership
was to
manage the investments … with a
view
to selling them off within the
partnership
term and achieving the maximum return”, giving sale “a well understood meaning”
of “transfer of property to another party for a money consideration” (Lord
Sumption, paras 4 and 13); and
23.2 any distributions “at
the end of the term of the Partnership”
(clause 8.2.1) enable distributions to
be made during the course of liquidation, but require these to be made by
reference to a state of affairs existing at the commencement of the
liquidation, rather than by reference to the position as and when distributions
are made (Lord Sumption, para 14).
In my opinion, the principal purpose of the partnership
was and is as defined in para 19.3 above, namely to achieve a high overall rate
of return, for the benefit of all concerned, in all the ways indicated in para
19.4 above, and the articles contemplate distributions during liquidation by
reference to
values
ascertained during the process of liquidation and
distribution.
24.
In my opinion neither the respondent’s nor the Board’s interpretation
corresponds with any intention which the Partners
are likely to or did have
when agreeing these articles. Starting with the points identified in paras 22.1
and 22.2, I accept of course that, taken by itself “sale of all investments of
the
Partnership”
points to a sale in the strict legal sense involving the
transfer of property for a monetary consideration. But I do not consider that
this is or can be its only meaning in the context of clause 7.2, even in the
basic situation contemplated by that clause, and still less, as will appear, in
the context of termination and liquidation of the
Partnership:
24.1 First, it is clear
that the primary object of the phrase “only following the sale of all
investments of the Partnership”
is to act as a trigger to define when and how
allocations between Limited
Partners
are to be made. But clause 7.2.1 also
postulates, as an alternative, agreement between the General and Limited
Partners
on some other trigger. That means that clauses 7.2.2 and 7.2.3 must
have been intended to operate by agreement in circumstances short of “the sale
of all Investments of the
Partnership”
– this, despite these clauses’
repetition of the phrase “following sale of all Investments of the
Partnership”,
without qualification to cover situations where the
Partners
agree otherwise under clause 7.2.1. This itself points against sale of all
Investments being regarded as the sole trigger for allocation of their
percentages of any positive Annual Return to the Special Limited
Partners.
The
parties would not have provided specifically for something to which they were,
on the respondent’s case, opposed as a matter of fundamental principle.
24.2 Second, there is no
sensible commercial reason why the sale in a strict legal sense of all
investments should be made a pre-condition to the intended rewards which the
Special Limited Partners
were to receive. Commercial parties are not likely to
gamble on uncertainties which are irrelevant to their principal objective and
over which they have no necessary control. Even if the
Partnership
had been
limited to investments only realisable by sale, it could
very
easily have been
highly profitable without all investments being sold. The fact that one
investment was not sold or saleable might be insignificant, compared with a
hugely positive return on the sale of every other investment. The fact that
there was not a sale of an investment could be due to any number of matters
throwing no doubt on the general investment skills or success of the General
Partner
or of its employees interested in the Special Limited
Partners.
These
included but are not limited to the materialisation of the acknowledged risk of
compulsory acquisition without compensation by a Central or Eastern European
state. It is no answer to these points for the respondent to point out that no
investments at all had in fact been sold by the Extended Termination Date. That
was plainly not envisaged by anyone. But what must have been envisaged is that
most of investments would be sold, whereas one or two might not be (and would
either have disappeared or would have to be distributed in specie). The
question is whether, in that situation, the parties can sensibly have intended
that the Special Limited
Partners
would forego their 30% share, even though
they had (as appears to be the case here) contributed to a highly positive
overall Annual Rate of Return on the
Partnership
Investments. I do not think
so.
24.3 Third and in any
event, the Partnership
purposes were expressly not limited to investments only
realisable by sale. The nature of the Investment Strategy and of the contemplated
Investments (para 19.5 above) demonstrates their contemplated
variety.
If sale
in a strict legal sense of all investments was critical, there is no sense in
the wide powers conferred on the
Partnership
and on the General
Partner,
to
invest in investments the
value
of which would not be realised by such sale,
and to exchange, realise or otherwise dispose of investments (see paras 19.4 to
19.6 above). The principal objective was to be achieved by selling, realising,
exchanging or distributing investments, the
value
of many of which could not or
would or might well not be realised by sale. The General
Partner
would have
been failing in its duty if it did not consider investing, and where it seemed
best investing, in investments which could or would be realised by means other
than sale. It would have been failing in its duty if it did not realise their
value
in the best way, even if that did not involve sale in a strict legal
sense. Some might be exchanged for other investments, which on a literal
reading would mean that not all the investments were sold, even though the new
investments so acquired were sold for cash. Others might be realised by a
leveraged recapitalisation, involving the distribution of a large dividend,
reducing or eliminating their equity
value.
Critically, many of them might only
be realisable or realised by being repaid or reaching maturity. The phrase
“sale of all investments” cannot have been intended to operate in the narrow
legal sense advocated by the respondent as a trigger in all circumstances to
the operation of clauses 7.2.1 to 7.2.3. It would be in fundamental conflict
with the intended Investment Strategy, with the nature and purpose of the
intended Investments and with the principal objective and purposes of the
Partnership.
24.4 Fourth, the
respondent’s case introduces into the Partnership
and articles perverse
conflicts of interest. Assuming an overall successful investment history as the
Partnership
was nearing its final termination date, the Special Limited
Partners
would only be rewarded if their employees achieved sales, at whatever
value
(provided it did not eliminate the overall positive net return).
Otherwise, on the respondent’s case, the Principal Limited
Partner
would scoop
the pool, as it is by this litigation seeking to do. Especially in a context
where the whole purpose of the Special Limited
Partners’
involvement was to
incentivise the General
Partners’
employees behind the Special Limited
Partners
to achieve a high overall return (which it was no doubt their duty in law as
employees to seek to achieve in any event), it seems completely unrealistic to
ignore the implausibility of reverse incentivisation of this nature. Human
nature is human nature - as the
very
presence and role of the Special Limited
Partners
as parties to the articles recognises.
24.5 Fifth, if failure to
sell for cash all the Partnership
investments was critical, what reason could
there be for allowing the Special Limited
Partners
their 24% and 6% shares of
any Investment Income received after the Extended Termination Date on unsold
investments yielding a positive Rate of Return at that Date (paras 19.21 and 20.3
above)?
24.6 Sixth, the respondent’s case on clause 7.2.4 (paras 19.17 and 22.2 above) represents in my opinion both an unnatural and an unrealistic reading of the place and sense of that clause in the overall scheme:
a.
On its face clause 7.2.4 is directed to a situation where no positive Annual
Rate of Return has been achieved bringing either clause 7.2.2 or 7.2.3 into
operation. The respondent submits that there could not in this situation be any
positive net distribution to the Special Limited Partners
under clause 7.2.4,
or under clause 8.1(g) which refers to “the positive amounts allocated to [the
Partners]”
under clause 7.2.4, so that these clauses must be dealing with
something else,
viz
the distribution of net surplus in a situation where there
was a positive Annual Rate of Return but no “sale of all Investments of the
Partnership”.
b. This is to my mind unpersuasive:
i.
A similar point could be taken on the combination of clause 7.2.3 and
clause 8.1(f) which refers back to “the positive amounts allocated to them [the
Partners]”
under clause 7.2.3. If the Annual Rate of Return of all
Partnership
Investments is 0% or less, which is the predicate of clause 7.2.3, then there
can be no positive amounts allocated to the Principal Limited
Partner
under
clause 7.2.3(b).
ii. In reality, all these clauses are drafted in a similar format and wording, and a degree of incongruity or redundancy is unsurprising. Both clauses 7.2.3(b) and clause 7.2.4 in fact refer not to distribution but to allocation, a term appropriate to cover a situation of net negative Annual Rate of Return; and each is expressed to relate to all the individual elements that go to make up any such Rate of Return (“Net Income, Net Losses, Capital Gains and Capital Losses”), some of which may show a net positive Return, and others a net negative Return, with the overall result being a net negative Annual Rate of Return.
iii.
Clauses 8.1(f) and (g) do in contrast refer to “net positive amounts”
being “allocated to them [the Partners]”
pursuant to respectively clauses 7.2.3
and 7.2.4. Again, this is repetition of the format and language which appears
throughout clauses 8.1(e) to (h). Both the reference in clause 7.2.3(b) to “the
cumulative Net Income, Net Losses, Capital Gains and Capital Losses of each
Strategy” being “allocated between the
Partners”
in respect of unprofitable
Strategies, “100% to the Principal Limited
Partner”
and the reference in clause
8.1(g) to the net positive amounts “allocated to them [the
Partners]”
pursuant
to clause 7.2.4 (which on any
view
only allocates amounts to the Principal
Limited
Partner)
appear on any
view
inapt.
iv.
It is impossible to derive from nice grammatical points of this nature
made by the Principal Limited Partner
a conclusion that clause 7.2.4 relates to
anything other than its natural subject-matter, that is situations in which
there has been sale (whatever that means) of all
Partnership
Investments, but
no net profitability bringing either clause 7.2.2 or 7.2.3 into play.
c.
The respondent’s submission that clause 7.2.4 has the sole purpose of
addressing situations where not all the Investments are sold is thus in my
opinion both unnatural and unreal. But so too is any modified submission that
the respondent advances that it has at least an additional purpose of
addressing such situations. Nothing in clause 7.2.4 or in its context suggests
that it has a double purpose. Clause 7.2.4 was clearly directed to situations
of no net positive return on sale of all investments. Had it been intended to
make the fundamental point that, if sale of all the investments was not completed,
then, whatever the net profitability of the Partnership,
the whole benefit was
to go to the Principal Limited
Partner,
with the Special Limited
Partners
getting nothing, one can be confident that this fundamental additional purpose
would have been made clear.
d.
This is reinforced by the consideration that, since it was contemplated
that clauses 7.2.3 and 7.2.4 could operate in a situation where not all
Partnership
investments had been sold if the
Partners
so agreed (para 24.1
above), clause 7.2.4 cannot have been intended to be triggered by such a
situation, or it would undermine the provision for, and any purpose in, such an
agreement between
Partners.
e.
In my opinion, both on its natural reading and in the light of the
above, clause 7.2.4 is a provision subsidiary to clause 7.2.1 which, like
clauses 7.2.2 and 7.2.3, only operates when there has been a sale of all
Investments, whatever that may mean in context either during or at the end of
the life of the Partnership.
f.
If this is so, then on the respondent’s case that “sale of all
Investments” is to be read in a narrow legal sense, no distributions at all to
anyone are possible, since no such sale has occurred. But that in my view
brings one full circle to the conclusion that clause 7.2.4 is simply addressing
situations where the operation of clause 7.2 has been triggered, but there has
been no net positive Annual Rate of Return, either on all investments or on any
particular Strategy. It is not addressing situations where the operation of
clauses 7.2.1 to 7.2.3 has not been triggered.
g.
The conclusion from all the above points is that sale of all Investments
of the Partnership
must in the context of clause 7.2.4 be given an umbrella
meaning covering all types of realisation of the
Partnership
Investments –
though not, save on termination and liquidation, any distribution in specie (to
which I turn in the next paragraph).
25. As to the points identified in paras 22.3 and 22.4 above:
25.1 The respondent’s
reliance on the phrase “at the end of the term of the Partnership”
in clause
8.2.1 to exclude from consideration under clauses 7.2 and 8.1 all that happens
thereafter by way of sale of investments (in whatever sense the word “sale” is
used) involves a literalism which I am unable to accept. Once it is accepted, as
Lord Sumption accepts, that clause 8.2.1 prescribes that distributions are to
be made at or after the end of the
Partnership
term, and so during the course
of liquidation, it is natural that they should also be made by reference to
values
and priorities ascertained at the same time.
25.2 The phrase “at the
end of the term of the Partnership”
is coupled with the alternative “or at such
other time as may be agreed by the General
Partner
and the Limited
Partners”.
Again,
this is inconsistent with a literal reading according to which the parties
viewed
it as critical that entitlement to distribution under the waterfall in
clause 8.1 must have accrued by the end of the term of the
Partnership.
25.3 The provision in
clause 7.2 for allocations where all the Partnership
Investments are sold or
where the
Partners
agree must be read with the elaborate provisions in clauses
8.2.1, 8.6 and 11.5.4 for distributions when the
Partnership
has reached its
end at a Termination or Extended Termination Date and is being liquidated.
During the life of the
Partnership,
the only distributions capable of being
made under clause 8, referring back to the allocation provisions of clause 7.2,
are in cash. Clause 8.6 so provides (subject only to the possible impact of any
agreement under clause 8.2.2, which can for present purposes be left on one
side).
25.4 However, at the end
of the Partnership,
clauses 8.2.1, 8.6 and 11.5.4 all contemplate that the
waterfall in clause 8.1 (and so on their face the provisions of clauses 7.2.2
and 7.2.3) will be capable of operation in favour of the Special Limited
Partners
even though
Partnership
Investments remain unsold and have to be or
are distributed in specie. There is nothing to suggest that clauses 8.1(e) and
(f) are in this context irrelevant. In short, the scene changes at the end of
the
Partnership,
and distributions are now permissible in specie, although the
underlying scheme of profit sharing provided
via
clauses 8.1(e) and (f) by
reference to clauses 7.2.2 and 7.2.3 remains applicable. It follows that
clauses 7.2.2 and 7.2.3 must be read as prescribing profit sharing on a basis
which does not require all or any of the
Partnership
Investments to have been
sold or realised for monetary consideration in any way.
25.5 These elaborate provisions,
for distribution in specie after termination and in liquidation, are coupled
with clause 7.3.8 (para 19.20 above) providing for assets distributed in specie
to be “deemed to be realised” for the purposes of computing Capital Gains,
Capital Losses and Capital Proceeds at “their Value”.
The significance which
the respondent tries to attach to this provision is that it would be relevant
to final accounting under clauses 6 and 12 and in particular to determining
what would constitute repayment to the Special Limited
Partners
of any
outstanding management fee due to the General
Partner
or any outstanding
Capital Contributions due to any of the Limited
Partners
under clauses 8.1(c)
or (d).
25.6 That is to my mind an
implausibly limited explanation of clause 7.3.8, not least when management fees
were payable to the General Partner
in advance in quarterly instalments and
were a first deduction against Net Income (clauses 7.1.3 and 7.1.5(a)) and the
Special Limited
Partners’
Capital Contributions amounted to US$100 each:
25.6.1 Clause 7.3.8 is an integral part of clause 7.3. Clause 7.3 is entitled “Calculation of Income, Gains and Annual Rate of Return” and its provisions address in detail the calculation of the “Net Income, Net Losses, Capital Gains and Capital Losses” and the “Annual Rate of Return” which are themselves integral to clause 7.2.
25.6.2 Clause 7.3.8
appears in the middle of clause 7.3 between provisions of general application
regarding the calculation of Acquisition Costs and Annual Rate of Return: see
clauses 7.3.6 to 7.3.10. Clause 7.3.7 concerns the determination of Annual Rate
of Return at the time of sale of an Investment. Clause 7.3.8 is a parallel
provision designed to equate a distribution in specie upon liquidation with a
realisation by way of sale “for the purposes of computing Capital Gains,
Capital Losses and Capital Proceeds at their Value”.
For good measure, “Capital
Proceeds” is, as noted (para 19.20 above), also defined in general terms to
cover “the
Value
of … Investments distributed in kind”.
25.6.3 Clause 7.3.8
refers expressly to distributions in specie under clause 8.6. Clause 8.6 is
another provision of general application and deals in terms with “all”
distributions under clause 8, by providing first that these must be in cash prior
to final liquidation of the Partnership,
but may be in the form of
non-marketable securities, ie in specie, thereafter.
25.6.4 The use in clause 7.3.8 of the word “realised” to my mind confirms rather than undermines the proposition that sale should be understood in a broad sense, capable in liquidation of embracing a distribution in specie.
25.7 The respondent’s case effectively deprives clauses 8.1(e) and (f) of any relevance on a distribution following termination. Nothing in the articles hints at this.
25.8 Further, accepting,
as I do, that clause 8.2.1 must be read with clause 11.5.4, so that clauses
8.1(e) and (f) which in turn refer to clauses 7.2.2 and 7.2.3, contemplate
allocations and distributions by reference to sales taking place during the
process of liquidating the Partnership
assets, nothing in these clauses hints
at a continuing distinction between sales in a strict legal sense and
distributions in specie. On the contrary, distribution in specie is introduced
in bland terms as a right available to the General
Partner
on a final
liquidation (clauses 8.6 and 11.5.4). Why the General
Partner
would want or
ever dream of exercising the right when its exercise would, on the respondent’s
case, be fatal to its employees receiving their intended profit share is wholly
unexplained.
26.
It is in my view,
therefore, clear that the Special Limited
Partners
were intended to receive profit shares totalling 30% of any Annual Rate of
Return on termination of the
Partnership
and liquidation of its assets calculated
under clauses 8.1(e) and (f) by reference to clauses 7.2.2 and 7.2.3, even
though not all the
Partnership
assets were sold in a strict legal sense or
realised at all and some or all were as a result distributed in specie. I would
have humbly advised Her Majesty to allow this appeal accordingly and restore
the judgment given by Bannister J at first instance in favour of the two
Special Limited
Partners.