Contract – Construction – Side letter – Claimant seeking declaratory relief as to meaning of side letter to agreement for refinancing of loan – Whether terms of letter requiring profit on sale of property before defendant liable to pay agreed sum to claimant – Claim allowed
The claimant was a company incorporated in the British Virgin Islands. Its primary business was making short-term or bridging loans against the security of real property. The defendant carried on business buying and selling real estate and purchasing and developing properties.
In 2015, the defendant purchased for development a twin tower block in Poole, Dorset for around £2.8 million. In 2018, it was looking for new capital to pay off its existing indebtedness and entered into a written secured loan facility agreement with the claimant. The facility was for a one-year loan (less a day) of just over £2.8 million. Although the purpose of the loan was defined as for the purchase of property, it was in fact to pay off earlier lending. The loan was guaranteed by the defendant’s then parent company secured by a second legal charge over other land and buildings. In September 2018, the defendant entered into a legal mortgage of the property and a debenture in favour of the claimant.
Following default under the loan agreement, a third party (C) agreed to re-finance the loan in part. There was a shortfall of about £155,000 between the re-financing monies C was prepared to provide and the sums required to discharge the claimant’s loan. Therefore, the parties agreed a side letter which provided for the defendant to pay the claimant “a sum of £213,000 by way of preferred profit… from the proceeds in the event of a sale or refinance of… [the property] … after repaying the first charge loan, legal fees and related transaction costs”.
In 2020, a sale of the property was agreed and the claimant sought payment of the £213,000. However, the defendant argued that, as the sale was likely to result in a loss, there would be no profit from which the sum could be paid pursuant to the side letter. The claimant sought declaratory relief as to the meaning of the side letter.
Held: The claim was allowed.
(1) When construing a contract, the overall process was a unitary exercise involving an iterative process which involved not just a consideration of the words of a contract but a consideration of the same against the relevant background knowledge and the commercial consequences of competing constructions. However, in general, the parties’ negotiations were inadmissible as an aid to construction of an agreement. If there were two possible constructions, the court was entitled to prefer the construction which was consistent with business common sense and to reject the other. Where the parties had used unambiguous language, the court had to apply it. The court also had to consider the commercial consequences of competing constructions, although the purpose of interpretation was to identify what the parties had agreed, not what the court thought they should have agreed: Global Display Solutions Ltd v NCR Financial Solutions Group Ltd [2021] EWHC 1119 (Comm) followed.
In the present case, the side letter clearly stated that the payment was to be made from the proceeds in the event of a sale or refinance of the property (not from any profit). Furthermore, the sum fell due to be paid after repaying the first charge loan, legal fees and related transaction costs. The source of the payment was from the relevant proceeds. The question was whether the characterisation of the payment as a preferred profit distribution overrode or affected the clear words of the side letter regarding when and from where the payment was to be made.
The words of the agreement, so far as they referred to preferred profit, were seeking to characterise what the payment of £213,000 was, not when it fell due nor where the payment was to be sourced from. Further, that characterisation did not further limit the clear words of the clauses providing for the payment of the fixed sum to be made from the proceeds, after the discharge of the C loan and the transaction costs.
(2) If the payment was only to be made if and to the extent that the defendant had made a profit on the overall holding of the property, the side letter would have needed to say so expressly, not least because it provided for payment out of the proceeds of sale or refinancing. It was difficult to see how a standard refinancing by way of further loan could give rise to a profit or indeed how a profit could begin to be calculated until the property was in fact realised. A profit might be identified (but not be realised) if, for example, at the time of the refinancing, a valuation of the property was undertaken as at an anticipated sale date and existing and anticipated liabilities in achieving that sale were valued and calculated. However, there was no mechanism in the side letter to provide for any such process or to identify on what basis it would be carried out. The natural reading of the side letter was that profit meant something different to proceeds. The reference to further distribution was further to any distribution to the claimant.
On the basis that the third party would not agree to a second charge over the property, the side letter attempted to provide a mechanism that would delay any right to repayment of the claimant until after repayment of the C loan, without any acceleration clauses for default or the like; and provide a contractual right to repayment out of future sale/refinancing proceeds but no equitable security right to the same (for example, one valid as against third parties or on insolvency). That was why the preferred profit language was used to characterise the nature of the payment.
(3) The absence of any proper mechanism to determine profit (and the uncertainty as to what it meant) and the inability of the side letter to apply to refinancing if sums could only be paid to the extent that the defendant had distributable profits under the Companies Act 2006, led to the conclusion that the side letter did not require the payment under it to be made only from distributable, or any other, profits of the defendant.
In its textual context, the side letter provided for payment of the £213,000 from, amongst other things, the proceeds of sale of the property and irrespective of whether the defendant had distributable profits.
Victor Steinmetz (instructed by DLA Piper LLP) appeared for the claimant; The defendant appeared by its representative.
Eileen O’Grady, barrister
Click here to read a transcript of Whitehall Capital Ltd v Land South East Ltd
