Lloyds Tsb Foundation For Scotland V. Lloyds Banking Group Plc
| Jurisdiction | Scotland |
| Judge | Lord Carloway,Lord President,Lord Kingarth |
| Judgment Date | 29 December 2011 |
| Neutral Citation | [2011] CSIH 87 |
| Court | Court of Session |
| Published date | 29 December 2011 |
| Date | 29 December 2011 |
| Docket Number | CA115/10 |
| FIRST DIVISION, INNER HOUSE, COURT OF SESSION | |
| Lord President Lord Carloway Lord Kingarth | [2011] CSIH 87 CA115/10 OPINION OF THE COURT delivered by THE LORD PRESIDENT in causa LLOYDS TSB FOUNDATION FOR SCOTLAND Pursuer and Reclaimer; against LLOYDS BANKING GROUP PLC Defender and Respondent: _______ |
Alt: Wolffe, Q.C., Barne; Maclay Murray & Spens LLP
29 December 2011
[1] The trustees savings banks which operated prior to 1986 had a tradition of charitable giving. When TSB Group plc was floated in that year there were established several charitable foundations, of which the pursuer and reclaimer was one, to carry forward that tradition. Arrangement were put in place for the funding of these foundations. In the case of the reclaimer this was done by a Deed of Covenant dated 10 September 1986 by which TSB Group plc ("the Company") bound and obliged itself at quarterly terms to pay to the reclaimer the greater of "(a) the amount equal to one quarter of one third of 0.1946 per cent of the pre-tax profits (after deducting pre-tax losses) for the accounting reference periods ... or (b) the sum of £9,730". "Pre-tax profit" and "pre-tax loss" in relation to an accounting reference period were defined as meaning "... 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, 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 thereto". "Audited Accounts" were defined for certain specified periods as "the consolidated accounts of the TSB Group plc for those respective periods ..." and for subsequent periods as "the audited consolidated accounts of the Company and its subsidiaries for that period".
[2] The 1986 Covenant was amended in 1991 and again in 1993. The 1991 amendment is not material for present purposes, except that it substituted an annual payment for four quarterly payments. The 1993 amendment provided that, with effect from 1 January 1994, the Covenant should be varied by incorporating in the definition of "pre-tax profit" and "pre-tax loss" after the words "minority interests" the words "and any profits or losses arising on the sale or termination of an operation" and by a consequential amendment to the like effect. The background to those agreed amendments, the Lord Ordinary found, was that it was contemplated that one-off, non-trading losses might arise on the sale of Hill Samuel Bank and TSB Property Services, whilst profits might arise from the sale of Swan National Leasing and Noble Lowndes. Accounting Standard FRS 3, issued by the Accounting Standards Board in October 1992, had required profits or losses on a sale or termination to be included within pre-tax profits, even though they were not included in the profit on which tax would be assessed.
[3] Following the merger of Lloyds Bank and TSB Group Ltd to form Lloyds TSB Group plc and a change in accounting period, a Deed of Covenant dated 23 January and 4 February 1997 was entered into between Lloyds TSB Group plc (the respondent in this reclaiming motion) and the reclaimer. It was in effect a consolidation of the earlier deeds. Clause 2(1) was in the following terms:
"The Company hereby covenants with the Foundation that on every Covenanted Payment Date during the period specified in Clause 3 the Company will subject to the provisions of this Clause pay to the Foundation whichever shall be 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 Accounting Reference Periods all or part of which fall within the Base Period but excluding in the case of any Accounting Reference Period part of which falls outside the Base Period that proportion of the Pre-Tax Profit or Pre-Tax Loss therefor which the duration of the said part bears to the duration of that Accounting Reference Period; and
(b) the sum of £38,920
TOGETHER with interest thereon for the relevant Interest Period calculated at the Interbank Rate".
Clause 1 had included the following definitions:
"'Audited Accounts' in relation to any Accounting Reference Period, means the audited consolidated accounts of the Company and its subsidiaries for that period".
"'Pre-Tax Profit' and 'Pre-Tax Loss' means 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."
"Accounting Reference Period", "Base Period" and "Covenanted Payment Date" were also defined but these definitions are not material for present purposes. That Deed remains in force. Its construction and application are the issues which arise in this reclaiming motion.
[4] The respondent's Annual Report and Accounts for 1997 included a consolidated profit and loss account containing an item described as "Profit on ordinary activities before tax", with figures for the current and immediately preceding accounting reference periods. Generally accepted accounting practices - which the respondent followed - did not at that stage require "negative goodwill" to be accounted for as part of profits before tax. "Negative goodwill" arises when the price paid for an acquired entity is less than the aggregate fair value of its identified separable net assets. This may occur either because the acquired business is loss-making or because the acquirer has made a good bargain.
[5] On 19 July 2002 (EC) Regulation No. 1606/2002 was adopted. It was published in the Official Journal of the European Communities on 11 September 2002. It came into force on 14 September 2002. Article 4 of the Regulation provided that from 1 January 2005 UK listed entities, of which the respondent is one, had to prepare their consolidated accounts in accordance with International Financial Reporting Standards ("IFRS"). For the purpose of the Regulation the IFRS for UK listed entities, so far as concerned the treatment of goodwill, was IFRS 3, which was adopted by the International Accounting Standards Board ("IASB") in March 2004. In December 2002 the IASB had issued an exposure draft ED 3. From 1 January 2005 the respondent, as it was required to do, adopted IFRS 3.
[6] Paragraph 56(b) of IFRS 3 required the immediate recognition of negative goodwill as a gain in the group consolidated income statement (the successor to the group consolidated profit and loss account). This had already been proposed in the consultation document ED 3, which invited comments on a number of issues relating to accountancy for business combinations. The expert witnesses for the parties to this action explained in slightly different ways the reasoning behind this treatment. Mr Simmonds, the expert led on behalf of the respondent, testified that, as set out in the Basis for Conclusions in IFRS 3, negative goodwill relates to a bargain purchase and is therefore treated as an immediate gain to be recognised immediately in the consolidated income statement notwithstanding that the gain is unrealised (since the related net assets of the acquired entity have not been realised through use or sale). Mr Merris, the expert led on part of the reclaimer, testified that, at the date of acquisition, the acquirer is immediately better off by the amount by which the fair value of what is acquired exceeds the consideration paid for it. This treatment was different from that required under previously applicable accountancy principles and statutory provisions. It was, however, directly applicable Community law and the respondent, naturally, complied with it. No amendment to the 1997 Covenant was made in anticipation or furtherance of this change in treatment.
[7] In its accounting period ended 31 December 2009 the respondent acquired HBOS. It did so for a consideration significantly below the fair value of HBOS's identified separable net assets. Negative goodwill accordingly arose and required to be reflected as a positive entry in the respondent's group consolidated income statement for that period. The figure so entered was £11,173 million. The effect of that entry was to translate the next entry into "Profit before tax" of £1,042 million, whereas if no figure had been entered for negative goodwill a loss (of more than £10,000 million) would have been brought out. For the purposes of the Deed of Covenant the figure of £1,042 million fell to be adjusted by deduction of the profit attributable to minority interests (agreed at £135 million). On that basis, according to the reclaimer, the "Pre-Tax Profits" for the Accounting Reference Period ending 31 December 2009 was £907 million. The amount payable on that basis to the reclaimer by the respondent is agreed to be £3,543,433. If, however, negative goodwill does not, for the purposes of the Deed of Covenant, fall to be treated in this way, the reclaimer's entitlement is restricted to the minimum sum of £38,920.
[8] The Lord Ordinary considered that there were two approaches towards construction which might be adopted by him: to address first the words used in the contract and thereafter to consider whether any relevant background caused him to depart from the meaning suggested by the words or, alternatively, to conduct a single exercise by addressing the words used against the context of any relevant background. He adopted the first approach. Having done so he concluded (para [72])...
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