Lloyds TSB Foundation for Scotland v Lloyds Banking Group Plc
| Jurisdiction | Scotland |
| Judge | Lord Carnwath,Lord Hope,Lord Clarke,Lord Reed,Lord Mance |
| Judgment Date | 23 January 2013 |
| Neutral Citation | [2013] UKSC 3 |
| Date | 2013 |
| Docket Number | No 10 |
| Year | 2013 |
| Court | Supreme Court (Scotland) |
[2013] UKSC 3
Lord Hope, Deputy President
Lord Mance
Lord Clarke
Lord Reed
Lord Carnwath
Appellant
Helen Davies QC
Jonathan Barne
(Instructed by Group Legal, Lloyds Banking
Respondent
Richard Keen QC
Jane Munro
(Instructed by Simpson and Marwick) Group plc)
Heard on 27 and 28 November 2012
Lord Mance (with whom Lord Reed and Lord Carnwath agree)
The issue on this appeal is how a covenant should be construed and understood as applying in a novel legal and accounting context, which was not foreseen or foreseeable—or was, according to uncontradicted expert evidence, "unthinkable"—when the covenant was entered into.
The covenant was contained in a Deed agreed and executed in 1997 between the appellant, then known as Lloyds TSB Group plc and now known as Lloyds Banking Group plc (and which I shall for simplicity call "Lloyds Bank"), and the respondent, Lloyds TSB Foundation for Scotland ("the Foundation"). The 1997 Deed replaced an earlier Deed executed in 1986 and varied by agreement between the parties in 1993. The 1986 Deed was one of four entered into upon the floatation of the TSB Group plc ("TSB") and intended to provide four charitable foundations with payments totalling 1% of the pre-tax profits of the TSB.
Under Clause 2 of the 1997 Deed, Lloyds Bank covenanted to pay the Foundation the greater of "(a) an amount equal to one-third of 0.1946 per cent of the Pre-Tax Profits (after deducting Pre-Tax Losses)" for the relevant Accounting Reference Periods and "(b) the sum of £38,920". Clause 1 defined "Pre-Tax Profit" and "Pre-Tax Loss" as meaning
"in relation to any Accounting Reference Period…. respectively the 'group profit before taxation' and the 'group loss before taxation' (as the case may be) shown in the Audited Accounts for such period adjusted to exclude therefrom any amounts attributable to minority interests and any profits or losses arising on the sale or termination of an operation, such adjustment to be determined by the Auditors on such basis as they shall consider reasonable, which determination shall be conclusive and binding on the parties hereto".
The words "and any profits or losses arising on the sale or termination of an operation" were added to the 1986 Deed by the amendments mutually agreed in 1993, and were maintained in the replacement Deed mutually agreed and executed in February 1997. Clause 1 further defined "Audited Accounts" as meaning, in relation to any Accounting Reference Period, "the audited accounts of the Company and its subsidiaries for that period".
The appeal concerns the level of payment to be made to the Foundation on the basis of the Lloyds Bank group's audited accounts for 2009. Those accounts included in the consolidated income statement (the modern equivalent of a profit and loss account) a figure for "gain on acquisition" of over £11 billion, converting a loss of over £10 billion into a figure for profit before taxation of over £1 billion. This unrealised "gain on acquisition" related to the rescue of HBOS mounted by Lloyds Bank in 2008. It was described on p 160 of the accounts as reflecting the difference between, on the one hand, the book value of HBOS's assets written down by (in percentage terms) small "fair value adjustments" and, on the other hand, consideration given by Lloyds Bank of about half that written down fair value. Further insight into the envisaged and likely outcome may be provided by the Group Chief Executive officer's statement under the heading Results Overview on p 11 that
"we acquired the business at half book value in anticipation of the likely losses resulting from their troubled asset portfolios".
However that may be, unrealised profits are not the same as realised profits. There is many a slip "twixt cup and lip", and, not surprisingly, a "gain on acquisition" is not capable at any level of a group's or its members' accounts of being income distributable by way of dividends. Nor is it taxable as income. Indeed, it did not even appear in the income statement of Lloyds Bank itself, where the acquisition was accounted for at cost. At the dates of the various Deeds, it would have been contrary to both the law and accounting practice to include in a profit and loss account an unrealised item like "gain on acquisition". This remained the case until 1 January 2005, on and after which date a change in the law and accounting practice instituted at European Union level required listed companies to make such an entry in their consolidated (but not their individual) accounts, albeit with the different implications already mentioned by comparison with other items in the consolidated income statement.
In the present case, therefore, Lloyds Bank maintains that the "gain on acquisition" should be left out of account for the purposes of the 1997 Deed when ascertaining the group's profit or loss before taxation by reference to the audited accounts, while the Foundation maintains that it is no more than one of many items making up a bottom line figure for pre-tax profit or loss, with the result that the group made for those purposes a profit of over £1 billion, rather than a loss of over £10 billion, before taking into account minority interests.
To understand the Deeds, it is necessary to place them in the legal and accounting context at the dates when they were executed. In this respect, when the original Deed was made in 1986, amended in 1993 and replaced in 1997, there were two fundamental legal and accounting principles: (a) that a profit and loss account was concerned with ordinary activities before taxation and (b) that only profits realised at the balance sheet date could lawfully be included in the profit and loss account.
These principles followed from the Companies Act 1985, itself implementing the Fourth Council Directive 78/660/EEC: see Schedule 4, paras 3(6) and 12a. Schedule 4, para 3(6) of the 1985 Act read:
"Every profit and loss account of a company shall show the amount of the company's profit or loss on ordinary activities before taxation".
Schedule 4, para 12 read:
"12 The amount of any item shall be determined on prudent basis, and in particular —
(a) only profits realised at the balance sheet date shall be included in the profit and loss account; and
(b) all liabilities and losses which have arisen or are likely to arise in respect of the financial year to which the accounts relate or previous financial year shall be taken into account…."
Paragraph 91 of Schedule 4 of the Companies Act 1985 provided:
"Realised profits
91. Without prejudice to—
(a) the construction of any other expression (where appropriate) by reference to accepted accounting principles or practice, or
(b) any specific provision for the treatment of profits of any description as realised,
it is hereby declared for the avoidance of doubt that references in this Schedule to realised profits, in relation to a company's accounts, are to such profits of the company as fall to be treated as realised profits for the purposes of those accounts in accordance with principles generally accepted with respect to the determination for accounting purposes of realised profits at the time when those accounts are prepared."
The like principles applied to group accounts: section 230(1) of the 1985 Act. Their function was to "combine the information contained in the separate balance sheets and profit and loss accounts of the holding company and of the subsidiaries dealt with by the consolidated accounts but with such adjustments (if any) as the directors of the holding company think necessary": Schedule 4, paragraph 61.
The position regarding group accounts was shortly to change pursuant to the requirements of the Seventh Council Directive 83/349/EEC due for implementation by 1 January 1988. By amending section 255 of, and introducing section 255A into, the Companies Act 1985, the Companies Act 1985 (Bank Accounts) Regulations SI 1991/2705 required banking companies and banking groups to prepare their accounts in accordance with an amended Schedule 9, rather than Schedule 4, of the 1985 Act. Paragraph 19 of the amended Schedule 9 was however in identical terms to paragraph 12 of Schedule 4.
An aspect of these statutory provisions worth brief mention concerns the four prescribed Formats for a profit and loss account prescribed by Schedule 4. Consistently with the requirements of the Fourth Directive (articles 23 to 26), they list a number of items of income and expenditure; after such items, no specific line appears for "profit or loss on ordinary activities before taxation". However, the Formats then proceed (with or without a line identifying the tax) to identify "profit or loss on ordinary activities after taxation", thereafter any "extraordinary income" and, finally, "profit or loss for the financial year". Under the prescribed Formats group consolidated accounts could thus have had no single line correlating with a concept of "group profit before taxation". In fact, the group's 1986 accounts did contain such a line, entitled "Group operating profit before taxation". If they had not done, the "group profit [or loss] before taxation" would have had to beidentified by an exercise in subtraction. The figure would however still be "shown in the Audited Accounts".
In contrast, the two permissible Formats introduced by Schedule 9 amended by the 1991 Regulations had specific lines for "[profit] [loss] on ordinary activities before tax" and for "[profit] [loss] on ordinary activities after tax", followed by lines for extraordinary income or charges, for tax on extraordinary profit or loss, for extraordinary...
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