Spring 2012

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Welcomefrom the Editor Marc Brown

Following our Silks Week in November 2011, in this issue we are showcasing the four Silks in the St-Philips Commercial Group. In addition to the articles in this Newsletter, you can find full details of all four of the Silks featured in our new Leaders booklet, which can be viewed on the St-Philips website – www.st-philips.com.

You will also find full details of our seminar programme for 2012 on the St-Philips website.

Please be sure to book early to avoid disappointment as our seminars have proved extremely popular.

I hope you enjoy this special edition of the Newsletter and the new look design. As ever, if you would prefer your copy electronically in future, or have any other comments on the Newsletter, please feel free to contact me at mbrown@st-philips.com

In this issueNewspage 2 & 3

Eroding the Anti-Deprivation RuleWritten by: Avtar Khangure QCpage 3,4 & 5

Claims against directors of companies in liquidation: focus on wrongful and fraudulent tradingWritten by: Mohammed Zaman QCpage 6 & 7

Contractual ObligationsThe use of best and reasonable endeavoursWritten by: Lance Ashworth QCpage 8,9 & 10

Terminating ContractsWritten by: John Randall QCpage 10 & 11

If you would like to receivefurther copies of this bulletin,please emailjluckman@st-philips.com

The bulletin is also available inpdf format on our website atwww.st-philips.com

Commercial

Silks

Welcome to our special Silks edition of the Newsletter. I hope you find this an engaging mix of articles from St Philips Commercial Group’s Queen’s Counsel.

John Randall QC, Head of St Philips Commercial Group and leading chancery and commercial silk has won the prestigious ‘Barrister of the Year Award 2012’ at this year’s Birmingham Law Society Legal Awards....more on page 2

John Randall QC wins Barrister of the Year Award 2012 (full story page 2)

Special Edition

St Philips appoint leading Midlands Company Law SpecialistSt Philips Chambers is delighted to welcome specialist company and commercial law barrister Dominic Roberts to its ranks. Dominic joins the Birmingham based set from one of the UK’s leading law firms, Wragge & Co LLP, where he was a corporate and litigation partner.

Dominic specialisies in all aspects of company law, financial engineering and commercial disputes. He is widely acknowledged as being an expert in such matters attracting clients such as major UK and international corporates; leading UK and overseas law and accountancy firms.

In 2009 these skills were recognised by The Financial Times when they awarded Dominic their Innovative Lawyers Award for the creation of the concept of a contractual profit reserve.

Dominic commented “I am very honoured to have been invited to join St Philips which is recognised nationally as a leading set of chambers for company and commercial work. It will be a privilege working alongside my new colleagues in delivering specialist legal expertise on transactional and contentious company law and commercial matters.”

Dominic also has a leading practice in shareholder and corporate governance disputes, including director defence work, and has been appointed to advise on various internal and governmental corporate investigations.

Kevin Hegarty QC, head of St Philips Chambers, said: “Dominic’s arrival is a key appointment for our Chambers, he brings with him a unique area of expertise which perfectly complements our existing commercial and chancery offering and increases our civil practice group to 63 Barristers.”

“John is an excellent advocate and a truly deserving winner of this award. “

John Randall QC wins Barrister of the Year Award 2012

John Randall QC, Head of St Philips Commercial Group and leading chancery and commercial silk, has won the prestigious ‘Barrister of the Year Award 2012’ at this year’s Birmingham Law Society Legal Awards.

John went head to head with two other Barristers from St Philips, Andrew Smith QC

and Tariq Sadiq, as St Philips had an impressive three finalists out of five in the

category this year.

The Judges made particular

reference to John stating: “the

winner of this award has made a

major contribution to the profession

over many years. [His] involvement

in a number of important and high

profile cases and commitment to

training and education set [him]

apart from the other finalists.”.

Kevin Hegarty QC, Head of Chambers, said: “I was very honoured to see three of our

Barristers up for such a highly contested award; John is an excellent advocate and a

truly deserving winner of this award.

“Likewise, it was wonderful to see the judges highly commend Andrew Smith, who

will be appointed Queen’s Counsel this week.”

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Eroding the Anti-Deprivation RuleWritten by: Avtar Khangure QC

“... the law is too clearly stated to admit a shadow of doubt that no person possessed of property can reserve that property to himself until he becomes bankrupt, and then provide that, in the event of his becoming bankrupt, it shall pass to another and not to his creditors.” (Whitmore v Mason (1861) 2 J & H 204, 212 per Sir William Page Wood V-C)

1. In Belmont Park Investments PTY Ltd v BNY Corporate Trustee Services Ltd and another [2011] UKSC 38, the Supreme Court held that the anti-deprivation principle is unlikely to invalidate the provisions of an arm’s length commercial contract, entered into by the parties to it in good faith. The principle operates to avoid transactions entered into by parties with the objective of frustrating the operation of the statutory insolvency regime, by removing property from a party on its insolvency.

2. Lord Collins, who gave the main judgment, says at paragraph 1 that:

a) the anti-deprivation rule; and b) the rule that it is contrary to public policy to

contract out of the parri passu distributionare two sub-rules of the general principle that parties cannot contract out of the insolvency legislation.

The anti-deprivation principle in outline

3. The basis of what is referred to as the “anti-deprivation principle” is a common law rule of long standing. The court will not allow an insolvent entity to arrange its affairs to frustrate the legitimate interests of that entity’s creditors (Higinbotham v Holme (1812) 19 Ves Jun 88).

4. The principle allows the court to invalidate a transaction if its effect is to deprive an entity’s creditors of property that would otherwise be

realised for the benefit of those creditors on the entity’s insolvency.

5. The underlying common law rule is also the basis for the provisions of the Insolvency Act 1986 which allow for the challenge to transactions in the run up to an entity’s insolvency.

Genesis of the rule

6. The phrase “anti-deprivation” was first used relatively recently by Neuberger J. in Money Markets International Stockbrokers Ltd v London Stock Exchange Ltd [2002] 1 WLR 1150, which concerned a provision in the articles of association of the London Stock Exchange Ltd (“LSE”). LSE’s articles provided

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St Philips Commercial Law Seminar SuccessOver 200 commercial solicitors attended a ‘civil procedure update seminar’ at St Philips Chambers.

Originally booked only for the morning, the event proved so popular that it had to be re-run for another audience in the afternoon.

The seminar, run in conjunction with Birmingham Law Society, was chaired by Lance Ashworth QC, with an expert panel of speakers headed by Ed Pepperall who, as a member of the Civil Procedure Rule Committee, provided delegates with an “insider’s guide” to recent and imminent procedural reform.

Other speakers included Marc Brown and Rob Mundy who spoke on ‘security for costs’ and ‘without prejudice privilege’.

Ed Pepperall commented: “The feedback from the seminar has been very encouraging and we are delighted that so many solicitors attended the event. We ran the event twice in order to accommodate as many people as we could and will be running it again in the future for all those who were unable to attend.

“St Philips Commercial Group has a series of seminars planned throughout the year on a variety of topics and we are hoping that they continue to be as successful as this CPR update.”

4Silks Special Edition

that a broker that became insolvent forfeited its membership of LSE. The court held that the articles did not offend the anti-deprivation principle, because M’s membership of LSE was not freely transferable and so was of negligible realisable value for creditors.

7. British Eagle International Airlines Ltd v Cie Nationale Air France [1975] 1 WLR 758, was a case concerning a “clearing house” arrangement, providing a mechanism for the settlement of debts arising between various airlines. The House of Lords held that the arrangement was invalid because it effectively contracted out of the statutory scheme for parri passu distribution of the property of insolvent companies, it was therefore contrary to public policy and void. In Carreras Rothmans v Freemen, [1985], Peter Gibson J held: “where the effect of a contract is that an asset which is actually owned by the company at the commencement of its liquidation would be dealt with in a way other than in accordance with the [parri passu] rule … then to that extent the contract is as a matter of public policy avoided.”

This appears to be another category or sub rule of the anti-deprivation principle and at paragraph 9 Lord Collins says: “the distinction between the two sub-rules is by no means clear-cut.” Consideration of case law shows that cases that have been characterised as falling into one category could also fall foul of the other. Paragraph 13 continues: “There is little difference in practice between declaring a contractual provision invalid or ineffective because it is inconsistent with the statute and declaring it contrary to public policy for the same reason.”

8. Proprietary interests that determine on insolvency (“flawed assets”) have been regarded as falling outside the scope of the anti-deprivation principle. A landlord’s right to forfeit a lease on a tenant’s insolvency is a qualification of the tenant’s interest in the land, not a means of depriving the tenant of property on insolvency (Roe d Hunter v Galliers (1787) 2 Term Rep 133).

What is the real difference between the two rules:

a) the anti-deprivation rule applies only if the deprivation is triggered by bankruptcy / liquidation, which has the effect of depriving a debtor of an asset which would otherwise be available to creditors;

b) the parri passu rule applies always, whether the trigger is bankruptcy or liquidation or not.

In British Eagle (supra) it was said that one occurs on bankruptcy (the anti-deprivation principle) and the other in bankruptcy.

The contractual position - Lehmans and the Dante programme investments

9. The Dante programme was one of the investment products offered by Lehman Brothers International Europe (LBIE), funded in part by Lehman Brothers Special Financing Inc. (LBSF). LBIE and LBSF were subsidiaries of Lehman Brothers Holdings Inc (LBHI).

i. The Dante programme was a collateralised debt obligation (“CDO”) investment product, in which investors invested in a basket of bonds.

Collateralised Debt Obligation: CDO

Lehman Brothers Holdings Inc

Lehman Brothers Special Financing Inc

Lehman Brothers International Europe

Subsidiary (the Issuer) set up for the purpose of purchasing a basket of bonds (the Collateral)

ii. Each basket of bonds (known as “the Collateral”) was bought by a subsidiary of LBIE, incorporated for that purpose (“the Issuer”). iii. The Issuer funded its purchase of bonds by issuing loan notes to investors.iv. LBSF agreed to provide the Issuer with the funds necessary to repay the notes, in return for the Issuer’s agreement to pay all interest yielded by the Collateral to LBSF.v. Another special purpose vehicle (“the Trustee”) held the Collateral on trust for the Issuer, pending the maturity of the notes.

10.The contractual relationship between the Issuer, LBIE, LBSF and the investors was governed by:

i. A principal trust deed, an umbrella agreement setting out the general terms for all investments under the Dante programme.ii. A supplemental trust deed, setting out particular obligations between the Issuer, the Trustee, LBIE, LBSF and the investors for particular Collateral.iii. A credit default swap agreement constituted by the ISDA Master Agreement and a swap confirmation between the Issuer and LBSF.iv. The Trustee granted charges over the Collateral:

a) In favour of LBSF, to secure the payment to LBSF of the payments due to LBSF under the

agreements;b) In favour of the investors, to secure repayment of the sums under the notes.v. The principal trust deed provided that the charge over the Collateral in favour of LBSF had priority over the charge in favour of the investors.vi. However, the supplemental trust deed provided that, on the occurrence of an event of default (as defined in the ISDA Master Agreement), the priority of the charges over the Collateral reversed, so that the investors’ security took priority over LBSF’s (the priority flip).vii. The ISDA Master Agreement allows parties to a swap to terminate the agreement if certain events of default occur.viii. These events of default include failure to pay sums due in relation to a swap and the commencement of insolvency proceedings against a party to the swap. ix. In order to terminate a swap, the non-defaulting party must serve notice on the defaulting party, confirming the particular default relied on.

Facts

An event of default occurs

11. On 15 September 2008, insolvency proceedings began in respect of LBHI when it filed for bankruptcy protection under Chapter 11 of the US Bankruptcy Code. 12. On 3 October 2008, LBSF also filed for Chapter 11 protection.

13. Relying on LBSF’s bankruptcy filing, the investors caused the Trustee and Issuer to terminate the swap agreement, by serving notice. As a result of these events, the Trustee confirmed that it considered that a priority flip had taken place, so that the investors’ security over the Collateral had priority over LBSF’s security.

14. It is to be noted that only the anti-deprivation principle was applicable in this case – bankruptcy triggered the loss of the company’s priority over assets.

LBSF challenges the priority flip

15.The loan note holders issued proceedings against the Trustee seeking to procure the release of the Collateral held by the Trustee. LBSF was subsequently joined as a party.

16.LBSF argued that the priority flip was contrary to the anti-deprivation principle and void. The effect of the priority flip, according to LBSF, was to deprive the creditors of LBSF of the benefit of its security interest in the Collateral, as a result of its insolvency.

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17. LBSF failed before the High Court and the Court of Appeal. Both courts held that the priority flip did not engage the anti-deprivation principle. Among the most important elements of the judgments of the courts below were that:a) The anti-deprivation principle only applied where the trigger for the loss of property was the insolvency of the debtor in question. In this case, an event of default (triggering the priority flip) occurred when LBHI entered Chapter 11 bankruptcy. Accordingly, LBSF did not lose any property because of its insolvency, as the flip had already taken place before LBSF entered Chapter 11 bankruptcy.b) LBSF’s creditors suffered no genuine loss. The Issuer bought the Collateral with funds provided by the investors (not by LBSF). LBSF (and its creditors) stood to profit from the interest yields from the Collateral. However, as LBSF had not contributed to the Collateral’s purchase, in a commercial sense, LBSF had no “property” in the Collateral itself.

LBSF’s arguments before the Supreme Court

18. LBSF argued that:i. The scope and effect of the anti-deprivation principle was broader than either the High Court or the Court of Appeal had allowed.ii. The principle existed to prevent parties from contracting out of the insolvency regime. Accordingly, if a contract had the effect of taking property out of the hands of an entity on insolvency, the contract was invalid. iii. In British Eagle, the House of Lords recognised the commercial sense in the arrangements in question, but still held that those arrangements were invalid, because they offended against the parri passu principle.iv. The principle was engaged wherever there was a causal connection between an entity’s insolvency and the loss of property, even if the specific trigger for the deprivation was the formal insolvency of another party. v. In this case, as the fortunes of LBHI and LBSF were inextricably linked, the principle applied, even if the court took the trigger point for the priority flip as being LBHI’s filing for Chapter 11 bankruptcy protection.vi. Under the ISDA Master Agreement, the occurrence of an event of default had no effect until the non-defaulting party served notice of default. By importing the event of default definition into the supplemental trust deed, the parties must have intended to import a requirement on the non-defaulting party to give notice. In this case, the notice issued under the ISDA Master Agreement cited LBSF’s bankruptcy as the default complained of, which demonstrated that it was, in reality, LBSF’s insolvency that triggered the priority flip.

Decision

19. The Supreme Court unanimously dismissed LBSF’s appeal. Lord Collins gave the leading judgment - British Eagle was distinguished.

20. The starting point of Lord Collins’ judgment is the distinction between the anti-deprivation principle and the rule (expressed in British Eagle) that parties cannot contract out of the provisions of the English insolvency regime relating to the distribution of assets.

21. Lord Collins held that although the two rules derive from the same core principle (that parties cannot arrange their affairs to frustrate the operation of the insolvency regime), they apply differently in practice.

22. The circumstances of a particular case may bring both rules into play, as well as the provisions of the IA 1986 that allow for the challenge of antecedent transactions.

23. However, the two rules are distinct and apply independently of one another and the provisions of the IA 1986.

Link to entity’s insolvency essential

24. Lord Collins held that the anti-deprivation principle only applies to contractual provisions that directly link the loss of property to the insolvency of a particular entity. If the trigger for the loss of property is another event, the principle is not engaged.

25. However, the concept of insolvency in this respect is not limited to the commencement of a formal insolvency process. A deprivation of property that is triggered by the economic circumstance of insolvency may fall foul of the anti-deprivation principle.

26. This is in contrast to the rule in British Eagle, which is engaged if a contract attempts to displace the distribution mechanisms of the insolvency regime, whatever trigger causes that replacement mechanism to come into effect.

27. Lord Collins held that did not imply that notice was a prerequisite to an event of default. The occurrence of an event of default was purely a question of fact.

Commercial intention critical

28. The court should attempt to determine whether the commercial objective of the parties was to remove property from one party, if that party became insolvent. However, the court should be cautious about striking down a commercially legitimate transaction, entered into by the parties in good faith.

29. On the facts of this case, the priority flip was (as the High Court and Court of Appeal both found), an expression of the underlying commercial bargain.

30. The Dante programme put in place a scheme by which investors could invest in the Collateral. The funds used to buy the Collateral came from the investors. LBSF’s role was to provide additional certainty over the return on the investment, in return for which it received the benefit of the yields on the Collateral over time. Indeed, Lord Collins observed that the triple-A rating given to the investments was in part dependent on the priority flip being in place.

31. Accordingly, the commercial intention of the priority flip was not to deprive LBSF of property, but to ensure that, on LBSF’s insolvency, the investors were entitled to the return of what was, in a commercial sense, “their” Collateral.

32. A factor was that the Collateral was bought with funds provided by the investors. This was relevant in determining the commercial intention of the parties, but had no significance beyond that.

33. Lord Mance did not accept that the priority enjoyed by LBSF’s security amounted to property belonging to LBSF. The commercial arrangement between the parties was that the Trustee held the Collateral pending repayment of the notes or defaults. If a default occurred, the priority flip ensured that the non-defaulting party obtained the commercial benefit of the Collateral.

34. Accordingly, LBSF had no interest in the priority of the security until it defaulted, at which point its interest was that of a subordinate creditor to the investors.

Conclusion

35. The Court emphasised that it was “beyond the proper province of the judicial function to discard 200 years of authority, and to attempt to re-write the case law in the light of modern statutory developments or complicated commercial transactions.

36. The judgments of the Supreme Court emphasise that the commercial objective of the parties is the key factor.

37. A successful challenge to an arm’s length transaction, entered into in good faith and for legitimate commercial purposes is consequently unlikely, even where the transaction deliberately anticipates the insolvency of one of the parties.

38. The rule in British Eagle is wider

39. The judgments in this case only deal with the anti-deprivation principle.

6Silks Special Edition

Claims against directors of companies in liquidation: focus on wrongful and fraudulent trading

Written by: Mohammed Zaman QC

1. In 1982 the Cork Committee (reviewing insolvency law) reported that ‘fraudulent trading’ was originally introduced as an ‘experiment’ in the Companies Act 1929, but as it was an intermixture of civil and criminal liability it imposed an unduly stringent burden of proof in relation to the ingredient of fraud, which inhibited liquidators from making claims.

2. They recommended a new provision ‘wrongful trading’ to provide a civil remedy for those who suffered financial loss on insolvency, but where the directors had not acted dishonestly. Their recommendations became in due course sections 213 and 214 of the Insolvency Act 1986

Wrongful trading – section 214

3. Although section 214 is headed ‘wrongful trading’, the body of the section neither refers to ‘wrongful’ conduct nor to ‘trading’.

4. It gives the court discretion to declare that a director of the company (to whom the section applies) shall be liable to make such contribution to the company’s assets as the court thinks proper.

5. The only person who may make an application is a liquidator.

6. There are 3 conditions for liability:(1) The company has gone into insolvent liquidation (voluntary or compulsory). (2) At some time before the commencement of the winding up of the company, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation;(3) It applies to any person who is or has been a director. It expressly applies to shadow directors. Whilst there is no reported case in which the point has been determined, it applies to de facto directors (see Re Hydrocan (Corby) Limited [1994] BCC, 161).

7. In Re Hawkes Hill Publishing Co Limited [2007] BCC 938 Lewison J restated that

‘wrongful trading’ does not impose a statutory duty not to trade whilst insolvent, nor does it impose a duty not to trade at a loss. Directors may properly take the view that it is in the interests of the company and of its creditors that, although insolvent, the company should continue to trade out of its difficulties

8. In Re Continental Assurance Co of London plc 2001 BPIR 73 Park J stated:“....Ceasing to trade and liquidating too soon can be stigmatised as the coward’s way out.”

9. It is essential that the liquidator should plead the date, or dates, upon which the director ‘knew’ or ‘ought to have known’ that there was no reasonable prospect that the company would avoid going into insolvent liquidation.

10. The relevant date is a pleading point and subject to the usual rules on permitting amendment. In Re Sherborne Associates Limited [1995] BCC 40, HHJ Jack QC refused to allow a liquidator to argue for alternative unpleaded dates.

11. There is always a contrary case: Hazel Williamson QC in Re Brian D Pierson (Contractors) Limited (1999) BCC 26, treated the pleaded date of ’13 June 1994’ to cover the period to August 1995 describing the issue of the date as ‘unduly technical’.

12. The current view is that the pleaded date is highly significant. In Re Continental Assurance Company of London plc (in cvl) (14 November 2000) Park J stated:

“I believe that it would be wholly unsatisfactory for the starting date to remain at large. ...... I would not wish my decision to be cited hereafter as authority for the proposition that in all cases under section 214 the Liquidator must always specify his starting date and must lose the whole case if he cannot satisfy the court that his case is made out by reference to that particular date. Cases vary in detail and complexity [and then went on to say]...the Liquidator’s case must stand or fall with their chosen date of 19th July 1991.”

13. The standards and the knowledge of the director: Section 214 (4) provides that:....the facts which a director of a company ought to know or ascertain, the conclusions which he ought to reach and the steps which he ought to take are those which would be known or ascertained, or reached or taken, by a reasonably diligent person having both

(a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company, and(b)the general knowledge, skill and experience that that director has.

14. The first part of section 214(4) is objective. The second part is subjective. The director must at least meet the objective standard, but the better qualified he is the higher the standard he has to meet. A chartered accountant appointed as finance director is expected to meet a higher standard than a salesman appointed as sales director, but neither of them can rely upon their ignorance as a defence.

15. In Re Produce Consortium Limited [1989] 1WLR 745, Knox J stated the test is objective and does not fit well with the test under what is now section 1157 of the Companies Act 2006 (which allows the court to excuse a director who has acted honestly and reasonably).

16. The final test is still one that requires section 213(2)(b) to be addressed, namely ‘was there no reasonable prospect that the company would avoid going into insolvent liquidation’?

17. The motive and intentions of the director are irrelevant, as is hindsight.

18. The statutory defence: Section 214(3) provides that:

The court shall not make a declaration under this section with respect to any person if it is satisfied that after the condition specified in subsection (2)(b) was first satisfied in relation to him that person took every step with a view to minimising

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the potential loss to the company’s creditors as (assuming him to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation) he ought to have taken.

19. The defence is of limited application. In Brian D Pierson (Contractors) Limited [1999] BCC 26 at p.54, Hazel Williamson QC stated :

“.... this section is intended to apply to cases where, for example, directors take specific steps with a view to preserving or realising assets or claims for the benefit of creditors, even if they fail to achieve that result. It does not cover the very act of wrongful trading itself, just because this would have been done with the intention of trying to make a profit.”

20. Contributions: if the court is satisfied that the section applies, the court needs to assess the level of the contribution (if any). The section gives no indication as to the basis upon which the contribution is to be assessed.

21. It is clear that the provision is not penal. See Chadwick J in Morphitis v Bernasconi [2003] Ch 553.

22. The preponderance of the authorities (from Continental Assurance Co. of London

plc [2001] BPIR 733 ChD) is to look at ‘depletion’ of assets from the pleaded date to the date of liquidation. The liability of directors is prima facie several, although the court can impose joint and several liability.

23. Limitation: A claim brought under sections 213 and 214 of the Insolvency Act 1986 is subject to a 6 year limitation period (section 9(1) of the Limitation Act 1980 - see Farmizer (Products) Limited [1997] BCC 655, CA). As the winding up is an essential component, the cause of action accrues upon the company being wound up, which in the case of compulsory winding up is the date of the resolution (in voluntary liquidation) and date of the presentation of the petition (in compulsory liquidation).

Fraudulent trading – section 213 of the Insolvency Act 1986

24. With the coming into force of ‘wrongful trading’ the utility of ‘fraudulent trading’ (section 213) has diminished:

(1)Section 213(1) applies in the course of a winding up where ‘it appears that any business of the company has been carried on with intent to defraud creditors of the company or creditors of any other person, or for any fraudulent purpose.’

(2)In wrongful trading there is no need to prove intention.

(3)Intent to defraud requires proof of intent or recklessness as to the consequences.

(4)The remedy is no greater than in wrongful trading.

25. The real utility of fraudulent trading is that it covers persons who were not directors.

Bullet point considerations

26. Wrongful trading:

Liability is dependent on what the director knew or ought to have known.Adequate record keeping by company and director.Discussions about cessation of trading – must be minuted.Resign if necessary – not necessarily determinative.Consult insolvency practitioner and take advice.

27. Fraudulent trading:Don’t do it.

© Mohammed Zaman QC 2012

8Silks Special Edition

Contractual ObligationsThe use of best and reasonable endeavours

Written by: Lance Ashworth QC

SCOPE OF THIS PAPER

1. In this paper, I intend to look at provisions in contracts that one or both parties shall use “reasonable endeavours” or “all reasonable endeavours” or “best endeavours” to achieve a particular outcome and to attempt to distil the Courts’ current thinking of what such clauses mean.

2. Despite a lack of clarity as to what such clauses mean, they have been used for many years. Frequently, they appear to be used where an issue as to what might happen in a particular set of circumstances is too difficult for the parties to work out at the time of drafting. They also tend to appear in contracts where there is an obligation to achieve something which is dependent on the actions of a third party, for example, the obtaining of an unconditional planning permission.

3. The reason why they are capable of creating such uncertainty is evident from the judgment of HHJ Mackie QC in Jet2.Com Ltd v. Blackpool Airport Limited [2011] EWHC 1529 in which he said that “The meaning of the expression remains a question of construction not of extrapolation from other cases ... the expression will not always mean the same thing.” In the Court of Appeal in the same case Lewison LJ (albeit in a dissenting judgment) agreed with the Judge on this point (see [2012] EWCA Civ 417 at paragraph [41]).

Best Endeavours

4. It is easier to say what is not meant by best endeavours as opposed to what is. A party subject to an obligation to use best endeavours is not obliged to conduct its business so as to offend its traders and drive them to the competition, but subject to such limits should broadly speaking leave no stone unturned in pursuing the object to be achieved by the use of best endeavours (Sheffield District Railway Coy v. Great Central Railway Coy (1911) 27 TLR 451).

5. In Terrell v. Mabie Todd & Coy Ltd [1952] 69 RPC 234, Sellers J said that a party under an obligation to use best endeavours to promote sales was not obliged to carry on the attempted sale to the certain ruin of the Company or

to the utter disregard of the interests of the shareholders. However, that party’s obligation was to do what they reasonably could do in the circumstances. The standard of reasonableness was that of a reasonable and prudent Board of Directors acting properly in the interests of the company and applying their minds to their contractual obligations.

6. In IBM United Kingdom Ltd v. Rockware Glass Ltd [1980] FSR 335, one of the conditional contract cases under which the purchaser was required to make an application for planning permission and use its best endeavours to obtain the same and not withdraw the application without the vendor’s written consent. Planning permission was sought and refused. No appeal was made by purchaser to the Secretary of State. 2 questions arose, namely (1) what was it that the purchaser was obliged to use its best endeavours to do? and (2) what was the extent of the purchaser’s undertaking to use its best endeavours? The Court of Appeal held that best endeavours included an obligation to appeal to the Secretary of State in the event of the application to the local authority being unsuccessful, such appeal having some prospects of success, concluding that the test for “best endeavours” is answered by asking the question “what would an owner of the property with which we are concerned in this case, who was anxious to obtain planning permission, do to achieve that end?” That would oblige the purchaser to take all those reasonable steps which a prudent and determined man, acting in his own interests and anxious to obtain planning permission, would have taken.

7. However, even the obligation to use “best endeavours” cannot override an obligation owed by a director to give good advice to the company shareholders, or by a financial adviser to give good advice to its clients (Rackham v. Peek Food [1990] BCLC 895). The “best endeavours” clause did not oblige the advisers or the directors to give advice which they genuinely believed to be bad advice.

Reasonable Endeavours

8. This imposes the lowest of the 3 obligations. The expression “reasonable endeavours” has a lesser meaning than “best endeavours” and

entitles the relevant person to weigh on the one side the duty and on the other side all relevant commercial considerations. The likelihood of success of the reasonable endeavours in bringing about the desired objective is of prime importance (UBH (Mechanical Services) Ltd v Standard Life Assurance Co (The Times 13th November, 1986)).

9. In P&O Property Holdings Ltd v. Norwich Union Life Assurance (1994) 68 P&CR 261 the House of Lords held that a “reasonable endeavours” clause does not require the party bound to use reasonable endeavours to sacrifice its commercial interests. Similarly in Philips Petroleum Co UK Ltd v. Enron Europe Ltd [1997] CLC 329 the Court of Appeal held that it was impossible to say that a requirement to use reasonable endeavours imposed on the buyer of gas a contractual obligation to disregard the financial effect on him, and indeed everything else other than technical or operational practicality, when deciding how to discharge his obligation to use reasonable endeavours to agree to a commissioning date prior to a specific date. If the obligation were to be strait-jacketed in that way, that is something which would have been expressly stated.

10. In Rhodia International Holdings Ltd v. Huntsman International LLC [2007] 2 Lloyd’s Rep 325, it was argued that there was no difference between “reasonable endeavours” and “best endeavours”. The Judge disagreed, holding that there may be a number of reasonable courses which could be taken in a given situation to achieve a particular aim. An obligation to use reasonable endeavours to achieve the aim probably only requires a party to take one reasonable course, not all of them, whereas an obligation to use best endeavours probably requires a party to take all the reasonable courses he can. He said that in that context, it may well be that an obligation to use all reasonable endeavours equates with using best endeavours.

All Reasonable Endeavours

11. As a matter of logic, it might be thought that “all reasonable endeavours” fell somewhere between “reasonable endeavours” and “best endeavours”. That appeared to be the traditional view as stated in the UBH

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(Mechanical Services) case (supra), but was not the view taken in the Rhodia International case.

12. In Yewbelle Ltd v. London Green Developments Ltd [2008] 1 P&CR 17 there was a purchase contract which was subject to a suitable agreement under section 106 of the Town and Country Planning Act 1990 being entered into. The vendor was under an obligation to use all reasonable endeavours to secure a completed s 106 agreement, substantially in the form of the draft then in existence. The s 106 was not entered into and the question for the court was whether the vendor remained bound by the contract. The Court of Appeal accepted Lewison J’s analysis of what was involved in “all reasonable endeavours”, namely that in using its reasonable endeavours, the vendor was not required to sacrifice its own commercial interests, but that the obligation required the party to go on using reasonable endeavours until the point had been reached when all reasonable endeavours have been exhausted, and to go on would be mere repetition, though account had to be taken of events as they occurred, including extraordinary events.

13. There was a variation on the theme in CPC Group Ltd v Qatari Diar Real Estate Investment Company [2010] EWHC 1535 (Ch) where the relevant clause was one to use “all reasonable but commercially prudent endeavours”. Vos J considered the meaning of “all reasonable endeavours”. Following Rhodia International Holdings Ltd v Huntsman International LLC [2007] 1 CLC 59 he accepted that, prima facie, “reasonable endeavours” is a less onerous obligation than “best endeavours” but that “all reasonable endeavours” can be equated with “best endeavours”. He stated that an obligation to use “all reasonable endeavours” did not always require the obligor to sacrifice his commercial interests. In any event, the wording of the obligation in this case (using “all reasonable but commercially prudent endeavours”) meant that the requirement to sacrifice its own financial interests could not be said to have applied to Qatari.

14. In the case of Jet2.Com Ltd v. Blackpool Airport Ltd [2011] EWHC 1529 (Comm) tried by HHJ Mackie QC, it was common ground between the parties that all reasonable endeavours means the same as best endeavours. This was notwithstanding that the relevant clause used both “best endeavours,” and “all reasonable endeavours” which might have led the court to think that the parties had been intending to draw some distinction between the two. The judge accepted that when the obligation to use all reasonable endeavours is applied, for example, to an obligation to obtain something from a third party, the sacrifice of a party’s own commercial interests is not required. However,

the judge held that BAL’s ability to fulfil its duty to use all reasonable endeavours was within its own control and not, as in previous cases, outside of its control. Accordingly, BAL could not “pick and choose” what to do in its own interest and that its actions in setting conditions on its performance of the contract with Jet2 amounted to a serious breach of contract. In essence it had to sacrifice its own commercial interests.

15. With respect to HHJ Mackie QC, it is difficult to see the rationale for this distinction. It is difficult to reconcile with Yewbelle and CPC Group. It could be said that in almost every case the ability to fulfil a duty to use all reasonable endeavours or best endeavours is within a party’s own control. Ultimately, money talks. A difficulty in obtaining a local authority’s agreement to a section 106 agreement can often be overcome by throwing money at the local authority. Why is that, which is clearly contrary to a party’s own commercial interests, not required, but opening an airport outside of normal hours, which is also contrary to a party’s own commercial interest, is required? He did not expressly consider to what extent a party’s own commercial interests had to be sacrificed, in particular how close to the certain ruin of one’s own company does one have to get.

16. The Jet2.Com case has very recently gone to the Court of Appeal, with judgment being given on 2nd April, 2012 [2012] EWCA Civ 417. By a majority (Moore-Bick LJ and Longmore LJ, with Lewison LJ dissenting) the Court of Appeal upheld Judge Mackie’s decision. Again it was conceded that there was no difference between “best endeavours” and “all reasonable endeavours”. The debate in the Court of Appeal was whether the obligation to use best endeavours/all reasonable endeavours was too uncertain to be capable of giving rise to an enforceable obligation, the majority holding that it was not too uncertain.

17. Moore-Bick LJ held that the obligation to use best endeavours to promote Jet2’s business obliged BAL to do all that it reasonably could to enable that business to succeed and grow. That extended to keeping the airport open to accommodate flights outside normal hours “subject to any right [BAL] might have to protect its own financial interests”. However, he held that the judge was right to say that whether, and if so to what extent, a person who has undertaken to use his best endeavours can have regard to his own financial interests will depend very much on the nature and terms of the contract in question (see paragraph [32]). In the context of this contract, he held that:

“one would not expect the parties to have contemplated that BAL should be able to restrict Jet2’s aircraft movements to normal opening hours simply because it incurred a loss each time

it was required to accept a movement outside those hours, or because keeping the airport open outside normal hours proved to be more expensive than it had expected. On the other hand, I can see force in the argument that if, for example, it were to become clear that Jet2 could never expect to operate low cost services from Blackpool profitably, BAL would not be obliged to incur further losses in seeking to promote a failing business.”

18. In his dissenting judgment, Lewison LJ held that the particular clause was unenforceable as it was too vague. In his judgment the object of the endeavours and the range of possible endeavours must be considered together in order to decide whether there is a justiciable obligation. Moreover it is wrong in principle to focus on the particular factual situation which has given rise to the dispute without considering to what other factual situations the clause might extend if one side or the other is correct (see paragraph [50]). He went on to disagree with the Judge’s conclusions, holding that the Judge had not interpreted the contract but had made the contract which the parties had not themselves made (paragraph [60]).

19. In the third judgment, Longmore LJ agreed with Moore-Bick LJ. He held that the fact that a party has agreed to use his best endeavours pre-supposes that he may well be put to some financial cost, so financial cost cannot be a trump card to extricate himself from what would otherwise be his obligation, but agreed with Moore-Bick LJ that if it became clear that Jet2 could never expect to operate low cost services profitably from Blackpool, BAL could not be expected themselves to incur losses after that time in seeking to promote or effectively prop up a failing business (paragraph [70]).

20. What has to be drawn from the Jet2.Com case is that the answer will always depend on the nature and terms of the contract in question in the case before the Court and accordingly on the views of the particular tribunal as to the enforceability of the contract on grounds of vagueness. The majority judgments were given by 2 judges of the Commercial Court, who might be thought to be more keen to make a contract work by giving it practical effect, and the minority from a judge of the Chancery Court, who might be thought to be more keen to look at the words used and to consider what they really mean, not being afraid to declare them to be of no effect. The majority’s view as to the lengths to which the party agreeing to use best or all reasonable endeavours must go appear to be dependent on the financial success of the other party to the contract. Like Judge Mackie, they do not consider to what extent a party’s own commercial interests have to be sacrificed, in particular how close to the certain ruin of one’s own company does one have to get, other than in a situation where

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the other party to the contract is never going to operate profitably. It is, of course, highly unlikely that the parties will always agree when that point is reached, especially where the party under the obligation to use best/all reasonable endeavours will not be privy to all of the financial information and decisions that the other party has and takes.

Conclusions on Endeavours Clauses

21. The following seems to flow from a review of the above cases:

(a) each case depends on its own facts, specifically the nature and terms of the particular contract, so the use of precedent is not helpful (although every case in which this has been said has reviewed a substantial number of previous authorities);

(b) the first question will be whether the obligation creates an enforceable obligation, i.e. is it too vague to be enforced. A question which will be answered by looking at the object of the endeavours and the range of possible endeavours;

(c) “reasonable endeavours” is less than “best

endeavours”;

(d)“best endeavours” equates in almost all cases to “all reasonable endeavours”;

(e)“reasonable endeavours” entitles the relevant person to weigh on the one side the duty and on the other side all relevant commercial considerations, the likelihood of success of the reasonable endeavours in bringing about the desired objective being of prime importance. It only requires a party to take one reasonable course;

(f ) “best endeavours” requires a party to take all those reasonable steps which a prudent and determined man, acting in his own interests and anxious to obtain the desired outcome, would have taken. It probably requires a party to take all the reasonable courses he can to achieve the aim. It should not require a party to commit himself to a course which will lead to his ruin or to disregard utterly his own interests or sacrifice his own commercial interests where the ability to achieve the outcome is not within its own control;

(g)“best endeavours” may require a party to sacrifice its own commercial interests where

the ability to achieve the outcome is within its own control, at least unless and until it becomes clear that the other party could never expect to operate low profitability, at which point the party obliged to use “best endeavours” could not be expected themselves to incur losses after that time in seeking to promote or effectively prop up a failing business;

(h) there can be no certainty of outcome when an endeavours clause is included in a contract;

(i) endeavours clauses are fertile ground for litigation, so try to avoid them when drafting contracts. If an endeavours clause is to be included, the client should be advised prior to execution of the agreement of the potential uncertainties in the event of the parties falling out subsequently.

Clients have been let down by another party with whom they have a contract. They want your advice about whether they can or should terminate the contract, and if so how. You are not entirely sure whether the breaches will be viewed by the courts as serious enough to constitute a repudiation, entitling your client to terminate at common law, but an express termination clause (ETC) in the contract seems to cover the circumstances. Is that the way to go? The interaction and relative advantages of rights to terminate via these two routes are an area of some legal difficulty, and merit careful consideration before advising clients. A number of legal questions in the area have recently been addressed by the Court of Appeal in Stocznia v Gearbulk [2010] QB 27, but others remain difficult.

The theoretical bases on which a contract may be terminated by the injured party ‘accepting’ the other’s repudiation are well enough known, and include principally breach of a term constituting a strict Condition, a sufficiently serious breach of an intermediate term, and a so-called ‘anticipatory breach’,

generally founded on a stated unwillingness or incapacity to perform when the due date arrives. However the frequently encountered question of whether a breach of an intermediate term is sufficiently serious to constitute a repudiation “gives rise to very great difficulty”, as Treitel puts it.

So why bother, when there is also an ETC available? The principal advantage of such clauses is often put as providing certainty for an injured party as to whether he has indeed become entitled to terminate the contract. Furthermore, Stocznia v Gearbulk has now confirmed that a termination is indeed a termination in the usual sense, whether effected at common law or under an ETC (see at [34]). However this certainty may come at a price to the injured party, and may also prove to be short term, if subsequently it turns out that the clients will only be able to obtain a full remedy on the basis of a termination at common law.

Some noteworthy features of termination under an ETC are as follows:

if the grounds for termination specified in the ETC are or include apparently minor or trivial grounds, the court will try to construe them so as to be limited to serious breaches – see e.g. Dominion Corporate Trustees v Debenhams [2010] EWHC 1193 (Ch)

the exact wording of the contractually specified grounds must be satisfied – see e.g. MMP v Antal [2011] EWHC 1120 (Comm)

how strictly a termination notice must comply with the terms of the ETC is currently unclear. Chitty on Contracts somewhat tentatively suggests that strict compliance may no longer be required, applying the approach to construing notices in the well known landlord and tenant case of Mannai Investment v Eagle Star [1997] AC 749, and cites Ellis Tylin v Co-operative Retail Services [1999] BLR 205 in support. However other texts, such as Treitel, take a more conservative view

that said, it is clear that time provisions in an ETC must be strictly adhered to, and even slight prematurity will be fatal: Afovos Shipping v Pagnan [1983] 1 WLR 195 (HL)

Terminating ContractsWritten by: John Randall QC

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similarly, if (as is often the case) the ETC provides that the contract breaker must first be given an opportunity to remedy the default, the prescribed procedure must be strictly followed, and that opportunity must be clearly stated when the first notice is given: Western Bulk Carriers v Li Hai Maritime [2005] 2 Lloyd’s Rep 389 at 406-7.

It should be remembered that at common law a party can ordinarily justify a termination of a contract on any ground which in fact existed at the time, whether or not he initially invokes that ground in his termination notice. Recent authorities confirming this long established principle include Stocznia v Latco (No 2) [2002] 2 Lloyd’s Rep 436 at [22] per Rix LJ, and Stocznia v Gearbulk at [44] per Moore-Bick LJ. On this basis, a party who initially terminates in reliance on an ETC may later (generally in order to obtain loss of bargain damages – discussed below) rely on the same notice as acceptance of a common law repudiation, if he can establish that one had occurred and was available for acceptance at the time of his original notice.

However, an important exception to this principle is where the specified consequences of a termination under an ETC are inconsistent with, and not simply less than, those of a termination at common law upon acceptance of a repudiation. As Christopher Clarke J put it in Dalkia Utilities v Celtech [2006] 1 Lloyd’s Rep 599 at [143]-[144] “In the present case markedly different consequences would arise according to whether or not there was a termination under [the ETC] or an acceptance of a repudiation… The same notice cannot operate to produce two … diametrically opposing consequences. In those circumstances it should take effect in, and only in accordance with its express terms, namely as a determination under [the ETC].” In such a case, a termination notice served in reliance on an ETC operates as an election to terminate on that ground, and later reliance on acceptance of a common law repudiation is not open to the notice giver.

There are a number of possible consequences of the presence of an ETC in a contract, and/or of its being invoked by an injured party, which may need to be considered on the facts of any given case. They include:

Whether common law rights of and/or following termination are excluded or limited, either expressly or by necessary implication. The starting assumption is that they will not be (Dalkia Utilities v Celtech at [21]), but there are cases where such exclusion has been found, such as Lockland Builders v Rickwood (1996) 77 BLR 38 (CA)

Whether termination on the expiry of notice or on a specified future date (which may well be very desirable commercially) is legally possible. Provision for this is quite common in ETCs (an example is afforded by the ETC in Walkinshaw v Diniz [2001] 1 Lloyd’s Rep 635),

but (as the authorities stand) this is not possible at common law. A common law acceptance of a repudiatory breach must be with immediate effect (Harrison v Norwest Holst [1985] ICR 668 (CA) at 683 per Sir Denys Buckley)

Whether termination may be achieved in advance of the time when the relevant performance becomes due. With an ETC this depends on the wording of the grounds for termination, but they will generally be the commission of one or more actual breaches, in which case a valid termination has to await their commission. By contrast, the common law allows for termination following an ‘anticipatory breach’

Whether the injured party can recover full loss of bargain damages. In Australia, and probably in England, the answer is only where there has (also) been a repudiation at common law; the bare fact of a valid termination under an ETC is not enough (Shevill v Builders Licensing Board (1992) 149 CLR 620; Financings v Baldock [1963] QB 104 (CA)). In Canada, however, a valid termination under an ETC suffices (Keneric Tractor Sales v Langille (1987) 43 DLR (4th) 171)

Where there is a forfeiture provision, and the contract has been terminated under a linked ETC, it may be somewhat easier for the

other party to obtain relief from forfeiture of a proprietary interest, or in some cases a possessory interest, than it would have been on a termination for repudiation

Where there is an exclusion or limitation of liability clause, on which the other party seeks to rely, it may be more difficult for him to succeed in doing so on a termination for repudiation (and in particular a deliberate repudiation – see Internet Broadcasting v Mar LLC [2009] 2 Lloyd’s Rep 295) than it would be where the termination is founded simply on an ETC

If for some reason a termination turns out to be ineffective, and the other party has leaped at the opportunity to treat the termination notice itself as a repudiation and purported to ‘accept’ the same, then if an ETC has been invoked in good faith, but mistakenly, it will be easier for the injured party who originally attempted to terminate to persuade the court that his termination notice, albeit ineffective, did not amount to a repudiation, as was achieved in cases such as Woodar v Wimpey [1980] 1 WLR 277 (HL) and Eminence Property Developments v Heaney [2010] 3 EGLR 165 (CA).

Commercial CounselJohn Randall QC 1978/1995Avtar Khangure QC 1985/2003Lance Ashworth QC 1987/2006Mohammed Zaman QC 1985/2009Douglas Readings 1972James Quirke 1974Giles Harrison Hall 1977Patrick Darby 1978Simon Clegg 1980Stephen Eyre 1981Dr Mirza Ahmad 1984Tom Rochford 1984David Stockill 1985Jonathan Salmon 1987Andrew Maguire 1988Conrad Rumney 1988Sandra Bristol 1989

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Colin Baran 2003Naomi Candlin 2003Marc Brown 2004Amrisha Parathalingam 2004Davinia Riley 2004Amit Gupta 2006Lydia Pemberton 2006Ali Tabari 2006Iqbal Mohammed 2007Carl Garvie 2008Robert Mundy 2008Katy Asimeng 2009Joe Millington 2009Kate Rogers 2009Dominic Roberts 2011

Edward Pepperall 1989Edmund Beever 1990Anthony Verduyn 1993Andrew Charman 1994Angus Burden 1994John Brennan 1996James Morgan 1996David Warner 1996Emma Kelly 1997Richard Adams 1999Shakil Najib 1999Andrew Evans 2000Paul Dean 2001David Griffiths 2001Sean O’Brien 2001Matthew Weaver 2002Duncan Bagshaw 2003