Court of Appeal endorses commercial common sense approach

Court of Appeal endorses commercial common sense approach

Published:

Author: Joanna Lane

In the case of Chalabi & Others v Agha-Jaffar & Another the Court of Appeal has followed the recent decision by the Supreme Court in Rainy Sky SA and others v Kookmin Bank (Rainy Sky).

The court held that, when interpreting the meaning of a contract, the correct approach is to apply commercial common sense.

The facts

The claimants and the defendants owned a group of companies that were to be sold to a third party (the Buyer). The Buyer sought various warranties about the companies, which the claimants were reluctant to give. In order for the sale to proceed, the parties agreed a back to back structure whereby the claimants would first sell their interest in the companies to the defendants and the defendants would then sell the companies on to the Buyer separately, giving the required warranties.

The share sale agreement entered into between the claimants and the defendants included a warranty from the defendants that the price paid by them under that agreement amounted to three fifths or more of the sum that the defendants would ultimately 'receive for the sale' from the Buyer.

Separately, the defendants had also agreed with the Buyer that the onward sale would be structured as a share and asset sale. This structure significantly increased the defendants' tax liability and the Buyer agreed to cover the cost of any additional tax payable.

On completion of the onward sale, in addition to the purchase price, the Buyer paid $3.17m to the defendants to cover the additional tax liability. The claimants sued the defendants, claiming that the $3.17m was part of the price that the defendants had 'received for the sale' and therefore the claimants were entitled to three fifths of it. The question before the Court of Appeal was whether the tax payment constituted monies 'received for the sale' or not.

The decision

The Court of Appeal held that the tax payment did not form part of the purchase price received for the sale and was therefore not recoverable by the claimants. The purpose of the payment was to cover an expense incurred by the defendants as a result of structuring the sale in a particular way. The Court held that it did not make commercial sense to treat the tax payment as part of the purchase price. To do so would effectively allow the claimants to pocket three-fifths of the tax payment whilst leaving the defendants to pay virtually the whole of the increased tax liability. The Court of Appeal unanimously agreed that such an interpretation would be unfair on the defendants and would not reflect the commercial reality of the situation.

Comment

The case once again demonstrates the importance of ensuring commercial contracts are drafted with precision and accuracy to avoid any ambiguity in the meaning of the language used. In following the Supreme Court judgment in Rainy Sky (see: How to interpret contracts: use commercial common sense) the Court of Appeal confirmed that there is now 'the highest possible authority' that, when faced with two possible constructions of a commercial document, the more commercially sensible solution is to be preferred.