Collins Hill Group Pty Ltd v Trollope Silverwood and Beck Pty Ltd
[2002] VSCA 205
•13 December 2002
SUPREME COURT OF VICTORIA
COURT OF APPEAL
No. 7914 of 2000
No. 7924 of 2000
| THE COLLINS HILL GROUP PTY. LTD. | |
| Appellant | |
| v. | |
| TROLLOPE SILVERWOOD & BECK | Respondent |
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JUDGES: | ORMISTON, CHARLES and BATT, JJ.A. | |
WHERE HELD: | MELBOURNE | |
DATE OF HEARING: | 30 July 2002 | |
DATE OF JUDGMENT: | 13 December 2002 | |
MEDIUM NEUTRAL CITATION: | [2002] VSCA 205 | |
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CONTRACT – Interpretation – Informally drawn commercial agreement – Percentage fee for management consultancy – Meaning of “increase in … profit” and “increase in … profitability” comparing two financial years – Loss of $1.55m. in first year – Whether reduction in loss to be taken into account or whether confined to actual profit – Provision for agreement “on the basis for our further involvement” in later year – Whether such agreement necessary to entitlement to recover fee based on increase in profit for that later year.
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| APPEARANCES: | Counsel | Solicitors |
| For the Appellant | Mr B.E. Walters, Q.C. and | Norton Gledhill |
| For the Respondent | Mr R.C. McCaw, Q.C. and Mr A.T. Kincaid | Arnold Bloch Liebler |
ORMISTON, J.A.:
This appeal raises again issues as to the proper interpretation of informally drawn commercial agreements and the evidence, if any, relevant to that process of interpretation. The primary issue on the appeal is the meaning of the expression “pre-tax profit” in circumstances where the clause in question required a comparison between the pre-tax profit of one year and that of the next. There was no dispute that under the relevant clause the appellant was entitled to 5% of that difference by way of an “incentive” fee. But the difficulty which arose was that in the first year there had in fact been a loss of $1,552,686, so that the issue presently is whether that loss should be taken into account in making the necessary “comparison” in ascertaining the base figure from which to calculate the 5% fee. The appellant was successful in the County Court only to the extent of obtaining a fee of 5% of the actual pre-tax profit in the second year of $350,867[1], leading to an entitlement under that clause (clause (iii) ) of $17,543.33. In essence, therefore, the learned judge had taken a nil figure as the pre-tax profit for the preceding year, in accordance with what he said was the proper construction of that clause of the agreement. The appellant contends, however, that the proper basis for the calculation should be $1,888,270, by taking into account the preceding year’s loss, upon an interpretation of the relevant words as effectively requiring a comparison of the “bottom line” results in each year.
[1]This was accepted by the parties at the trial and on this appeal, although the claim had been based on a profit of $335,584.
The cross-appeal has been brought by the respondent in relation to a similar calculation which the appellant successfully claimed should be made in relation to the following year (i.e. the third year) pursuant to clause (iv) of the agreement, there being an increase in profit in each of the relevant years for this purpose. The respondent, on the other hand, contended that that calculation was not an agreed part of the original arrangement in that it says that, on its proper interpretation, the clause did not represent the final agreement of the parties which was said to have been a matter for further agreement upon a consideration of the whole of the terms of the document.
The relevant agreement appeared in a letter dated 31 July 1997 from the appellant, a management consultant, to the respondent, a company involved in the design, manufacture and construction of retail and commercial interiors, which confirmed the letter by countersigning it at its foot. One might have hoped that it would have been sufficient to refer only to the terms of this letter but, as is customary, a good deal more of what was admitted in evidence was relied upon as affecting its interpretation. Nevertheless it is first necessary to set out the substantive part of that letter in full:
“Further to our letter of July 4 and subsequent discussions, I am writing to confirm our agreement in relation to professional fees, which is as follows:
(i)We will work with you on a flexible basis until June 1998, with the goals of substantially lifting current profitability, laying the foundation for sustained revenue growth, and putting in place an appropriate funding structure for the business. The work program will include regular meetings (initially weekly), and work on specific initiatives to achieve agreed goals. The work will be performed by Nigel Hannam and myself, and I will guide the whole process in conjunction with you. In June 1998, we will agree on the basis for our further involvement in 1998/99.
(ii)We will invoice you progressively, on a monthly basis, for amounts equivalent to 33% of the costs that we incur based on time involved at our standard chargeout rates (Christopher Tipler $500 per hour, Nigel Hannam $400 per hour, Analyst $150 per hour). The first invoice will be issued today, covering time expended in June and July. TS&B will pay these accounts within 30 days of receipt of invoice.
(iii)In September 1998, Collins Hill will invoice you for an amount equivalent to 5% of the increase in TS&B’s pre-tax profit for the year ended June 1998, in comparison with the year ended June 1997. Profit will be determined in accordance with your normal accounting standards and will be an audited result. The time-based fees invoiced during 1997/98 will be fully rebated in the event that the profit-based fee is more than six times the total time-based fees (eg, if total time-based fees for the year are, say, $60,000, then the profit-based fee would need to be a minimum of $360,000 before the $60,000 would be rebated). The net invoice (profit-based fee less any rebate) will also be paid within 30 days of receipt.
(iv)In September 1999, Collins Hill would invoice you for an amount equivalent to 5% of the increase in pre-tax profitability in the 1998/1999 year relative to the previous year. A rebate arrangement similar to that outlined above would also apply. Again, this invoice will be paid within 30 days of receipt.
I would appreciate it if you would sign and return the attached duplicate of this letter in confirmation of our agreement.”
As I have said it is also necessary to have regard, for the purpose of considering the argument, to some at least of the copious evidence called in relation to the issues raised, which included evidence of not merely what preceded the making of the contract but also, more controversially, as to what had occurred subsequently. I shall not recount all of that evidence, although it will be necessary to return to some of it in order to discuss the arguments put forward.
It was some time in or about April 1997 that the respondent, through its managing director Mr Trollope, commenced to seek advice from the appellant, a professional provider of management and consulting services to businesses. It seems that the respondent had had a history of financial difficulties and was at the time under financial pressure from its bank. By the end of that financial year (30 June 1997) it had made a loss for the year of some $1,552,686, but the extent to which this was known to the appellant during the period of the negotiations is not so clear. Certainly in its first written response to the respondent’s original request, the appellant stated in a detailed letter dated 22 April 1997 that its understanding was that “after a long and difficult period in which your company came under enormous pressure financially, you have now managed to achieve a modest level of profitability ...”. There were, however, passages in the evidence which suggested that the respondent had put forward a somewhat less optimistic assessment of its position at the time.[2]
[2]See para.[10] below.
As the letter of 31 July 1997 says relatively little about the nature of the work to be performed by the appellant and because it is asserted, at least by the appellant, that there is ambiguity in the terms of the letter, it is desirable to say something more about the nature of the work discussed and promised before that time. Largely the matter at that time was discussed in generalities but, because the respondent was under financial pressure, especially from its bank, there was an immediate need to satisfy the bank’s demands by improving its profitability, which in the first place had to be worked out on a short term basis, and there was also a need in the medium and long term for a plan to deal with “strategic” and organisational issues. The respondent employed a considerable number of people, many of whom were engaged in the manufacture of the company’s products in a factory at Clayton. The appellant’s managing director Mr Tipler said there would be a need to work on a fairly intensive basis for some three or four months and then it expected to work on a somewhat different basis with less intensive activity in providing advice and some supervision in the carrying out of the strategic plan. The letter of 31 July 1997 referred back to an earlier letter of 4 July of that year, upon which the respondent particular placed particular weight, but it contained a somewhat more comprehensive statement of the appellant’s obligations, at least as they were perceived at that time:
“First, I will comment on the nature of the advisory process that is likely to ensue over coming months. I think it is most likely that we will work in a collaborative manner with you and your team on the development of a management agenda aimed at driving costs down and revenue up. We have clearly started the process with Shelving, and I think over the next few weeks a clear plan of attack will emerge here for enhanced profitability and growth. We need to do the same for the Interiors and Panel fold businesses. As we work on these individual agendas, the need for work on specific matters will almost certainly arise … There is also clearly the matter of funding, which will need to be addressed over the next few weeks as our understanding of the task in front of us improves. Ultimately, I think that we will be involved in assisting you with some sort of refinancing initiative, as yet undefined.”
There was, therefore, an element of uncertainty as to the extent to which the appellant would provide its advisory services once the short term and medium term plans had been worked out, a process which was not expected to take much more than a few months, although that was by no means certain at that stage. It seems from the discussions that the later assistance to be provided by the appellant might run for a year or more but that was not yet known and would depend upon the nature of the advice yet to be given.
From this it seems that the proposal involved work by the appellant at a senior executive level for which it wished to be remunerated on an hourly chargeout basis but the respondent was unwilling to agree to that because of its presently precarious financial position. Somewhere between April and July 1997 it was proposed and then accepted that the appellant would charge only a proportion of its chargeout fees but in return would obtain a form of contingency or “success” fee based, in general terms, on increased profitability. It seems that in the course of discussion it was at least suggested that that calculation of increased profit might well be extended over a two-year period because of the unlikelihood that there would be sufficient profit in the first 12 months to produce an adequate return on that basis.
Even before agreement was reached the appellant commenced work in the latter part of May and into June on some of the advisory work and produced a 12-page document analysing in broad terms the issues which it intended to address by setting out in dot point form particular issues, such as the respondent’s markets, the focus of its business, corporate finances, staffing and particular aspects of its business, such as joinery, metal shelving, commercial interiors and panel fold which might need to be restructured, together with a summary of the figures based on those of previous years and the existing budget.
The significance of the negotiations, in law and in fact, must be considered later, but by 4 July, in the letter to which I have already referred, the structure of the fees was advanced sufficiently for it to be proposed by the appellant in writing. As the appellant relied upon it I shall set out the balance of that letter here, without accepting that it necessarily provides guidance in the interpretation of the criticial letter of 31 July 1997. The 4 July letter had begun by observing that they had commenced working together and that the appellant was writing on the subject of its professional fees with the object of reaching agreement on the basis for proceeding further. After the paragraph already set out[3] dealing with the nature of the work the letter continued:
[3]See para.[6].
“With respect to our fees, our conversations in May centred on a basis which included some very small payments to cover part of our costs, and a success fee geared to profit improvement. I spoke in terms of Collins Hill receiving 10% of the increase in TSB’s profitability over a two year period from July 1 (based on the final accounts for 1996-97). I still think that some sort of structure of this sort is appropriate, given that we will have to expend a lot of relatively high cost time and effort on your behalf, and given your inability to pay normal consulting fees. Realistically, however, I think it can be argued that you have already laid the foundation for some improvement in profitability, to which I think we will add significantly. In this light, I propose the following arrangement:
(i)We will commit to work with you on a flexible basis until June 1998, with the goals of substantially lifting current profitability, laying the foundation for sustained revenue growth, and putting in place an appropriate funding structure for the business.
(ii)We will invoice you progressively, on a monthly basis for amounts equivalent to 33% of the cost that we incur based on time involved at our standard chargeout rates. TSB will pay these accounts within 30 days of receipt of invoice.
(iii)In August 1998, Collins Hill will invoice you for an amount equivalent to 5% of the increase in TSB’s pre-tax profit for the year ended June 1998, in comparison with the year ended June 1997. I understand that there will need to be some give and take in the determination of final results, but presumably the accounting standards that you have applied in recent years would continue to apply, and the accounts would be audited. This invoice would also be paid within 30 days of receipt.
(iv)In August 1999 Collins Hill will invoice you for an amount equivalent to 5% of the increase in pre-tax profitability for the 1998-1999 year relative to the previous year. Again this invoice would be paid within 30 days of receipt.
Barry, for our part this arrangement will provide us with some incentive to assist you on a continuing basis to realise the potential of the business. In June 1998 we can agree on the extent to which our further involvement is necessary.
I look forward to your response to the above proposal.”
Clearly there were further negotiations before the letter of 31 July was sent.
Some weight was also placed by the respondent in particular on the extent to which the company was or was believed to be profitable at the time the contract was entered into. Objectively, when the accounts were completed for the year, there was no doubt that a very substantial loss had been incurred. However, at an earlier stage, perhaps because of the absence of conclusive figures, the appellant had been led to believe, particularly as reflected in the letter dated 22 April 1997, that the respondent had by that time achieved “a modest level of profitability and there appear to be some good prospects for revenue growth”, a belief which seems to have been reflected in the letter set out in the last paragraph. Mr Tipler on behalf of the appellant also said, however, that by the end of the financial year the respondent clearly was going to make a loss and he described the company as one “in such poor condition” as he had seldom previously come across in his experience. So he understood the profitability was on a month to month, rather than a yearly basis at that stage. Evidence from Mr Francis of the respondent confirmed the generally poor condition of its finances inasmuch as he said that the bank had been threatening to put them into receivership and the company was “in an extremely parlous state”.
In accordance with the agreement the appellant gave advice and performed related work directed to the structure and financial improvement of the respondent over the succeeding months. It was billed, as agreed, upon the basis of one-third of the appellant’s customary chargeout rates, for which invoices were sent each month. The amount of work performed varied from month to month although it is fair to say that more work was done in the first few months, as was expected. Thus bills for $12,600 and $10,541 were sent for July and August 1997, but for the next two months bills were sent for approximately $4,000 or $5,000 and thereafter bills between $2,000 and $3,000 were sent until February 1998, with a thousand dollars or less billed for the last two months which appear to have been April and May 1998. These bills for the most part were not paid for some time after they were sent. Of course, it was not possible to make the calculation with respect to the “pre-tax profit” for the year ended June 1998 until those accounts were prepared. In fact, by January 1999 only unaudited accounts had been prepared and forwarded in that month by the solicitors for the respondent. An invoice was sent on 19 February 1999 pursuant to the third clause of the agreement. The precise calculations were not set out but the amount billed, namely $94,413.50, was clearly enough calculated on a basis of the difference between the loss suffered in the previous year, that is to 30 June 1997, and the pre-tax profit made to 30 June 1998 which amounted to only $350,867. As I understand it there were no sums to be rebated in those circumstances under clause (iii).
In the following year, 1998-1999, no further work seemed to be necessary or was requested of the appellant, so again no question of the rebate could have arisen. The respondent did not send any details of its accounts, but in early 1990 the appellant sent an invoice merely claiming 5% of the unspecified difference in profit between the two years in question, that is between the years ended 30 June 1998 and 30 June 1999. In that year there was in fact a far higher pre-tax profit of some $2,411,180. The respondent refused to pay either bill saying there was no obligation to pay anything in relation to the second year and saying that the sum in relation to the first year was excessive, the relevant comparison being between a pre-tax profit of nil for the year ended 30 June 1997 and the $350,867 in fact made by way of profit in the later year.
After a trial in the County Court the learned judge delivered a careful and well ordered judgment dealing with the arguments put before him by the parties. The first issue for his decision was whether the expression “pre-tax profit”, for the purpose of the comparison to be made under clause (iii) of the agreement, should be taken to mean the relevant profit in the strict sense or whether the parties intended a comparison to be made between the “bottom line” figures of the company in the two financial years. On this issue his Honour held that the expression meant what it said and that “profit” could not include loss. It was therefore inappropriate to make a calculation which used the previous loss as a means of calculating the difference between the profits in the respective years. As a result he held that the appellant was not entitled to the full sum it claimed for the first year but was entitled to 5% of the difference between nil and $350,867, being the figure ultimately agreed as being the correct pre-tax profit for that year, 5% of which amounted to $17,543.33. The second issue which the judge said he had to determine was whether there was any right in the plaintiff at all to make a claim in respect of the second year, the respondent contending that there was no concluded agreement in respect of the second year because of the use in clause (i) of the agreement of the expression “we will agree on the basis for our further involvement in 1998/99”. The respondent argued that, as there had not been any subsequent agreement for the appellant’s “further involvement” for the latter year, clause (iv) of the agreement had nothing on which to operate as there had yet to be a concluded agreement in respect of that year. His Honour, however, held, after considering in particular the letter of 4 July 1997, that clause (iv) was intended to operate in all circumstances, and, so it would seem, whether or not any further agreement for the performance of work in the later year had been reached pursuant to clause (i).
Proper construction of the agreement
There cannot be the slightest doubt that the informal agreement which the parties reached on or shortly after 31 July 1997 ought to be interpreted in a straightforward, common sense way and upon the basis that the letter of that date was neither drafted by lawyers nor intended to express with legal precision what the parties intended. Its language was not always carefully or consistently expressed, nor did it purport to do more than state in one business executive’s own language what he believed to be the arrangements between the parties. To pick on individual words or phrases and test their grammatical effect and their consistency is unfairly to subject the document to a process of construction which the parties neither desired nor expected. As stated in the letter it sought merely to “confirm” what had already been worked out and agreed over the preceding month. Doubtless it was intended to express their agreement in terms which might provide a record of what had been worked out, but it was expressed with that informality which one might expect in a letter dictated by a busy executive.
Moreover, although the parties concede on the pleadings that the agreement was constituted solely by the written terms of the letter, a brief perusal of it shows that much of the parties’ understanding was left unstated. In particular, the appellant’s own obligations were largely not spelled out. That need not, on reflection, seem surprising, for all the letter purported to set out was the parties’ “agreement in relation to professional fees”. So it is equally unsurprising that, for example, the precise “basis” for the “involvement” of the appellant was not fully described.
Two things may be said to flow from this.[4] The first is that the limited subject matter of the letter almost invites enquiry as to what the subject matter of the fees was intended to be, even if there may not be any ambiguity on the face of the agreement. This may well be a case where an ambiguity could be created by an understanding of circumstances outside the language of the parties’ agreement. In particular the sentence commencing “In June 1998 …” (in clause.(i)) referred to the “further” involvement of the appellant in the year commencing 1 July 1998, but it may not be easy to understand what sort of involvement was being described without a more comprehensive knowledge of the agreed involvement up to that time. Likewise in relation to clause (iv) the question of the application of the “success fee” in the second year must, at least in part, depend upon the nature and performance of the work for which that fee was intended to be part of the appellant’s remuneration.
[4]What follows is not intended to deny the operation of the “parol evidence” rule to a part of a contract if it is identifiably separate, but that is not this case: cf. Cheshire and Fifoot’s Law of Contract (8th Aust. ed.) para.10.4 fn.19 and Carter on Contract (2002) para.13-030 fn.6.
The second matter which may be said to flow from the informal nature of the agreement is the approach the Court should take to arguments based on the grammatical form of the letter and on the precise meaning of words used in it. Two particular matters were raised in argument, the first being the apparently erratic use of the words “will” and “would” throughout the letter. The respondent, in particular, placed reliance on the use of the word “would” in clause (iv), at least in the first two sentences.[5] Thus it contended that “would” connoted that there was as yet no agreement as to the payment of a success fee in the second year, so that it was dependent upon the reaching of further agreement as to future involvement by the appellant before that fee became payable. Secondly, both parties made use of the contrast between the word “profit” in clause (iii) and the word “profitability” appearing in clause (iv). “Profitability”, which also appears in clause (i), was said to comprehend a calculation based on the extent of both profit and loss, so leaving open the argument as to whether a mere reduction in losses in one or both years would be sufficient to attract the “success fee” under either of the clauses. The precise significance of this must be discussed later.
[5]Though it may be noticed that the word “will” appears in the final sentence of that clause.
What other matters should be taken into account in ascertaining the proper construction of a document such as the letter dated 31 July 1997? As I have already said, this is pre-eminently a case where the document in question must be read as written by and devised for persons engaged in business and in accordance with a practical, common sense approach. This is not a case where a commercial document has been drafted by lawyers where one is unsure to what extent one can look behind the language for the business object sought to be achieved by the parties. Nor is it a case where the parties, or one of them, chose to ask their legal advisers to produce a document which conformed with the commercial purpose of one or both of those parties. It is therefore unnecessary to examine the authorities on the “commercial” interpretation of documents of that kind.[6] Here the language, for better or worse, is that of a businessman seeking to put on paper that which he has agreed with his opposite number. There can be no other way of reading the document except as one intended in broad terms to achieve the business purposes of both parties. It must not be forgotten, nevertheless, that in those circumstances one ought ordinarily to assume it was the product of some give and take in the course of negotiations over some time, where it was not unlikely that one party or the other may have conceded some term or other which originally it would have preferred to avoid.
[6]See, generally, e.g., the cases discussed in Lewison on The Interpretation of Contracts, 2nd ed., paras.1.06-1.07 and in Australia, e.g., Upper Hunter C.D.C. v. Australian Chilling and Freezing Co. Ltd. (1968) 118 C.L.R. 429 at 437; Schenker & Co. (Aust.) Pty. Ltd. v. Maplas Equipment & Services Pty. Ltd. [1990] V.R. 834; Murray Goulburn Co-op. Ltd. v. Cobram Laundry Service Pty. Ltd. [2001] VSCA 57. Cf. Maggbury Pty. Ltd. v. Hafele Australia Pty. Ltd. (2001) 76 A.L.J.R. 246; 185 A.L.R. 152; [2001] H.C.A. 70 at [11], [44] per Gleeson, C.J., Gummow and Hayne, JJ.
Finally, so far as these general observations are concerned, in part for reasons already stated, this seems to be an agreement where it is necessary to look beyond its terms to the course of negotiations, so far as that is permitted by law.[7] Apart from the limited nature of its subject matter, namely the fee base for the appellant’s remuneration, there are several examples of ambiguity of a kind justifying resort to extrinsic information. By way of example one may take both the sentence referring to possible agreement on the basis for future involvement and the use of the words “profit” and “profitability”.
[7]See, esp. Codelfa Construction Pty. Ltd. v. State Rail Authority of N.S.W. (1982) 149 C.L.R. 337 and cf. the discussion in para.[27] below. See now (after argument was completed) the detailed and helpful examinations of authority in the 8th Australian edition of Cheshire and Fifoot’s Law of Contract paras.10.4-10.16 and Chapter 13 (paras.13-001 to 13-180) of Carter on Contract (2002), esp. paras.13-090 and 13-120.
In turning to the specific issues raised by appeal and cross-appeal, it appears preferable to deal with the cross-appeal first, whereby the respondent, as defendant, seeks to reduce the judgment given in favour of the appellant by saying that the appellant was not entitled to recover any percentage of the increase in profit in the second year, effectively denying clause (iv) any operation in the circumstances of the case. If the respondent be correct in that matter, then it might be preferable to treat that clause as largely irrelevant to the issues raised on the appeal, for on that view clause (iv) would merely presage what might have been agreed for a second year of operation of the agreement. I shall therefore deal with that question first, before turning to the issue generally raised by the appellant as to whether the word “profit” was wide enough to include the extent to which the respondent’s earlier losses were diminished.
Cross-appeal – Whether agreement comprehended second year
The respondent by its cross-appeal seeks to confine the success fee to the increase in profit for the first year of operation under the appellant’s advice, that is for the year 1997-1998. In essence it contends that the parties had not agreed on any “further involvement” by the appellant during the following year 1998-1999, because (a) the relevant last sentence in clause (i)[8] clearly shows that at the time that involvement had yet to be agreed and that there was in fact no later agreement; and (b) clause (iv) was expressed in the subjunctive mood by the parties’ use of the word “would”, which was expressed in that way only on the hypothesis that agreement might, but not necessarily would, be later reached as to the appellant’s future involvement.
[8]I.e. the sentence which read: “In June 1998, we will agree on the basis for our further involvement in 1998-99.”
I cannot accept this, apparently strict, construction of the clauses, in part because the later clause does not necessarily bear such a limited meaning if one merely compares it with the earlier sentence, and in part because the inherent ambiguity created requires some understanding of the relationship between the parties and, also arguably, of their negotiations, which point to no such conclusion.
As to the first point, it is difficult to see why clause (iv) was included at all if all remuneration arising in respect of the year 1998-1999 was yet to be agreed. Clearly enough the sentence in clause (i) (“In June 1998 we will agree …”) leaves open the possibility of an agreement by the parties in the future as to the extent the appellant would be involved in the latter year and the “basis” of that involvement. That might, on one view, have led to a reconsideration of the profit element, though that seems unlikely having regard to the actual terms of the letter, but there seems (on that hypothesis) to have been little reason to have fixed the profit element and the rebate arrangement in advance if the whole question of the appellant’s involvement and remuneration for the later year was yet to be worked out and agreed.
It is preferable to see the last sentence of clause (i) and the appellant’s possible involvement, therefore, in the context of the rest of the clause: the “involvement” is part of work carried out on a “flexible basis”: the work has no fixed outcomes (except “profit”): it has no fixed timetable. The work is expected to proceed to “June 1998”, but it is possible that it will extend beyond that month into the following year. As one might expect from those engaged in quasi-professional work of an advisory kind, the appellant could sensibly have preferred to wait until the following year, or just before, because its chargeout rates in the market might well have increased from those stipulated in clause (ii) and the parties might even have thought that the percentage of those fees to be paid in the second year should be increased. That is all the sentence intended, namely, (i) that it was uncertain and only a possibility that further work would be required of the appellant and (ii) that that work might be performed at different rates.
In consequence, on its face clause (iv) could have some independent operation regardless of agreement as to the appellant’s “further involvement” in the later year. Moreover it made business sense to provide for some additional element of profit from the second year of operation once the “appropriate funding structure for the business” had been “[put]” in place, as clause (i) recited. What was being sought was advice leading to a programme or plan intended to lift profitability and provide a “foundation for sustained revenue growth” by the respondent in the future. Clause (i) contemplated that work would be performed through to June 1998, though obviously enough how much work would be concentrated in the first few months after 31 July 1997 and how much would be needed towards the end of the financial year was not yet known and so was not prescribed by the terms of the letter. One has only to try to predict realistically how the performance of the appellant’s obligations might operate on the business itself to see that the chances of a large turnaround in the first few months, even in the latter months of the year, would not obviously be great, so that the “success fee” would have a relatively limited chance of application, limited to the extent that the respondent’s business could produce increased profits within eleven months from the making of the agreement. After all a comparison had to be made with the “profit” (or “profitability”) of the respondent for the whole of the financial year to 30 June 1998. Much of that time, even on a simple reading of the terms of the letter, might well be expected to have been spent unprofitably or at least without any significant increase in profit. On the other hand, the figures for the succeeding year, 1998-1999, would be far more likely to reflect the success or otherwise of the appellant’s advice and reforms. There would therefore seem to have been strong grounds for thinking that, as part of the business proposal, the respondent was agreeing to a second year being used also as a measure of the “success fee”. If one ignores the use of the word “would” and treats it as the equivalent of “will”, the clause can operate sensibly and without difficulty. The rebate might not apply (though that would reduce the fee), but the application of that provision would not become relevant if all necessary work had been completed within the first year.
If these conclusions seem to read too much into the actual language adopted by the parties as to the nature of their agreement, then they become much more obvious and realistic, in my opinion, if one is permitted to have regard to the commercial background to their arrangement. The right to look beyond the four corners of the agreement to its matrix ordinarily depends on detecting some ambiguity in the way the parties have expressed their agreement, but it is arguable that, where a contract is only in part constituted in writing, one can look generally at the surrounding circumstances and background to the parties’ agreement in order to construe the written part of that agreement. It is not necessary here to express any conclusion, although, but for the parties’ concession on the pleadings, there would be strong grounds for saying that the letter of 31 July 1997 was confined to that part of the agreement prescribing the fees to be paid for the appellant’s work and some incidental matters.
Here, however, the language of the last sentence in clause (i) certainly gives rise to a sufficient element of uncertainty and ambiguity, especially in so far as it relates to the provisions contained in clause (iv), so as to bring into play the principle in Codelfa. The right to have recourse to the matrix, the commercial background surrounding the parties’ relationship, is perhaps most succinctly and recently expressed in the judgment of the majority of the High Court in Royal Botanic Gardens and Domain Trust v. South Sydney City Council[9], where it was said[10] that, “if the language be ambiguous or susceptible of more than one meaning”, “it is appropriate to have regard to more than internal linguistic considerations and to consider the circumstances with reference to which the words in question were used and, from those circumstances, to discern the objective which the parties had in view.” As they continued[11]:
“In particular, an appreciation of the commercial purpose of the contract:
‘… presupposes knowledge of the genesis of the transaction, the background, the context, the market in which the parties are operating.’”
[9](2002) 186 A.L.R. 289; [2002] H.C.A. 5.
[10]At paras.[9] and [10] per Gleeson, C.J., Gaudron, McHugh, Gummow and Hayne, JJ.
[11]Ibid, citing Reardon Smith Line Ltd. v. Yngvar Hansen-Tangen [1976] 1 W.L.R. 989 at 995-996.
There cannot be any real doubt that the contract in this respect, without having regard to the nature of the work to be performed and the manner in which it was to be performed by the appellant, was ambiguous. It certainly said that one part of it was yet to be agreed. In another clause, despite that apparent limitation, it said that the appellant was entitled to a payment by way of a second success fee, based on the respondent’s results in the later period. If the respondent be correct as to the clear meaning of the sentence in clause (i) upon which it relies, that merely emphasises the ambiguity created by the inclusion of clause (iv). Even if one were to suggest that it seemed that that clause was inoperative in the circumstances, its very inclusion must create an element of ambiguity of the kind which would entitle the Court to look outside it for some further explanation. One might add, though it was not contended by the respondent, that a clear lack of agreement as to further involvement in 1998-99 might have evidenced a failure to agree as to the whole of the contract, unless one were to take the agreement as operating but for one year (11 months to be precise) and the words in the last sentence of clause (i) were to be treated as merely precatory or indicative of the parties’ desire to consider the possible future performance of work by the appellant for the respondent. I would not agree with such a conclusion and would maintain that in business agreements the parties are entitled to leave matters of detail, not essential to their fundamental contractual arrangements, to be worked out subsequently.
In the present case knowledge of the background, of the negotiations and of the way the appellant ordinarily did business and proposed that here it should do business, all make clear why that final sentence in clause (i) should be given a restricted meaning and clause (iv) should be treated as operating regardless of the later reaching of any agreement with respect to the year 1998-99 as to the appellant’s “further involvement”. What the appellant offered to do and agreed to do in this case was quite simple, albeit that it required some sophisticated understanding of accounting and business practices for it to be carried out. What was expected of the appellant was not mere accounting work nor the work of a mere subcontractor; its agreed function was to advise and to put forward a plan which would produce a desired result, being the financial turnaround of the respondent and the setting up of a structure for sustained revenue growth. If the respondent had known what had to be done, then there would have been little point in engaging the appellant in the first place.
What was required by way of advice and then in the form of a plan or business structure depended in part on what the appellant could itself discover about the respondent’s then weaknesses and on how it thought best to produce long term improvements. How long this would take was uncertain: indeed in the early stages the appellant was suggesting that it might be concluded within two or three months. Clearly enough at the outset the appellant would have preferred the respondent to pay its normal consulting fees calculated on a hourly chargeout basis. The “success fee” was part of a compromise whereby the appellant accepted only a third of its ordinary time-based fees in return for a result-based fee. Success was in substance to be an increase in profit, whatever that properly meant. It also seems clear from the negotiations that the time the appellant would have to be involved for this purpose could turn out to be somewhat longer than the parties originally anticipated, but in broad terms it seems that neither party expected that much work would remain to be done by the end of the financial year ending 30 June 1998. By then most of the advice would have been given and some plan or plans to achieve the respondent’s required ends ought to have been set in place, indeed, set in place a considerable time before the end of the year.
There was, because of the uncertainty surrounding the respondent’s financial position and what was required to remedy it, the possibility that some work would have to be done into the following financial year. That is all that the expression “further involvement” connoted, namely there might be a need to carry into the following year some of the work which the appellant was carrying out so as to bring it to completion or to provide some supervision and advice in relation to the implementation of any proposed plan. That was uncertain and that was what they might have to agree upon in June 1998, but, having regard to the whole of the history of the parties, it was not seen as very likely that there would be a long term continuing relationship for the provision of the appellant’s advisory services. The last sentence of clause (i) simply left open the possibility that some further work might have to be carried out in the following year and that the parties would then have to agree on the basis for that involvement, not as a new project, but as the completion of the original one.
In those circumstances it is highly unlikely that the “success fee” for 1998-1999 would be tied to the carrying out of work in that particular year. It should be seen as being all along, though with some hesitation on the part of the respondent, a satisfactory basis for calculating a fee based on the increased profit which would be generated, so it was hoped, by the appellant’s advice and plans. In fact the very uncertainty as to when the project would be completed and the fact that the parties left open the possibility that work might have to continue into a second year meant that it was more likely, rather than less likely, that the success fee would have to be calculated over two years rather than only in respect of the first year, when the effect of the appellant’s work might not by then have produced any significant increase in the respondent’s profits.
Upon a consideration of the whole of the evidence which was relevant for this purpose, I would conclude therefore that clause (iv) was intended to operate whether or not the parties agreed upon any “further involvement” by the appellant performing additional work in the year 1998-1999.
A complaint was made specifically that the learned judge placed too much reliance upon one of the earlier letters and in particular on what was said in the third paragraph of the letter of 4 July 1997 (which is the first paragraph of the passage from the letter quoted in paragraph [9] above). His Honour was criticised on the ground that undue reliance was placed on the reference to the two year period for recovery of the success fee based on profit, there suggested to be 10%.[12] The respondent’s managing director had said that he rejected that proposal, but the judge expressed doubt as to whether he should be believed on that subject, in particular pointing out that essentially the format of the proposed agreement and the agreement of 31 July were the same and each included, though in a slightly different position a reference to possible agreement in June 1998 to the appellant’s “further involvement”. There seems to me, therefore, to be nothing misconceived or casual about the insertion of clause (iv). Its obvious purpose was to ensure the potential recovery of a profit-based fee over a longer period than the first year when effectively the appellant was beginning its work. I can see no error in the judge’s conclusion that clause (iv) operated whether or not the parties found it necessary for the appellant to be involved in further advisory work into the year 1998-1999.
[12]Though, as may be seen, 5% was proposed in the letter in respect of the profit for each of the years ended 30 June 1998 and 1999.
Appeal – Meaning of word “profit”
The issue raised on the appeal seems a comparatively simple one for it asks the question whether in the circumstances the word “profit” as appearing in the letter of 31 July 1997 comprehends only the profit made in each year by the respondent by taking the excess of relevant income over expenditure or whether it is wide enough to include any improvement in the “bottom line” result by way of a reduction in the overall loss of the company as revealed in its accounts for the relevant years. On its face, “profit” must mean profit in a real sense, not a mere diminution in loss. The judge pointed out, as might readily be appreciated, that the purpose of engaging the appellant was to take the company out of its parlous loss-making state and back into a profit-making venture. Mere reduction in losses would not have been sufficient in a practical sense, for the respondent would eventually have gone under if it had continued along that unfortunate track. What it wanted was profit and it was prepared to pay a percentage of that profit if that was effectively the outcome of the appellant’s work for it.
I confess I am greatly attracted by this argument, for it produces a simple answer and meaning to what appear to be simply expressed words. Moreover, it seems the answer that business executives would be attracted to, unless they gave the word some different meaning or had accepted in the course of their negotiations that it had such a different meaning.
As I understand the evidence there was nothing conclusive from what the parties said or wrote which would indicate that they gave the word “profit” a wider meaning so as to include reduction of losses. The only indicator of any different intention which the appellant could point to was the frequent use of the word “profitability”, as if it were a synonym for “profit”, in the course of their correspondence and discussions. The expression used in clause (iii), of course, was “the increase in … pre-tax profit for the year ended June 1998”, whereas in clause (iv) the expression used was “the increase in pre-tax profitability in the 1998/1999 year …”. Profitability was said to be a looser term connoting merely the difference between income and expenditure before tax. Doubtless, if I be correct about the cross-appeal, then the use of “profit” and “profitability” in the two success fee clauses applicable to each of the relevant years would demonstrate that the parties saw no real difference in the use of those words, although one may note that the reference to the relevant year is expressed in slightly different terms which makes each word rather more apt in its context. I shall, however, assume that the parties saw no real difference between the two terms. Moreover, in construing a document prepared by business executives it would not be desirable to fix too closely on the technical meaning of the word “profit” merely because in clause (iii) that was the preferred term.
The difficulty facing the appellant, nevertheless, is to persuade the Court that there is a significant difference in the two words such as to entitle the Court to reach the conclusion that the parties intended that a mere reduction in losses would justify the payment of the success fee. There were experts called on each side as to the meaning of the expression “in accounting terms”, but the judge was not persuaded by either of them that their technical approach was of great assistance, suggesting that the appellant’s expert had sought to interpret the contract as a whole rather than concentrating on the technical, accountancy meaning of the expression “pre-tax profit”. It seems the judge was more inclined to accept the evidence of the accountant called on behalf of the respondent who said that the expression “negative profit” was not customarily used in accounting circles.
In the end I do not think this is a matter to be resolved either by reference to expert opinion or by considering in detail dictionary definitions. I pause only to remark that the last quotation[13] appearing in the Oxford English Dictionary’s definition of “profitability” is one to the effect: “There is a direct connection between profitability and survival”. I rather think that that was the essence of the appellant’s task and the reason for the respondent engaging it.
[13]From a paper published in 1979.
The parties each asserted that the object of the arrangement would best be achieved if their construction was accepted. The appellant pointed to the risk that it was facing inasmuch as it was accepting one-third of its normal chargeout rates in return for the chance of obtaining 5% of the profit ultimately produced. It said that it would be hard on the appellant, if it produced a significant turnaround in the affairs of the respondent without actually producing a profit “above the line”, but it could not have the benefit of the success fee.
On the other hand the respondent said that it would be remarkable in the case of this company if a relatively small improvement in its pre-tax losses resulted in the earning of the success fee, say if those losses had been reduced only from $1.55 million to $1.05 million. Thereby as I see it, a success fee of some $25,000 would have been earned, on the appellant’s construction, and the company would still have been far short of recovery. It was said, of course, that the figures producing the losses were not precisely known to the parties at the time they entered into the agreement but I think the balance of the evidence suggested that it was well understood by the appellant that the respondent was in a “parlous” state.
Perhaps the interpretation of terms such as “profit” and “profitability” is not a matter about which one may be dogmatic, but my conclusion is that businessmen such as those engaged in these negotiations would not be greatly interested in variations in bottom-line figures so much as in a positive outcome which would preserve and strengthen the company. Whether one described the fee as a success fee or a contingency fee, normally those engaged in business, and most others for that matter, would see such a fee as being based on true success and for them that would connote a state of real profit, not reduction of loss. The fee would be earned by “winning”, not by making the losses less burdensome or more tolerable. In other words a fee of this kind would ordinarily be seen as coming from a surplus of income over expenditure, for that in effect would be the fund from which the fee could be taken without adding to expenditure. The company may not have been technically insolvent and there may have been ready moneys from which to pay the greatly reduced chargeout fees, but I doubt that the respondent, in particular, would have contemplated with equanimity the possibility of having to pay substantial additional fees while it was still “in the red”.
One may be strengthened in this conclusion by considering the outcome also on the cross-appeal, namely, that the right to obtain the success fee was to be gauged over two successive years. That would have given, and in fact did give, an opportunity for the appellant’s proposed reforms and plans to work and to produce the real profits which both parties hoped would result from the engagement of the appellant. Even though the first year might not produce much by way of profit (although in fact it did produce a small one), the appellant would retain the right to claim its fee based on the profit for the later year, when its planned reforms could be expected to be in place and producing results. That seems to be what these parties intended and hoped would happen.
I mention only one other matter, namely the appellant’s argument that the Court should take account of post-contractual conduct so as to persuade it that a different decision should be reached. A number of items were referred to and relied upon but essentially they all might be reduced to a series of references in the respondent’s books of account which included a debit for the higher figure based on the appellant’s claim including that for reduced losses. I am not persuaded that, where a claim for a specified sum has in fact been made, it is necessarily inappropriate to include that claim in a company’s books of account, but in any event it is not appropriate to allow evidence of this kind, at least as authority presently binds this Court. What has been said on a number of occasions in this State, and not seriously doubted by intermediate courts of appeal in other States, is that this evidence of later conduct is inadmissible for the purpose of interpreting a contract: see FAI Traders Insurance Co. Ltd. v. Savoy Plaza Pty. Ltd.[14] and Ryan v. Textile Clothing and Footwear Union of Australia[15]. This view seems largely now to be
accepted by the Court of Appeal in New South Wales: see Brambles Holdings Ltd. v. Bathurst City Council[16] and C.H. Magill v. National Australia Bank Ltd.[17]. The only qualification[18] I would place on this is that the rule is intended to apply to conduct which might otherwise have reflected an assumption or acceptance of a particular meaning of a term or terms of a contract; I would not see it necessarily as preventing the use of post-contractual conduct as a means of drawing inferences in the conventional way as to relevant circumstances existing before or at the time of the making of the contract.[19]
[14][1993] 2 V.R. 343.
[15][1996] 2 V.R. 235.
[16](2001) 53 N.S.W.L.R. 153 at 164 para.[26].
[17][2001] N.S.W.C.A. 221; (2001) Aust. Contract R. 90-131: at paras.[50]-[53].
[18]If so it can be described. It could only affect interpretation if the matrix is properly in issue.
[19]Cf. the 2nd and 3rd propositions in para.13-100 of Carter on Contract (2002) pp.30,145-30,146.
For these reasons I would dismiss both the appeal and the cross-appeal.
CHARLES, J.A.:
I have had the advantage of reading the reasons for judgment prepared by Ormiston, J.A. I agree with his Honour that the informal agreement, the substantive part of which is set out in paragraph [3] of his Honour’s reasons, must be interpreted in a straightforward and common sense way, and that the agreement left unstated much of the parties’ understanding. As his Honour says, the language is that of businessmen seeking to put on paper what had been agreed with an opposite number. I also agree, for the reasons given by Ormiston, J.A., that the cross-appeal should be dismissed.
I turn then to the appeal itself, as to the result of which I differ, with respect, from the other members of the Court. The trial judge took the view that there was no relevant ambiguity in the agreement, making it unnecessary for his Honour to consider any extrinsic evidence as an aid to interpretation. In the trial judge’s view, the expression “pre-tax profit” could not include a “loss” and his Honour added that he would not have been persuaded to a different view if he were to treat the appellant’s knowledge of the respondent’s projected loss in 1996-1997 as part of the factual matrix. His Honour said that he could see nothing odd in the notion that a management consultant would be rewarded by profit share if and only to the extent that its client company achieved profit in the year or years which followed.
I share, however, the view of Ormiston, J.A. that the agreement has several examples of ambiguity of a kind justifying resort to extrinsic information, to the extent that this is permitted by the cases, and for the reasons given by his Honour. I also agree that the correspondence between the parties shows that they saw no real difference in the use of the words “profit” and “profitability”. I only part from Ormiston, J.A., with great respect, on the question whether this interpretation entitles the Court to reach the conclusion that the parties intended that a mere reduction in losses would justify the payment of the success fee.
If one examines the Oxford English Dictionary definition of “profitability”, the expression “the capacity to make a profit” is included. While I agree that the matter is unlikely to be resolved by considering in detail dictionary definitions, it seems to me, having examined the correspondence between the parties and the informal agreement, that this is the sense in which it is likely the parties were using the word. The letter set out in paragraph [3] of the judgment of Ormiston, J.A. referred to the goal (as at 31 July 1997, the date of the letter) of “substantially lifting current profitability” and “putting in place an appropriate funding structure for the business”. As both parties were aware, the business had made a substantial loss before income tax for the year ended 30 June 1997 (even though the precise extent of that loss may not have been known at 31 July). The agreement contemplated a comparison, as the basis for calculation of the appellant’s success fee, namely “five per cent of the increase in TS & B’s pre-tax profit for the year ended June 1998, in comparison with the year ended June 1997.”
If the words “profit” and “profitability” meant, in context, the same to the parties, a view which I share, I think that the parties cannot have meant a surplus of income over expenditure, and for at least two reasons. In the first place, as at 31 July 1997 both parties knew that there was no surplus of income over expenditure, rather there was a substantial deficit. If profitability meant a surplus of income over expenditure, there was no current profitability to be lifted. Secondly, the agreement contemplated a comparison between the result achieved at the end of the June 1997 year and the result at the end of the June 1998 year, not a simple calculation of income over expenditure for the year ended June 1998 assuming a base of zero as the figure for the year ended June 1997. The latter method would provide no true comparison of the results of the two years, nor any real indication of the value of the work done by the appellant, effectively from 30 June 1997, approximately when the appellant commenced to work with the respondent, in lifting “current profitability”.
Furthermore when the books of account of the respondent are examined it can be seen that the operating revenue of the business for the financial year ended 30 June 1997 was $53,010,461. The operating loss before tax was $1,552,686. The respondent’s net asset position was $877,723. The outward cash flow of the business was largely made up of payments to suppliers, to employees, and for property, plant and equipment, and repayments of various bank loans and borrowings and payment of interest and other finance costs. Twelve months later the operating profit before tax was $350,867 according to the profit and loss account of the respondent, an amount which had been achieved from an operating revenue of $58,629,910, with the principal outgoings still being the payments to suppliers and employees, and repayments of borrowings and payments of interest being very substantially reduced. In the first year, the payments of interest and repayments of loans had amounted to nearly $3.7m. – in the next year this figure had been reduced to approximately $1.1m.
In these circumstances it seems to me most unlikely that the parties intended that the basis of comparison, as at 30 June 1997 should be regarded as being, in effect, nil current profitability. The respondent’s business then had a capacity to make a profit, as shown by the result achieved in the following year, and, indeed, the still further improved figures in the year afterwards. A proper comparison of the pre-tax profit (or profitability) for the first two years is, I think, only to be gained by using, not a figure of zero for the first year, but instead taking the negative figure actually shown in the profit and loss account, and by then calculating the difference between that figure and the positive result shown in the accounts for the following year. On this basis the appellant would have been entitled to a fee representing five per cent of the difference between the loss of $1,552,686 in the first year and the actual pre-tax profit of $350,867[20] in the second, an amount totalling $1,902,553. In my view it is by this process that the respondent’s capacity to earn profit is demonstrated to have been improved.
[20]The figure actually shown in the profit and loss account is $350,867, but a lesser figure, $335,584, was mentioned on at least three occasions in the trial judge’s reasons. His Honour, at p.9 of the reasons, said the higher figure was accepted by the parties as the appropriate amount.
For my own part I do not see why businessmen in assessing the capacity of the business to make a profit would not have been interested in variations in bottom-line figures, or only in a positive income. Nor does it seem to me to follow that a success fee of this kind would only be earned as coming from a surplus of income over expenditure. That surplus was not, I think, necessarily to be regarded as the only fund from which the fee could be taken. The surplus of income over expenditure is an accounting figure obtained by the employment of various accounting “fictions”, including such concepts as depreciation and a calculation of the future sacrifice of economic benefits. There seems to me no obvious reason why this should be regarded as the fund from which any such fee would be taken, rather than, say, the overall income of the business, or the total shareholders’ equity (which, by the end of June 1998, stood at nearly $1m.).
In my view it is unnecessary to consider the appellant’s argument that the Court should take account of any post-contractual conduct.
I would allow the appeal.
BATT, J.A.:
I agree with Ormiston, J.A. Whilst I recognise the force of Charles, J.A.’s reasons on the appeal, I have concluded that the notion of “the capacity to make a profit” is not apt to yield an actual money amount, as is required by clause (iii) of the letter of 31 July 1997. Further, in the letter of 22 April 1997 the word “profitability” is clearly not used in that sense, but in the sense of “profit”.
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