Legal Briefing

What is your ‘purpose’?

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Corporate and commercial | 01 July 2014

In a contractual dispute involving a written agreement, parties can face difficulties in proving the effect they originally intended particular words of the agreement to have, perhaps because the wording is ambiguous or fails to adequately express the intention of the contracting parties. In such circumstances, the court will analyse the agreement and the intention of the parties to determine the meaning of a particular word or clause, and consequently its legal effect. The existing case law is clear that this is an objective assessment, designed to establish what a reasonable person in the position of the parties would have understood the words in question to mean. This was concisely put by Lord Hoffmann in Investors Compensation Scheme Ltd v West Bromwich Building Society [1997]:

‘Interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract’.

The meaning should be generated from the words used in the contract, not from speculation as to what was meant by the parties in choosing those words. Further, the assessment must take account of the knowledge of the parties at the time of concluding the contract, referred to as the ‘factual matrix’. Lord Wilberforce in Reardon Smith Line Ltd v Yngvar Hansen-Tangen [1976] stated that:

‘No contracts are made in a vacuum; there is always a setting in which they have to be placed. The nature of what is legitimate to have regard to is usually described as “the surrounding circumstances”…’

In Rainy Sky SA & ors v Kookmin Bank [2011] Lord Clarke, having repeated the principles above, further added that ‘resolving an issue of interpretation is an iterative process, involving checking each of the rival meanings against other provisions of the document and investigating its commercial consequences’ and that if, having considered the surrounding circumstances, ‘there are two possible constructions, the court is entitled to prefer the construction which is consistent with business common sense’.

These principles were considered and applied most recently by the Commercial Court in Starbev GP Ltd v Interbrew Central European Holdings BV [2014] providing us with the opportunity to understand how a court will apply these principles when faced with the task of choosing between two or more interpretations of the same words in a written agreement.

FACTS OF STARBEV GP V INTERBREW

In 2009, Interbrew, a global brewer, entered into an agreement with Starbev, an entity that was part of a corporate structure sponsored by private-equity firm, CVC, and created to purchase Interbrew’s brewing business (the Business) in Central and Eastern Europe. Interbrew considered that Starbev had acquired the Business at $200m below its valuation and therefore the agreement included an element of deferred consideration in which Interbrew was entitled to a share of CVC’s profit in the onward sale of the Business.

This profit share was dependent on CVC receiving sums in excess of defined thresholds of the amount it had invested in the Business. The investment amount was defined in the agreement as funds ‘applied by Starbev acquiring the relevant interest [ie the Business]’ (the Investment Amount). The threshold operated on a stepped basis in multiples of the Investment Amount – the earlier the onward sale, the greater the share of profits Interbrew would receive. Further, the agreement also contained an anti-avoidance provision aimed at preventing CVC from structuring the onward sale to deprive Interbrew of payments which stated that ‘any transaction that is structured or undertaken that results in payments to [CVC] with the purpose of reducing payments… were deemed…’ to be returns received by CVC.

In June 2012 Starbev sold the Business to an American brewer, Molson Coors. The sale included a convertible note (the Note) in the amount of €500m which allowed CVC to take advantage of future share price rises in Molson Coors. On 18 June 2012 Starbev notified Interbrew that it had received €1.38bn from the sale (none of which was referable to the Note) and that the threshold for 2012 had not been surpassed. Interbrew disputed this and considered that the threshold had been exceeded based on the fact that its own calculation of the Investment Amount included costs of acquiring the Business. As a result, Starbev commenced proceedings in October 2012 seeking declarations that the threshold had not been exceeded.

In August 2013, CVC received €466m from exercising its option under the Note. CVC applied the 2013 threshold and paid Interbrew a total of €31.6m. Interbrew disputed this amount and issued a counterclaim seeking a declaration that the purpose of the Note was to reduce payments to Interbrew and therefore the deferred consideration should be calculated at the 2012 threshold, not 2013.

JUDGMENT

Judge Blair had to determine, a) the correct interpretation of the ‘Investment Amount’ and, b) the purpose of the Note and the correct interpretation of the words ‘the purpose of’ in the anti-avoidance provision.

‘Investment Amount’

Interbrew argued that the Investment Amount clause excluded the transaction cost of €20.4m as this cost was paid directly to third parties for their services. Interbrew further argued it was open to the draftsman to have stated that the entirety of the funds received from CVC could go to the Investment Amount but it was, in fact, limited to ‘acquiring relevant interests’ and therefore it was intended that only money spent on purchasing the shares of the Business could go to the Investment Amount. In contrast, Starbev stated all the sums invested by CVC funds were entirely applied by Starbev in acquiring the Business and that there was no good commercial reason to exclude sums paid to acquire the Business in the total Investment Amount as ‘no sane businessman would exclude acquisition costs in the calculation of his return on investment’.

In approaching the analysis, Blair J considered the surrounding circumstances, particularly the fact that Interbrew’s advisors had originally assessed the equity required from CVC on the basis that fees would be paid, and therefore Interbrew’s own estimate had included acquisition costs. Interbrew submitted that this was inadmissible as it was evidence of pre-contractual negotiations. While Blair J accepted that this was the general rule, he found that Interbrew’s understanding of the transaction costs was admissible as part of the factual matrix. He did however make it clear that it could not be more than background and could not obscure the Court’s task in construing the terms the parties eventually agreed.

Blair J concluded that, in light of the fact Interbrew had included fees in its pre-completion estimate, and against the backdrop that Interbrew knew of the acquisition costs at the outset, the transaction costs were just as much part of acquiring the Business as the price of the Business. Blair J concluded that such interpretation gave effect to the language used and there was no commercial reason for a contrary interpretation.

‘The purpose of’

Interbrew argued that as long as one of the purposes of the Note was to reduce the returns received by CVC in 2012 then the Note would fall under the anti-avoidance provision. In contrast, Starbev stated that the words ‘the purpose of’ should be interpreted as the ‘the sole purpose of’. Therefore as the Note had several purposes, such as allowing it to benefit from a rise in Molson Coors’ share price, the sole purpose of the Note was not to reduce payments to Interbrew and consequently did not fall within the anti-avoidance provision. Further, Starbev asserted it was free to pursue its own interests to the exclusion of Interbrew when structuring the onward sale.

Blair J held that Starbev’s analysis, that one must look to the sole purpose, was too narrow. He stated that to construe the term in such a way ‘would deprive the term of most if not all effect’. Blair J also disagreed with Interbrew’s construction that if one purpose is to reduce the payments to Interbrew, then the Note would fall within the anti-avoidance clause. Turning to Hayes v Willoughby[2013], Blair J relied upon the following to consider the meaning of ‘purpose’:

‘A person’s purposes are almost always to some extent mixed, and the ordinary principle is that the relevant purpose is the dominant one’.

Although this case considered the term ‘purpose’ in the context of a statutory provision, Blair J found that this was correct for the use of the word ‘purpose’ in a contractual context as well.

Turning to determining the purpose of the Note, Blair J stated that the correct approach to take was to look for the dominant purpose, which respected Starbev’s freedom to pursue its own interests while giving effect to the intention of the parties in entering into the deferred consideration agreement. The intention was expressed in the agreement – that Interbrew be allowed to participate in the returns enjoyed by CVC in the onward sale. Blair J confirmed that the test for assessing the purpose of the Note was an objective test and looked to the surrounding circumstances, reviewing an e-mail to a CVC partner on 14 October 2011 discussing options for the structure of the onward sale and how they affected payments to Interbrew, and an internal e-mail from Molson Coors, which stated that they thought Starbev had a ‘strategic and unknown agenda for delaying the receipt of the cash on the deal’. Blair J accepted that the agenda was a reference to the deferred consideration payment to Interbrew and found the dominant purpose of the Note was to reduce the payments made to Interbrew.

COMMENT

This decision confirms the existing authorities in how to approach conflicting interpretations of contractual terms in a written agreement and the fact that the courts will examine the ‘surrounding circumstances’ and not just the terms of the agreement. However, it is notable that evidence of pre-contractual negotiations was only exceptionally admissible in this case as it helped the Court determine the intention of the parties by contributing to the factual matrix and that this evidence will not supersede a court’s task in considering and interpreting the actual terms eventually agreed.

Further, this decision provides a guide for those drafting contracts, in particular, the words ‘the purpose of’ will denote the dominant purpose and will not be interpreted as ‘the sole purpose of’ nor will the words be construed widely to represent any purpose. If an agreement requires use of the expression or similar, the drafter should consider whether the phrase can be made more specific, for example, using ‘the sole purpose of’ or ‘the dominant purpose of’.

Blair J stated that this dispute stemmed from the fact the parties had put off how the deferred consideration agreement would work in practice into the indefinite future. Disputes such as these may be avoided if parties take sufficient steps to consider how an agreement will operate in reality at the time of contracting, thus minimising the risk of costly litigation further down the line.