Mr Justice Andrew Smith :
Introduction
- Macquarie Internationale Investments Limited ("Macquarie") claim damages from Glencore UK Limited ("Glencore") for breach of warranties in a Sale and Purchase Agreement ("SPA") dated 31 July 2006 for the acquisition by Macquarie of the shares in Corona Energy Holdings Limited ("Corona"), the parent company of the Corona Energy group (the "Group"), a leading supplier of energy, principally natural gas, to the commercial sector in the UK. Their complaint is that Corona's subsidiaries had incurred charges (the "Charges") to Xoserve Limited ("Xoserve") that were not recognised in the relevant accounts and not disclosed to them. The Charges were:
i) a charge for gas supplied through some 276 meters for which Xoserve had not invoiced the Group in the usual way. I shall refer to this as the "Missed Meters charge". Macquarie say that, if the accounts had been as warranted in respect of the Missed Meter charge, they would have paid £2,496,522 less for the shares.
ii) charges that, as Macquarie say, were for gas supplied through meters that in the year ended 30 September 2006 increased their consumption and came to be categorised as "Larger Supply Points" rather that "Smaller Supply Points". I shall refer to these charges (for reasons that will become apparent) as the "Mod 640 charges". Macquarie say that, if the accounts had been as warranted in respect of the Mod 640 charges, they would have paid £599,514 less for the shares.
- The Group includes a number of retail companies. Corona, now known as Macquarie Corona Energy Holdings Limited, own the share capital in Corona Energy Limited, who in turn hold the shares in three retail companies, Corona Energy Retail 1 Limited ("Corona 1"), Corona Energy Retail 3 Limited ("Corona 3") and Corona Energy Retail 4 Limited ("Corona 4"). Corona 1 hold the shares in Corona Energy Retail 2 Limited ("Corona 2").
- In about August 2004, Glencore acquired a 25% interest in Corona. At the same time the Glencore group made a gas supply agreement with the Group, and during the period material to this claim the Group bought from Glencore almost all of the gas that they supplied.
- At the time of the SPA, the Group were trading at a loss and significantly below management expectations. According to the Group's consolidated unaudited management accounts for January to June 2006 (the "Management Accounts"), their turnover in the six months to the end of June 2006 was £191.9m and the cost of sales was £190m, leaving a gross profit of £1.9m, some £3.6m below budget. Over that period, the Group made a net loss of £2,075,000, compared with a budgeted profit of £1,113,000.
- By the SPA, Macquarie bought the entire issued share capital in Corona for £5,741,000. They were sold by Glencore, Baring European Fund Managers Limited and Flenwood Limited.
- Under the SPA, Macquarie were given various warranties about the audited statutory accounts for the year ending 31 December 2005 of Corona and the subsidiaries (the "Accounts"), about the Management Accounts, and about Corona's "books and records", an expression which Macquarie submit includes the Accounts and Management Accounts. The SPA referred to the Accounts as draft statutory accounts: in fact they were audited by and signed on 15 September 2006, the day when the SPA was completed. Only Glencore gave the warranties, having agreed with the other vendors in return for a premium to be the sole warrantor.
- In summary, Macquarie's complaint is that the Accounts and the Management Accounts were not as warranted because neither provided for the Missed Meters charge and because no provision was made in the Management Accounts for the Mod 640 charges. (They abandoned during the trial a complaint about the treatment of the Mod 640 charges in the Accounts, accepting that it was not material.) Macquarie's primary case, as it was opened by Mr Michael Fealy, who represented them, was that if the Charges had been properly recognised in the Management Accounts, the Group would have recognised additional liabilities in the sum of £2,977,000, and that they would then have paid £3,096,036 less under the SPA, because the price that they paid was dependant upon the Exchange Accounts, accounts prepared as at 31 July 2006 in accordance with the SPA, and the Management Accounts and the Accounts influenced the preparation of the Exchange Accounts.
- Glencore admit that the Group incurred the Charges, and provision was not made for them in the Accounts and the Management Accounts. Glencore dispute that at the relevant times they were to be treated as "liabilities" for accounting purposes, dispute that they affected the financial statements in any relevant way, say that in any event the Group's arrangements and obligations for paying for gas were sufficiently disclosed to Macquarie, and say that the Charges were not material. The essential question is whether therefore Glencore were in breach of warranty in respect of the Charges or either of them.
Evidence
- The dispute between the parties about the primary facts is fairly limited and there was only one witness of fact. Macquarie called Mr Gary Russell, who is a chartered accountant and, having joined the Group as a financial controller in 1998, has been the Finance Director of Corona since 31 July 2003. I consider that he was an honest witness, but I have been unable to accept all of his evidence and he did not have any direct or detailed knowledge about some of the matters about which he gave evidence.
- Macquarie suggested that in some way I should draw inferences against Glencore because they did not call evidence of fact and because they put Macquarie to proof upon some elements of their claim without advancing a positive case. Mr. Fealy cited the judgment of the Privy Council in Gibbs v Rea, [1998] AC 786, at p.798H/799A per Gault J.:
"It was of course open to the defendants to elect to give no evidence and simply contend that the case against them was not proved. But that course carried with it the risk that should it transpire there was some evidence tending to establish the plaintiff's case, albeit slender evidence, their silence in circumstances in which they would be expected to answer might convert that evidence into proof"
- I do not consider that this principle assists Macquarie. Glencore had no relevant evidence of fact to adduce, unsurprisingly given that they had sold their interest in Corona. This is not a case in which Glencore remained silent "in circumstances in which they would be expected to answer". On the contrary, I have had to consider what inferences I should draw because Macquarie did not call evidence from anyone in their Operations Team to explain what they knew before the SPA was concluded and completed about what gave rise to the Missed Meters charge. Macquarie did not adduce evidence from Mr. Crosland of the "Operations Team", who represented the Group at a meeting on 7 June 2006 of a body called the Billing Operations Forum (the "Forum"), at which, according to Macquarie, Xoserve provided significant information, nor did they adduce evidence from any recipient of the minutes of that meeting. Mr. Crosland was still employed by the Group at the time of the trial (although he was then leaving them) and there is no apparent reason that he or other recipients of minutes of the meeting could not have given evidence. Instead, Mr. Russell gave evidence about what he had been told by a Mr. Nicholas Ansbro, a former legal counsel to Macquarie, of what Mr Ansbro had been told by Mr. Crosland and two other recipients of the minutes about their reaction to them, without referring to Mr. Crosland's reaction to what was said at the meeting itself.
- Both parties called an accountant to give expert evidence. Macquarie called Mr. Jonathan Lovell, a partner in KPMG LLP. Glencore called Mr. Peter Dickerson, a consultant in the Forensic Services Department of Baker Tilly Restructuring and Recovery LLP. Both were well qualified to give their expert opinions, but, perhaps inevitably in view of the subject-matter of their evidence, both were at times drawn into expressing their opinion about questions of fact, which were strictly outside their proper remit. Nevertheless, I found Mr Dickerson a particularly impressive witness, who supported his opinions with cogent reasons and paid meticulous attention to detail. He appeared to me more willing to engage with some of the complexities of the case than Mr Lovell.
- I should mention, because Macquarie referred to it in their submissions, that Glencore brought part 20 claims in these proceedings against Mr. Russell and also against Mr. John Spellman, who was Corona's Managing Director until November 2007. On 21 July 2008 Paul Walker J gave summary judgment in favour of Mr. Russell and Mr. Spellman on the grounds that the proceedings against them were brought in contravention of the SPA. It does not seem to me that this part of the procedural history bears upon what I have to decide.
The Uniform Network Code
- In the United Kingdom gas is received from shippers at reception points known as beach terminals into the network of pipes known as the National Transmission System (or "NTS"). It is delivered to customers under arrangements between customers and suppliers through twelve Local Distribution Zones ("LDZs") by gas transporters, who own and operate the transmission and distribution system. While gas is in the NTS, it is pooled and is not allocated between shippers.
- Businesses such as the Group both ship gas into the system and supply it to customers. The balance between the amount of gas supplied to and the amount of gas drawn from the NTS by the shipper is managed through Xoserve, a company jointly owned by the five major gas distribution network companies and, as I understand it, National Grid NTS Limited ("National Grid"). Xoserve were founded in May 2005, when some of the distribution network was sold by National Grid, and their principal role was described by Mr. Russell as being to act as an "interface" between gas shipper companies and the distribution network companies. Xoserve operate information systems to calculate the volumes of gas that each shipper puts into the system and takes out of the system, and to calculate and collect charges for the imbalance between them: generally these charges are relatively small, because shippers have financial incentives to balance the gas that they supply to the system and the gas that they draw. The relationship between Xoserve and the shippers is governed by the Uniform Network Code (or "UNC"), by which Corona and all relevant subsidiaries of Corona are bound.
- The amount of gas consumed by customers is measured by meters at their premises. Each meter is known as a supply point. Some meters, known as Daily Meters (or "DMs"), are connected electronically to Xoserve and are read each day; others, known as Non-Daily Meters (or "NDMs"), are read less frequently. Most of Corona's customers have NDMs.
- In advance of each "gas year", an annual period from 1 October to 30 September, Xoserve estimate how much energy will pass through each meter in the year, an amount known as the Annual Quality or AQ. Xoserve allocate to each supply point an End User Category (or "EUC") by reference to the nature of the customer's business and other considerations relevant to consumption. They also categorise each supply point as either a Larger Supply Point, if its AQ is greater than 73,200 kWh, or a Smaller Supply Point, if its AQ is not greater than 73,200 kWh (or 2,500 therms). In broad terms, the Group supplies some 40,000 Larger Supply Points and some 10,000 Smaller Supply Points (whereas, according to a document called "Reconciliation by Difference Principles" published by Xoserve dated 1 February 2006, in all there are around 20 million Smaller Supply Points and around half a million Larger Supply Points in the United Kingdom).
- The Group send monthly invoices to their customers, using a computer system called ESI, which holds a database of all the supply points that they serve. For those customers with a DM, invoices reflect the actual consumption of gas in the month before billing, and for those with a NDM, they are based either on actual consumption, if the meter has been read, or on the Group's estimate of the supply point's AQ.
- Each day Xoserve compare the quantity of gas that each shipper is treated as having delivered to the system (the User Daily Quantity Input or "UDQI") with the quantity of gas that it is treated as having taken from the system (the User Daily Quantity Output or "UDQO"). The difference is the shipper's Daily Imbalance, which is treated by the UNC as having been bought and sold under a System Clearing Contract between the shipper and National Grid. Thus, if a shipper supplies less than it draws from the system, it is treated as a purchaser of gas and receives a "Balancing Invoice" for it.
- The UDQO is first provisionally determined by reference to actual consumption through DMs and estimated consumption through NDMs. Five days later Xoserve make a revised estimate of the energy consumed by the NDMs, and this, together with the actual consumption through DMs, provides what is known in the industry as the "D+5" quantity.
- In the case of Larger Supply Points with a NDM, when Xoserve later receive from the shipper information about a supply point's consumption from a meter reading, they carry out an "Individual NDM Reconciliation" between the measured consumption and the estimated consumption for the supply point used to assess the D+5 quantity. Hence, a "Reconciliation Clearing Value" is determined by reference to the daily prevailing System Average Price. Under the machinery of the UNC, each Individual NDM Reconciliation is treated as giving rise to a System Clearing Contract between the shipper and National Grid, and, if the Individual NDM Reconciliation shows additional consumption, a Reconciliation Clearing Charge is made to the shipper under a "Reconciliation Invoice".
- Xoserve reconcile consumption through Smaller Supply Points on an aggregate basis, without reference to individual meter readings. In broad summary, a User Aggregate Reconciliation Clearing Value for each LDZ is determined for each shipper by reference to the volume of gas supplied to that LDZ and the shipper's share of the relevant market. This procedure is known in the industry as Reconciliation by Difference or "RbD".
- The UNC permits Xoserve to correct errors in the amounts claimed in previous invoices by issuing an "Ad Hoc Invoice". However, after the expiry of 18 months after the "Invoice Due Date" (which was generally the later of 12 days after an invoice is treated as received or 20 days after the last day of the billing period to which it relates), no adjustment may be made to an invoiced amount in the absence of fraud or some other exceptional circumstances (under provisions the details of which are irrelevant for present purposes).
- Shippers also incur transportation costs to Xoserve, which include commodity charges. They are variable charges based on the quantity of gas shipped.
The Mod 640 charges
- As I have indicated, the UNC requires Xoserve to carry out an annual review of the AQ for each supply point to determine its AQ for the forthcoming gas year. They are to determine provisional AQs by 31 May each year, and to notify the shippers of them and, where available, the meter readings used to determine them by no later than 31 May in the case of Smaller Supply Points, and 30 June in the case of Larger Supply Points. The shipper has limited rights to object to a provisional AQ.
- The formula for determining AQs is complicated, and requires a calculation of the Relevant Metered Quantity, which is made by reference to the consumption measured by meter readings during the Relevant Metered Period, a period that ends with the "ending Meter Read", the latest Valid Meter Reading before 10 August before the gas year for which the AQ is being calculated. Xoserve extrapolate from that metered quantity a seasonally adjusted estimate of consumption by the meter in the gas year, which provides the AQ. If there are not the required meter readings, the provisional AQ is generally set at the same as that for the previous year. The formula does not depend upon only the Relevant Metered Quantity but other factors, such as an Estimated Weather Correction Factor.
- As a result of the AQ review, a Smaller Supply Point might be given an AQ of more than 73,200 kWh and so be reclassified as a Larger Supply Point. These meters are referred to in the industry as 'threshold crossers'. As Larger Supply Points, the meters come to be individually reconciled when they are read, rather than included in the aggregate Reconciliation by Difference of Smaller Supply Points. More importantly for present purposes, in the case of some threshold crossers the shipper might be liable for a charge which was introduced from 1 October 2004 following the implementation of modification 640 to the UNC. The UNC calls it a "Reconciliation Clearing Charge" in respect of the "User Annual Quantity Revision Difference Clearing Value", but it is commonly referred to in the industry as a "Mod 640 charge". Under the scheme of the UNC, when a Mod 640 charge is incurred, a System Clearing Contract is treated as having been made and the charge to the shipper is payable under it when invoiced by Xoserve.
- The amount of the User Annual Quantity Revision Difference Clearing Value, and so the amount of the Mod 640 charge, is determined by reference to the User Annual Quantity Revision Difference, the difference between the revised AQ and the AQ in the previous year. It is supposed that this additional consumption represented by the difference was consumed pro rata over the year and on this basis the Charge is calculated from (i) the additional demand attributed to the meter in each day of the last gas year in which it was classified as a Smaller Supply Point and (ii) the System Average Price for that day. However, as Mr Dickerson stated in his (unchallenged) evidence, the consumption through the meter is only one factor taken into account in setting a new AQ, and, if only because the procedure for setting a new AQ starts well before the end of the gas year, the new AQ can never reflect the actual consumption throughout the gas year. It is intended rather to be an estimate of the anticipated consumption of the meter in the next gas year. (Mr Dickerson illustrated this by referring to an email dated 20 April 2007 from Xoserve to the Group referring to a Mod 640 change where the AQ increased by 10,887,277 kWh, but the charge was based upon an AQ difference of 10,326,354 kWh.)
- At the time material to this claim, a Mod 640 charge was incurred in respect of threshold crossers only where (i) the AQ was increased by more than 20% and by at least 15,000 kWh; (ii) there had not been a change in the shipper registered to that supply point during the year; and (iii) the AQ had not been increased as a result of a report by the shipper before the Provisional AQ had been determined. In October 2006, the first and second of these conditions were removed with retrospective effect, these further changes being known in the industry as Mod 94 and Mod 95 respectively.
- Following the AQ review in the year ended 30 September 2006, 266 of the meters registered to the Group were threshold crossers. 257 of them had been supplied with gas by the Group prior to 31 July 2006, and the customers of 249 of them had been invoiced by the Group before 31 July 2006.
- By invoices dated 26 March 2007, Xoserve demanded payment from subsidiaries of Corona of £743,173 in respect of End of Year AQ Reconciliation Clearing Charges for the year ended 30 September 2006. These charges were incurred by Corona 1, Corona 2 and Corona 4 (which shipped gas and acted also for Corona 3 for relevant purposes and paid charges in respect of their customers). Of the sum of £743,173, £40,392 is attributable to the Mod 94 and Mod 95 changes, which were made after the SPA was completed and in respect of which Macquarie make no claim, and £702,781 is otherwise attributable to the Mod 640 charges.
- Mr. Russell has calculated how the charges built up by reference to the gas in respect of which the Group had invoiced customers by 31 December 2005 (the date of the Accounts), by 30 June 2006 (the date of the Management Accounts) and 31 July 2006 (the date of the SPA and the Exchange Accounts). I accept that his evidence about this is sufficiently reliable for the purposes of determining the issues between the parties . The figures are as follow -
i) By 31 December 2005: £74,000 in total, being £7,000 for Corona 1, £18,000 for Corona 2 and £49,000 for Corona 4.
ii) 30 June 2006: £543,000 in total, being £30,000 for Corona 1, £207,000 for Corona 2 and £306,000 for Corona 4.
iii) 31 July 2006: £599,514, being £32,000 for Corona 1, £241,000 for Corona 2 and £327,000 for Corona 4.
The Missed Meters charge
- Xoserve have three computer systems. Their "Sites and Meters" system holds a data base of all supply points, recording the shipper who supplies them and their AQs. If a customer changes supplier, the shipper registered for the supply point is amended. Xoserve's "Inv 95" system is used to produce most transportation invoices for charges made to shippers by the distribution network companies, and also to produce reconciliation invoices or credit notes, drawing upon information held in the Sites and Meters system and Xoserve's "Gemini" system.
- Since about 18 October 2005 Xoserve have used the Gemini system to determine on a daily basis the quantity of gas that each shipper is required to put into the system. Before then Xoserve determined this using a computer system called "AT Link", from which data was transferred to Gemini. Gemini does not hold details of each individual supply point, but collates information in terms of the aggregate AQ for each shipper's supply points, broken down by EUC and LDZ. Xoserve use Gemini to assess from that and other information, such as weather conditions, the aggregate D+5 quantity of gas drawn off the system by each shipper.
- The supply points registered to shippers constantly change as suppliers gain or lose customers. The record maintained by Gemini, or previously AT Link, of each shipper's aggregate AQ is updated each day on the basis of information received from the Sites and Meters database, and so the information on the Gemini and the Sites and Meters systems should always correspond in aggregate.
- On 3 October 2005, when preparations were being made to bring Gemini into operation, some information was not properly transferred from Sites and Meters. It related to customer withdrawals (that is to say, supply points lost by suppliers because they were shut down or because the customer changed supplier) notified on 2 October 2005 and confirmations (that is to say, new supply points or supply points gained from other suppliers) notified on 3 October 2005. Corona 2 lost 22 meters on 2 October 2005 and gained some 276 meters on 3 October 2005. (The precise number of meters gained is unclear and unimportant: possibly the Group registered one or two more meters, and apparently gas was never supplied through two of the meters. It is also unclear whether the error was made in transferring information to Gemini itself or in transferring it to the AT Link system initially, so that information later passed to Gemini from AT Link was incomplete. I shall, for convenience, take it that 276 meters gained by Corona 2 were not recorded on the Gemini system. I shall use the expression "Gemini error" to refer to the failure to record the information about these meters and the 22 meters on the Gemini system.) Corona 4 were also affected by the Gemini error, but in their case it resulted in Xoserve overcharging Corona 4 by a small amount, some £23,000, and Corona 4 becoming entitled to a net credit from Xoserve. Because of the Gemini error, when the Gemini system came into operation, the Group's aggregate AQ recorded on it was lower than it ought to have been. As a result, from then until the error was rectified in September 2006, Xoserve neither required the Group to provide to the NTS system the equivalent of the D+5 quantity of gas consumed through the 276 meters, nor charged the Group for this shortfall. On the other hand, Xoserve did require that the Group provide to the system the D+5 quantities attributed to the 22 meters, which the Group no longer supplied.
- The Missed Meters charge reflected an error by Xoserve about the D+5 consumption charged to the Group. It did not affect later reconciliations between the D+5 quantity and consumption reported from actual meter readings at Larger Supply Points or estimated readings for those meters that were not read. These actual or estimated readings were reported and recorded in the usual way for the meters that the Group had gained on 3 October 2005, because Xoserve did not use the Gemini system for the purpose of individual reconciliations, and Xoserve charged the Group for the difference between the actual consumption of gas and the D+5 estimate for them. But this did not pick up the D+5 quantity, which should have been, but had not been, already reconciled through the Gemini system.
- Similarly, because Xoserve did not use the Gemini system to calculate transportation charges, these were not affected by the Gemini error. The Group were invoiced for and paid the correct transportation charges incurred by shipping gas to the meters gained on 3 October 2005 and were not mis-charged for transportation to the 22 meters lost on 2 October 2005.
- After the Gemini error had been discovered and its effect calculated, on 5 January 2007 Xoserve charged Corona 2 £3,174,819.91, inclusive of VAT, under an Ad Hoc Invoice and Corona 2 paid it on 8 January 2007. This gave rise to the Missed Meters charge. The charge net of VAT was £2,701,974.39 and, as with the Mod 640 liability, it built up over the year to 30 September 2006. Macquarie's pleaded case is that the liability that had built up by 31 December 2005 was £474,441 and this liability should have been included in the Accounts; and that the liability that had built up by 30 June 2006 was £2,433,833 and this figure should have been included in the Management Accounts. It is also pleaded that by 31 July 2006 the liability that should have been brought into the Exchange Accounts was £2,496,522. These figures were supported by the evidence of Mr. Russell.
- There is now no dispute that, if any sum should have been included in the Exchange Accounts in respect of the Missed Meters charge, the figure should be £2,440,187, a figure derived from an adjustment made to Mr. Lovell's calculation that Macquarie accept is appropriate.
- The pleaded figure of £2,433,833 for the liability as at 30 June 2006 was not the subject of any challenge by Glencore, and I accept it as sufficiently accurate for the purpose of deciding the issues between the parties.
- In the course of final submissions, Mr. Fealy applied to amend Macquarie's pleading about the liability that had been built up as at 31 December 2005, and to allege that it was £566,000 rather than £474,441. It was unfortunate that this application was made so late, after Mr Russell, the only witness of fact, had supported the pleaded figure. However, Mr. Lovell had produced in his expert report dated 13 February 2009 a calculation that supported the figure of £566,000. The difference between the two figures reflects a difference in treatment of gas consumed through the 276 missed meters in December 2005, in respect of which customers had not been invoiced as at 31 December 2005. Mr. Dickerson's second supplementary expert report dated 3 July 2009 appeared to accept Mr. Lovell's basic approach, and in cross-examination Mr. Dickerson said that Mr. Lovell's approach was "more reliable" than that of Mr. Russell.
- When faced with the application to amend on the last day of trial Mr. Richard Southern QC, representing Glencore, initially opposed it. I reserved my decision, and accepted short supplementary submissions in writing. In light of Mr. Fealy's written submission, Glencore withdrew their opposition to the application, while observing that the amendment could not assist Macquarie.
- I agree that it is difficult to see how the amendment can affect the result of the proceedings, not least because Mr. Lovell said in cross-examination that he did not think that the difference between a liability of £474,000 and £566,000 would be sufficient to affect whether the item was material to the financial statements in the Accounts. Nevertheless, I consider that in view of the expert evidence I should allow the amendment so that Macquarie can advance the case which is supported by Mr. Lovell and which Mr. Fealy seeks to advance. There is little evidence before me about what is the appropriate figure for the Missed Meters charge as at 31 December 2005, but in view of the opinions expressed by Mr Lovell and Mr Dickerson, the best estimate that I can make is £566,000, and I so find.
Corona's accounting procedures: the Missed Meters charge
- Macquarie's case is that, because of the Gemini error, from October 2005 Xoserve did not require the Group to provide to the NTS the full amount of energy drawn off by them nor did they charge them for the imbalance. However, the Accounts, the Management Accounts and the Exchange Accounts recognised all revenue in the relevant period from gas sales, including revenue from the customers whose 276 meters were missed, apart from revenue from gas consumed in the last month of any accounting period, which had not been invoiced. (I shall refer to the 276 missed meters, without reference to the 22 meters wrongly included on the Gemini system, which to a limited extent off-set the impact of the 276 missed meters.)
- Mr Russell explained the Group's invoicing procedures and how the Group's Management Accounts were prepared. Each month the Group prepared management accounts, which showed both monthly figures and cumulative year-to-date figures. They were consolidated accounts, and not produced for the individual companies in the Group. The Group intended to prepare them in accordance with UK GAAP (Generally Accepted Accounting Principles).
- In preparing management accounts, the Group initially used their ESI system to calculate the net revenue from supplying gas to customers. The ESI system was linked to Xoserve's Sites and Meters system, so their records of meters corresponded, and this calculation was unaffected by the Gemini error. The Group then adjusted the volume of gas taken to have been supplied to customers to bring the revenue into line with Xoserve's D+5 assessment. This information came from the Gemini system, and so because of the Gemini error any revenue for gas supplied through the missed meters was excluded from the accrued revenue. This did not significantly distort the gross profit figure because neither was the cost of this supply brought into account.
- A spreadsheet prepared by Mr. Russell for the purposes of this litigation reflects how these adjustments were affected by the Gemini error, which was made in October 2005 and corrected at about the beginning of October 2006: the information was not contemporaneously collated in this way and the pattern shown in the spreadsheet would not have been available in this form before the litigation. Between October 2003 and September 2005 the general pattern (in 22 of the 24 months) was that the adjustments to the Gemini generated D+5 assessment increased the consumption figure: the only reductions in this period were by 9,768 therms in August 2004 and by 69,855 therms in June 2005. The pattern changed in October 2005, and thereafter in each month to August 2006 the adjustments reduced the consumption by between 188,067 therms and 885,794 therms. In terms of annual volumes, between October 2003 and September 2004 the D+5 assessment increased the estimated consumption by 996,281 therms, between October 2004 and September 2005 the D+5 assessment increased the estimated consumption by 730,838 therms, but between October 2005 and September 2006 the D+5 assessment reduced the estimated consumption by 5,455,779 therms.
- This change cannot be wholly attributed to the missed meters, but I accept Mr. Russell's evidence, which is supported by Mr. Lovell, that in the year October 2005 to September 2006 for the most part, as to some 4.6 million of the 5,455,779 therms, the relatively large adjustments were related to the 276 missed meters, and so attributable to the Gemini error.
- There is a curiosity about these figures in that in September 2006 and October 2006, after the Gemini error had been corrected, there were still adjustments reducing the consumption by more than 1,000,000 therms each month. Mr Dickerson suggested that this showed that "factors other than the Xoserve error were exercising a significant influence on the amount of the D+5 adjustment". Mr. Russell's explanation for these two months was that, after Macquarie had acquired Corona, the Group changed their end of month accounting procedures, and were required to report within three days of a month end, rather than within three weeks as previously. The D+5 assessment for the last few days of the month was not available in time to be included in these procedures and later adjustments were required. This was the more significant for September and October 2006 because the weather was uncharacteristically warm at the end of the months and the difference between the consumption estimated by the ESI system (which does not adjust to actual weather and assumes normal seasonal weather) and the assessment from the Gemini system was the greater. When Mr. Russell was cross-examined about this, I was surprised that an uncharacteristic weather pattern over a few days could have such a major effect on the consumption of gas, but I have no reason to doubt Mr. Russell's explanation and I accept it.
- The next relevant stage in the Group's accounting procedures after the adjustment to the D+5 information was that they sent customers invoices early in each month (generally in the first seven to ten days of the month following the month of supply), charging them for the previous month's supply. These were based either on actual meter readings or on the AQs for the meters held in the ESI database: they were not produced by Gemini and were not affected by the Gemini error.
- At the end of each month, the cumulative balances on the nominal ledgers kept by the Group were transferred to a computer based spreadsheet to make month end adjustments, and the information for each company was gathered, with appropriate inter-company adjustments, into consolidated monthly management accounts. Two documents were produced: one entitled Consolidated Management Accounts and the other entitled Consolidated Management Accounts Executive Summary (the "Executive Summary"). The Consolidated Management Accounts comprised a consolidated profit and loss account, a balance sheet, a cash flow analysis and other financial information.
- The Group prepared their management accounts on the basis of the invoiced amounts, and, because during the relevant period they included the 276 missed meters, the revenue from these meters, some £2,974,838, was brought into account in the accrued revenue account on the balance sheet.
- The accrued revenue account also recorded Xoserve's reconciliation statements (whether invoices or credits) for the costs of gas. However, the reconciliation statements were concerned only to adjust the consumption of gas that Xoserve had calculated by way of the D+5 assessment: the estimated consumption of gas though the missed meters that had been erroneously omitted from the D+5 assessment was not brought into Accrued Revenue account either though the reconciliation statements or otherwise. Thus, at this stage in the preparation of the management accounts, although all the revenue generated by supplies through the 276 meters was brought into account, much of the cost of those supplies was not.
- Glencore submitted that, because Macquarie's evidence was directed to the aggregate amount of the revenue credited to the accrued revenue account and not to what is attributable to individual meters, they have not established whether the Management Accounts did in fact recognise revenue without bringing into account the full cost of the sales that produced the revenue. By way of an extreme example to illustrate the point, they posit the position if the gas represented by the £2,974,838 had all been consumed through one meter, and observe that then all the gas apart from the D+5 assessment attributed to that one meter would have been paid for. This does not seem to me to answer Macquarie's argument: they have shown, as I conclude, that all the customers who were supplied through missed meters were invoiced either according to their actual meter reading or in accordance with their AQ; and that the revenue as invoiced was brought into the Accrued Revenue account, and, because the initial entry for the cost of sales based on the ESI system was reconciled to the Gemini generated D+5 assessment, the cost of the sales, in so far as the consumption should have been included in the D+5 assessment, was not brought into account.
- According to Mr. Russell, each month the Accrued Revenue account on the balance sheet was reconciled, and unsupported differences were transferred to the profit and loss account, where they were recorded under "Turnover – Ext – Gas Sales". When these transfers were made, it was believed that the Accrued Revenue account recognised the full cost of the sales reflected in the revenue that had been recognised. Favourable balances were observed on the balance sheet (as I shall explain further below), but Mr. Russell thought that these were attributable to advantageous price variations.
- Macquarie say that, as a result of these transfers, the distortion of the Accrued Revenue because of the missed meters came to be reflected in the Management Accounts and that the gross profit of the Group was overstated. Glencore do not accept that Macquarie have established this: as it was put by Mr. Dickerson in his second report, "… the case advanced by [Macquarie] … is that the claimed errors were the only errors in the accounts. The assumption, that there were no other errors, is not supported by any disclosed evidence. It is ... just as reasonable to assume that there may have been other errors which disguised the effect of the claimed errors. The possible existence of such further errors would provide an explanation for why the claimed errors were not identified at the time."
- This raises two questions:
i) Was the gross profit inflated because it reflected revenue from the missed meters while not accounting for the corresponding costs of sales?
ii) Does the SPA prevent Glencore from disputing that the gross profit was so inflated?
- The annual accounts were based generally (and so far as is relevant for present purposes) on information assembled for the Management Accounts, and so the Accounts of the Group and Corona 2 for the year ended 31 December 2005 similarly reflected the revenue from the missed meters but not the full cost of sales, and therefore, as Macquarie say, were similarly distorted.
Was the gross profit inflated because it reflected revenue from the missed meters but not the corresponding costs of sales?
- The Group adopted a balance sheet approach to accounting for accrued revenue and other items: that is to say, each month they calculated the amount required in the balance sheet and transferred any differences (arising in movements in balance from one month to the next) to the profit and loss account. The amount transferred was not ascertained or supported by an examination of individual transactions, but depended upon what it was perceived needed to be retained in the balance sheet.
- Mr Lovell and Mr Dickerson agree that it was proper to adopt this approach. They criticise one aspect of the procedure: for the purpose of preparing management accounts, the Group's practice was to include within the Accrued Revenue account adjustments arising from Xoserve's reconciliation invoices, and so the reconciliation invoices were offset against revenue. These should properly have been shown separately because good accounting practice does not allow revenue to be netted off against the cost of sales, but Mr Lovell and Mr Dickerson agreed, and I accept, that this does not affect what I have to decide.
- It was not only the difference between invoiced revenue and the costs of gas consumed as estimated by the D+5 assessments and reconciliation adjustments that flowed through from the Accrued Revenue into the profit and loss account. The other items that affected, or potentially affected, how much was transferred were these:
i) "Prior months unbilled": this related to gas consumed before the month for which the Management Accounts were prepared which, for one reason or another, had not been invoiced. The figure was calculated by Ms Jacqui Wren, Corona's Finance Manager, on the basis of information supplied by what was referred to as the "billing team".
ii) "Provisions for reconciliation of unread meters": this entry was not fully explained, but I understand that it was meant to account for price fluctuations when meters were not read. It appears only as a provision of £135,000 in the Accrued Revenue account for July 2006 and not in the accounts for previous months. Mr. Russell explained that it was known that this account would affect the Exchange Accounts under the SPA and would be the subject of audit on behalf of Macquarie, and that Glencore asked the Group to include the provision.
iii) "Withdrawn meters unbilled/recoverable": this item is obscure, and Mr. Russell was unable to explain it satisfactorily. He was inclined to think that it was concerned with when a meter had ceased to supply gas but had not been removed from the customer's premises. The item was not in the Management Accounts after May 2006: Mr. Russell speculated that this might have been because of improved procedures for removing redundant meters, but I am unconvinced that this explains why the item suddenly disappeared altogether.
iv) "Flexible procurement": this related to customers who were billed a fixed price throughout the year. The cost of gas to them fluctuated, and the flexible procurement balance in the Accrued Revenue account reflected an amount receivable from or payable to the customer at the year end in respect of the difference between the invoiced price and the actual price. The calculation was made monthly by Ms Wren and "someone in the Energy Team", but again Mr. Russell was apparently unable to explain an exercise that he described as "pretty complex".
v) "Provisions against accrued revenue" related, according to Mr. Russell, to provisions against receivables in respect of uninvoiced customers and meters that were withdrawn, but Mr. Russell was unable to explain how the figure was made up. He said that he "suspected" that it was simply "a percentage of the flexible procurement provision", and that it was determined by Ms Wren and himself. He then accepted that he did not know how the item was calculated.
vi) "Out of contract price variance" arose when customers were invoiced at the current market prices rather than the contract price, the difference being held back from turnover until it was paid. Again, the figure was provided by Ms Wren, and Mr. Russell said that he did not know how she calculated it.
vii) "Suppressed meter reads": I have explained that the UNC contemplated that, when a NDM at a Larger Supply Point was read, there was an Individual NDM Reconciliation, and if the consumption through that meter exceeded the assessed D+5 quantity, the supplier was charged in respect of the difference under a Reconciliation Invoice. The Group did not immediately pass meter readings to Xoserve and recognised this in the accrued revenue account by way of entries called "suppressed meter reads", that is to say entries relating to consumption measured by a meter that had been read but not yet submitted to Xoserve. Mr. Russell explained that, when in due course Reconciliation Invoices were received from Xoserve, they were brought into the accrued revenue account and the suppressed meter reads accrual was adjusted accordingly. The calculation of the figure to be entered into the Accrued Revenue account was undertaken by Ms Wren: she was supplied with information about the "suppressed" consumption by the Operations Team and then carried out what was described as a "manual" calculation in order to attribute an appropriate cost in view of the price of gas over the relevant period for the meter in question. It is apparent that the exercise as explained by Mr. Russell would have taken many hours of work, and Glencore understandably complain that it is unclear quite what was done.
The Accrued Revenue accounts also, for some months, included a provision for credit notes and inter-company realignment, which require no comment.
- Glencore say that because of this and the balance sheet approach:
i) without an analysis of how it was calculated (and Macquarie have produced no such calculation), it is impossible to say what (if any) amount of the revenue from the missed meters was transferred to the profit and loss account; and
ii) it cannot be said that the amount transferred to the profit and loss account was inappropriate in total or that as a result the accounts did not give a true and fair view or did not fairly reflect the financial position of the Group, because, unless it is assumed that other amounts contributing to the sum transferred were all appropriate, the effect of the Missed Meters charge on the net amount transferred might have been cancelled out in part or altogether.
- Mr. Dickerson calculated that during the 10 months period from October 2005 to July 2006 Corona's sales invoices were £155,156,000 and their sales accruals were £150,595,000, a difference of £4,561,000. There was a net additional credit from reconciliation invoices and credit notes issued by Xoserve of £4,823,000, increasing the surplus to £9,384,000. However, in fact nothing was transferred into the profit and loss account during this period: on the contrary, £510,000 was transferred from the profit and loss account. Mr Russell was able to identify some apparent errors in Mr Dickerson's calculation, and to provide some explanation for what Mr Dickerson observed, but Mr Dickerson's figures illustrate the scale of the adjustments involved in assessing the amounts that were transferred.
- Glencore's complaint is that Macquarie have simply not put before the court sufficient explanation of their accounting processes to support their claim. I see some force in that complaint. The calculation of transfers to and from the profit and loss account was complex, and there was certainly room for error and for assessments that turned out to be inappropriate. Mr. Russell was not sufficiently involved in the detailed preparation of the Accrued Revenue accounts to give a proper explanation for many of the items in them, and unable to give any real reason to think that they were reliable. Glencore say that, in these circumstances, there can be no assurance that the net amount transferred was inappropriate, and that the effect of the missed meters was not "trapped" in the balance sheet (to adopt the useful expression coined by Mr Dickerson) and had no impact on the profit and loss account.
- Glencore put forward a number of reasons to think that there might be "trapping" of this kind. They emphasise, in particular, the uncertainty associated with the treatment of "suppressed meter reads": whether the amounts were calculated by reference to the price at which gas was sold to customers (so that no profit on the sales was carried though to the profit and loss account until Reconciliation Invoices were received), or whether they were calculated by reference to the cost of gas charged to the Group. Mr Dickerson observed that there was "a large and increasing value of invoices for excess volumes on meter readings in suppressed meter reads, whilst the transactions during the period show more Xoserve credit notes than invoices". When Mr. Russell examined the suppressed meter read figures when preparing for the trial, he found errors in them which, although very small in amount, are relied upon by Glencore to argue that there might be other errors in the accrued revenue account that "trapped" in the balance sheet the revenue from the missed meters, so that it was not reflected in the profit and loss account.
- Macquarie emphasise that Glencore do not advance a positive case as to how the revenue from the missed meters might have been trapped. That is true, but does not answer Glencore's argument: that Macquarie have not discharged the burden of proof to show that the Accounts and the Management Accounts were significantly wrong. Macquarie dispute that this is a permissible argument: Mr. Fealy relied upon a provision in the SPA (at Schedule 4 paragraph 3.1(d)(vi)) that precludes a claim by Macquarie "if and to the extent that … the subject matter of the claim has been noted, provided for or otherwise taken into account in the Accounts, the Management Accounts or the Exchange Accounts"; and therefore, it is said, Glencore must raise by way of defence an argument that revenue might be "trapped", and bear the onus of proof to do so. I confess that I am unable to follow this submission: I fail to see how this contractual provision affects the burden of proof or that this can have been the intention of the parties to the SPA that it should do so.
- I did not find convincing Macquarie's attempts to analyse the amounts transferred from the Accrued Revenue account to the "Turnover-Gas-Other" in profit and loss accounts in order to support their contention that they included amounts attributable to the Charges. Mr Russell produced in tabular form breakdowns of amounts transferred in the accounts for the periods from October 2005 to July 2006, from October 2005 to June 2006 and from October 2005 to December 2005. For example, the table covering the period from October 2005 to July 2006 shows that the total figure in "Turnover-Gas- Other" for the Group was £3,774,000 and for Corona 2 was £3,299,000, whereas the amounts attributable to the Charges were £3,340,000 and £3,013,000 respectively. Mr Russell expressed the opinion that the table clearly demonstrated that the revenue in excess of the sales accrual from the two charges were included in the "Turnover-Gas-Other" line in the profit and loss account. I am unable to agree that it shows more than that this is a possibility. On any view some of the amount transferred remains unexplained.
- Nor was I convinced by Mr Russell's attempts to examine the residual amount transferred in what was called his "walkthrough" document. It was designed, as I understand it, to illustrate how price variances can arise between the amount of gas which it was assessed a customer would use and the amount for which the customer was in due course invoiced, and for this purpose he prepared a "walkthrough" of the consumption of three meters from the original sales accrual to the invoicing of the customer and subsequent reconciliation statement from Xoserve. Mr Lovell commented that these differences caused subsequent entries in the accrued revenue account in some cases more than a month after the revenue was initially accrued and considered that this was consistent with the revenue in the profit and loss account being subject to potentially significant variations on a monthly basis.
- When Mr Russell was cross-examined about this exercise, it became apparent how complex and error-prone were both the "walkthrough" exercise undertaken for the purpose of the litigation and also the exercise of assessing suppressed invoices for the purpose of the accrued revenue account. In the case of one of the three meters, for which the expected accrual brought into account was for 39,590 kWh whereas the actual credit was for 12,010 kWh, Mr Russell was unable to explain the discrepancy but speculated that it might be attributable to an additional invoice which had been overlooked. In the case of another of the three meters there was a difference between the amount accrued for the anticipated reconciliation invoice and the actual invoice of 50,464 kWh, or about 3% of the actual consumption, which Mr Russell suggested might be explained by the fact that "the calculation from meter reads is very complicated, and it goes through a number of steps of correction factors". The "walkthrough" exercise does not seem to me to provide any support for Macquarie's case.
- Despite the obvious difficulty that Macquarie had in explaining the composition of the amounts transferred to the profit and loss account, the question remains what might have happened to the revenue from the missed meters. The only possible answers, it seems to me, are (i) that it was included in the Accrued Revenue account and transferred to the profit and loss account or (ii) excessive entries for costs of sales or other credits extinguished it.
- I can well understand Mr. Dickerson's view that it is not reasonable to assume that the amounts of the Charges were transferred. However, the question that I have to decide is not whether the transfers that Macquarie assert are conclusively demonstrated by the accounting documentation that Macquarie have produced but whether on the balance of probabilities amounts reflecting the missed meters revenue were transferred. It is, to my mind, important to recognise that:
i) There is no reason to suppose that the Gemini error might have caused an excessive entry for costs of sales or other relevant items: the Gemini system affects the entries in the Accrued Revenue account only by way of introducing the D+5 assessment.
ii) The uncertainty that surrounds the other items in the Accrued Revenue account does not inherently tend to increase rather than decrease the cost of sales, and prima facie one might start with the assumption that they are likely to be evenly distributed, or at least not so unevenly distributed to answer Macquarie's case to any significant extent.
iii) Significant error is the less likely because the Accounts were audited without qualification by 15 September 2006.
For these reasons, I conclude that Macquarie have established to the required standard that the amount of the Missed Meter charge was transferred to the profit and loss account.
Corona's accounting policies and procedures – the Mod 640 charges
- Xoserve made the Mod 640 charges in respect of supply points that were threshold crossers because of revised AQs made for the gas year from October 2006 only on 26 March 2007, but the revenue from the consumption by "threshold crossers" was invoiced and recognised in the usual way. For essentially the same reasons as with the Missed Meters charge, I conclude that all the revenue associated with the meters of "threshold crossers" was brought into account in the Accrued Revenue account, and that, on the balance of probabilities, it was transferred to the turnover in the profit and loss account. In the month of supply, this was accrued on the basis of D+5 assessments and then, in the following month, the customers were sent invoices based on an actual reading or the AQ for the meter. The revenue in the period between 1 October 2005 and 30 June 2006 from these meters which is attributable to unanticipated consumption of gas (that is to say, which had not been brought into account as part of the aggregate assumption for Smaller Supply Points) was some £600,000.
- In reaching this conclusion, I do not overlook Mr. Southern's observation that the uncertainly about the treatment of the suppressed meters readings in the Accrued Revenue account is particularly pertinent to these meters. It would be expected that the meters in respect of which readings were suppressed were those where there was excessive consumption over the AQ. Generally there would not be reconciliation invoices for Smaller Supply Points, but Mr. Russell found that the balance in the Management Accounts for reconciliation invoices included reconciliations for three Smaller Supply Point meters: he said that they were included in error, but the error is unexplained. However it came about, it is not, to my mind, a sufficient reason to suppose that the revenue from the meters of threshold crossers was in some way "trapped" by the treatment of suppressed meter reads in the Accrued Revenue account, and not transferred into the profit and loss account.
Are Glencore entitled to dispute that the gross profit was inflated?
- In view of these conclusions it is not necessary for Macquarie to rely upon their alternative argument that Glencore are not entitled under the SPA to argue that the effects of the Gemini error and revenue from the threshold crossers might have been "trapped" in the Accrued Revenue account by other errors in the Management Accounts, so that the profit and loss account was not distorted by them. I shall deal with the argument only briefly.
- Mr. Fealy advanced these contentions in his opening submissions:
i) First, Glencore gave warranties in the SPA (i) that the Management Accounts were not misleading in any material respect, and (ii) that Corona's books and records had been maintained so as fairly to present and reflect all material transactions entered into and material liabilities incurred; and the SPA included an acknowledgment by the Sellers, including Glencore, that Macquarie relied upon the warranties in entering into the SPA. Therefore, it was said, Glencore are bound by an estoppel by representation from "denying the truth of the warranties that they gave".
ii) Secondly, it was said that Glencore are attempting "to mount a collateral attack on the Exchange Accounts" and that it is "impermissible" to "re-visit the agreed Exchange Accounts".
iii) Thirdly, Macquarie relied upon a provision in paragraph 7.1 of schedule 4 to the SPA which provides as follows:
"The parties agree to set off against any amount payable by [Glencore] in respect of any claim under the Warranties … the amount (if any): (a) by which any liability … of [Corona] or any Subsidiary included in the Accounts, the Management Accounts or the Exchange Accounts has been discharged or satisfied below the amount attributed to that liability or included in respect of that liability in the Accounts, the Management Accounts or the Exchange Accounts; and/or (b) by which any contingent liability or other matter … provided in the Accounts, the Management Accounts or the Exchange Accounts [has] been over provided for,
(in each case the "over provision") PROVIDED THAT in either case no such set off shall be applied unless and until the auditors for the time being of [Corona] or the relevant Subsidiary have certified … in either case that there has been such an over-provision …".
It was argued that Glencore cannot challenge the Exchange Accounts without an auditor's certificate. Mr Fealy cited the decision of the Court of Appeal in Gillatt v Sky Television Ltd, [2000] BCLC 103, which illustrates that an accountant's certificate can be a precondition to a right to bring a claim.
- In his closing submissions Mr. Fealy advanced a fourth argument that, because Glencore warranted in the SPA that the Accounts had been prepared in accordance with Relevant Accounting Standards and because those standards require that "the amount recognised as a provision should be the best estimate of the expenditure required to settle the present obligation at the balance sheet date", therefore Glencore warranted and so admitted that "the provisions made in the Accrued Revenue account were the best estimates of those matters as at 30 June 2006".
- These arguments were not pleaded by Macquarie, and, although Mr. Southern pointed this out in his opening, Mr Fealy made no application to plead them. In any event, it seems to me that, however the point is formulated, it proceeds upon a misapprehension about Glencore's position. As Mr. Southern made clear, Glencore do not assert that there were errors affecting the Accounts and Management Accounts that "trapped" revenue to prevent it from being transferred to the profit and loss account, but simply say that Macquarie have not proved what revenue from the missed meters and the threshold crossers was transferred, and so have not shown that the Accounts did not give a true and fair view or that the Management Accounts did not fairly reflect the financial position of Corona.
- I make these further comments upon the individual arguments:
i) The first depends upon treating the warranties as representations, and there is no reason to do so. Moreover, it is no part of Glencore's argument that any error that "trapped" revenue made the Management Accounts misleading in some material respect, or in that Corona's books and records had not been maintained so as fairly to present and reflect all material transactions entered into and material liabilities incurred.
ii) The argument that in some general and unspecified way it is impermissible for Glencore to "mount a collateral attack on the Exchange Accounts" does not seem to me justified by the SPA.
iii) I am unable to accept that paragraph 7.1 of schedule 4 to the SPA has any application. Glencore do not seek to assert a set-off.
iv) A warranty that "the best estimate" has been made for a provision is not a warranty that the estimate will turn out to be correct.
- The fluid formulation of these arguments demonstrates the importance that allegations of this kind are properly pleaded, and, had I thought that they had merit, I would have invited further submissions about the pleading point.
The discovery of the Gemini error and of its effect
- In or about November 2005, Xoserve realised that there was a discrepancy arising from the implementation of the Gemini system in October 2005. It was mentioned at a meeting on 7 December 2005 of the Forum, a body comprising representatives of shippers, transporters and Xoserve that met regularly to discuss billing issues. The Group had no representative at that meeting, but the minutes of this and the other meetings of the Forum to which I shall refer were sent - always, as I infer, shortly after the meetings - to six employees of the Group, including Mr Ian Simpson who was Head of Operations and others in the Operations Team and the Energy Team (as they were referred to). The minutes of the meeting on 7 December 2005 recorded at paragraph 4.4:
"Tricia Moody [of Xoserve] confirmed that Gemini implementation went to plan, however invoices were issued late in the day due to the extra validation carried out to ensure the invoices are accurate. A problem has been identified with the Exit Commodity Invoice, which is still under investigation, unfortunately Xoserve are unable to confirm any details at present, and it is believed that the values are small. Once the full details are known the group will be briefed."
Attached to the minutes were documents that were apparently used in a presentation to the meeting, and one of them, headed "Invoicing Update – Gemini", stated:
"A number of billing issues were identified: October Exit Commodity invoice – during our validations we became aware of minor anomalies in energy values, which we are investigating. Further information will be provided should there be any need for remedial actions."
Exit Commodity Invoices do not relate to the supply of gas but to transportation costs, which are relatively small, and it is to be observed that Xoserve themselves believed that "values are small".
- The next meeting of the Forum was on 1 February 2006. Again, no representative of the Group attended. The minutes recorded under the heading "Gemini update":
"Tricia Moody confirmed that following the implementation of Gemini a number of issues had been identified that affected the October, November and December 2005 invoices. Issues under investigation are incorrect [Load Profile Allocation] Factors being passed from Gemini to Inv '95 and duplicate sites recorded in Gemini. Investigations so far indicate that energy and financial values are not significant, however analysis will continue to determine the full extent of issues."
They also recorded that, in response to a question whether "the factors would always be incorrect", Xoserve "confirmed that they would be, however reconciliation would correct the position as long as the same factors were used".
- The minutes of a meeting on 4 April 2006, which was attended by Mr. James Crosland of the Group's Operations Team, recorded that:
"Tricia Moody gave a presentation explaining that a number of issues had been identified post Gemini implementation, affecting the October, November, December and January 2006 Exit Commodity invoices. As a result a project team is being assembled to investigate the data flows between systems (Gemini and Inv 95), identify the cause of the errors and the financial implications, which are not thought to be significant. Xoserve will report regularly on the findings of the project team. npower asked what were the timescales for addressing the issues, Tricia stated that this was dependent upon the project team's findings."
- Mr Crosland also attended the meeting of the Forum on 7 June 2006. The minutes, which were sent to two representatives of Macquarie as well as representatives of the Group, recorded that:
"At previous forums Tricia explained that energy differences had been found between Gemini and Invoicing 95. Two scenarios have been identified, one where incorrect SOQs [supply point capacities] were used on 29th October 2005, adjustments have been issued to relevant shippers on 1st June 2006. The second scenario is where NDM AQs and SOQs failed to load into Gemini on 2nd and 3rd October 2005, therefore if shippers had withdrawn from sites on the 2nd or confirmed on the 3rd their portfolio on Gemini has not been updated.
British Gas asked for details of the impact. Tricia confirmed that Sites & Meters hold the correct shipper portfolio information and that a datafix is required to bring Gemini back in line with Invoicing 95. At this stage Xoserve are not aware of the full impact on shippers, investigations are continuing and Tricia will provide updates."
The minutes were sent out under cover of an email dated 15 June 2006: it referred to three "matters of note" to which Xoserve drew the attention, but they did not include the differences between the information on the Gemini system and the Invoicing 95 system or the two "scenarios".
- Again, there were appended to the minutes some documents apparently used in a presentation at the meeting, and they referred to the two "scenarios". Of the first, the presentation document stated, "Incorrect [Supply Point Capacity] identified for the 29/10/05 affecting 25 shippers, total value - £63.03. Adjustments issued 1st June 2006". No financial amount was referred to in the context of the second "scenario", which in fact described the Gemini error. There was the general comment, "Investigation is ongoing to assess the shipper and financial impact".
- According to an appendix to the minutes of a Forum meeting in December 2006, Xoserve "were only able to confirm the reason for the error at the end of June 06". There is no evidence that this information was then communicated to the Group, or to others who attended the Forum. In any case, Macquarie do not rely upon any such communication.
- There was one further meeting of the Forum before the SPA was concluded. It was on 25 July 2006. According to the minutes, nothing was said about the problem with Gemini, and neither was anything said at the meeting on 24 August 2006, the last meeting before the SPA was completed on 15 September 2006. At the meeting on 27 September 2006, as the minutes record,
"Tricia Moody gave an update to Shippers regarding the Energy Mismatch between Invoicing 95 and Gemini. Shippers were previously notified at the December 2005 Billing Ops Forum. The mismatch is due to Shipper AQ and SOQ update files not being transferred to Gemini on Gas day of 3rd of October 2005. The error will be corrected on the 1st of October 2006 following the AQ review process. An adjustment will be issued to the affected Shippers that will correct the GRE and NTS Exit Capacity charges for the period from 3/10/05 to 30/09/06. Action: Shippers will be contacted as soon as possible with their adjustment details. The next update will be presented at the next Billings Ops Forum in December."
- Mr. Russell's evidence was that it should have been apparent to the Operations Team from the minutes of the meeting on 7 June 2006 that there had been a problem with Gemini that might have financial implications for the Group and should be investigated. He also said that, if the minutes of that meeting had been brought to his attention, he would have had the Supply Point Administration Team investigate which of the Group's meters had been lost on 2 October 2005 and which meters gained on 3 October 2005, and as a result the Group would have identified a discrepancy that would have had a financial impact of over £2.5 million over a 12 months period.
- On 17 November 2006, after a meeting of a body called the Energy Balancing Credit Committee in London, Mr. Mark Cockayne of Xoserve told Mr. Russell about the Gemini error. Although Mr. Russell was unable to recall quite what Mr Cockayne said, he indicated the scale of the problem. The information came as a shock to Mr. Russell: nothing had been said to him by Mr. Crosland or by any of those who had received the Forum minutes; indeed, Mr Russell was uncertain whether in November 2006 he had even heard of the Forum.
- Mr. Russell thought that Mr. Cockayne's information was likely to be right and was concerned to know how the problem could have arisen. He asked Xoserve for a list of the relevant meter reference points. Mr. Cockayne sent some details about them on 22 November 2006, and in his covering email he wrote, "We are still working on a written explanation for you, but information has been discussed via the billing ops forum in November 2005 and June 2006 respectively".
- When he received this email, Mr. Russell asked Ms Wren to investigate the position by reference to individual meters. Their initial thoughts are recorded in an exchange of emails between them in the evening of 22 November 2006. Ms Wren, having made investigations about three meters, confirmed that the Group had invoiced their customers and had carried out the established procedures for reconciling with Xoserve the amount of gas consumed by the customers and also for reconciling the transportation costs. However, Mr Russell observed "unexplained differences" on the monthly sales accrued files between the gas consumption figures produced by the Energy Team and the sales volumes calculated by the Finance Team. Ms Wren raised the question, "Could this imply that all our systems in house seem to be correct, but that [Xoserve] seem to be missing some meters from their D+5 calculation, even though they clearly have the meter on their system somewhere if they are reconciling to them?" Mr. Russell thought that this could be the explanation, but he could not understand why there was no (significant) discrepancy in the transportation charges. Ms Wren's suggestion turned out to be correct: although she and Mr Russell did not know that Xoserve had separate computer systems, they were indeed missing some meters from the system that provided the D+5 assessment, which was the source of the Energy Team's figures. She and Mr Russell did not know that Xoserve used another system to calculate transportation charges.
- In her last email on 22 November 2006, Ms Wren identified a further piece of the jigsaw: she observed that from October 2005 there was, as I have said, a change in the pattern of the adjustments between the consumption assessed from the ESI system and the D+5 assessment provided by Xoserve from the Gemini system. These adjustments had been made by Ms Wren or someone working under her, and Mr Russell, as I find, was unaware of the amounts of the adjustments or the change in their pattern. Ms Wren wrote this: "Just also … checked some of the accrued revenue files. Up until Sept 05 the difference on Retail 2 between the download and D+5 was positive … then flipped into negative … should have been picked up and investigated further at the time". She went on to say, however, that she still could not understand how the transportation costs could have been reconciled by the Operations Team if meters were missing. (The Operations Team was principally responsible for managing meter readings and for validating transportation changes and reconciliations charges or credits received from Xoserve. For this purpose they used the ESI system, which contained portfolio data about customers and tallied with the information held by Xoserve on their Sites and Meters system.)
- On 22 November 2006 Mr. Russell wrote to Mr. Spellman, "Why didn't Finance spot this? In part it can be explained by how we undertake our accounting (which assumes Xoserve is using only one Corona portfolio, not two), plus the exceptional balancing costs seen during the year (month to month) which have significantly clouded the issue. But we should still have caught such a large error." He explained in his evidence that he was referring to the adjustments being larger from October 2005 than previously, but he also agreed that, when he expressed the view that the error should have been caught, he was simply expressing disappointment "that myself and the team hadn't picked up such a large error": he was not assessing what evidence of the Gemini error had been available to the Group.
- On 29 November 2006 Xoserve sent the Group an email giving some explanation for what led to the Missed Meters charge: that the root cause was a failure to ensure that information about users was sent in October 2005 from the Sites and Meters system to the Gemini system. They said that the problem was first identified in November 2005, but that the Sites and Meters and the Gemini systems were so complex that it took until June 2006 to carry out the work to identify "where the problem lay", and then Xoserve had had to work out how to correct it.
- At a meeting of the Forum on 6 December 2006 Xoserve reported how the problem had arisen. It was said that for various reasons it had been "difficult to identify the root cause of the problem until June 2006. Detailed analysis took place to identify the supply points that were affected, validate the data and identify the Shipper impacts, which was finalised early November 2006. Further detailed analysis has taken place and an adjustment value has been calculated. Each affected Shipper was notified of their position on 29th of November". The minutes record that "Scottish Power expressed concern that the issue was not identified earlier and Shippers were not made aware of the significance of the issue. Centrica also expressed concern that Xoserve had not informed them that the adjustment would be of significant value and were led to believe that the adjustment value was small". In response Xoserve simply explained why the investigation had taken so long: they did not suggest that they had made others aware of the significance of the problem.
- Mr. Russell was still not satisfied that Xoserve had showed that the Group had not supplied gas to balance what they had sold through the missed meters. He observed in an email of 6 December 2006 that it would be very difficult for them to demonstrate this, and so justify a charge, because the Gemini system operated upon aggregate AQs.
- On 7 December 2006 Mr Simpson and another representative of the Group met Xoserve to discuss the "mismatch between Sites & Meters and Gemini". On 8 December 2008 Mr Simpson sent a report to Mr Russell and others under cover of an email in which he wrote, "My main concern is that the message gets across re: rubbish Xoserve communications, rubbish Xoserve processes, what we can do about improving processes (but 1st prize is dependant on Xoserve)". He described the progress of Xoserve's investigation in September 2006: "Affected meters were now identified and thought to be of more significant impact. At this stage the impacted shippers had been identified but financial values had not been finalised (and therefore individual shippers remained uninformed)". He reported that:
"Xoserve were challenged as to why there had been no direct communication throughout the year of researching the problem until such time. In September the impacted shippers had been identified and Xoserve claimed that they did try and communicate this at the September Billing Ops Forum (however unsuccessfully and in any case not directly with [the Group]). In summary, Xoserve did not want to unnecessarily alarm relevant shippers during the process of trying to resolve the problem as financial impact, being unknown, might not have been significant. [The Group] emphasised that it would be better to make the issue known (directly) and therefore [the Group] could carry out their own investigations, potentially before the problem was exacerbated. They may have even been able to help the process."
- There was an addendum to the report which was, as I conclude, written by Mr Russell. Commenting upon how Xoserve communicated the Gemini error to the Group, he wrote this: "It would appear communication of this issue was via the Billing Ops fora … There appears no reference to this issue in November 2005 or June 2006, as originally advised". This was, of course, wrong as far the as June meeting is concerned, but it is of some interest that the minutes of the meeting of 7 June 2006 did not, apparently, impress upon Mr Russell the information from Xoserve about the Gemini error.
- As I have said, on 5 January 2007 Xoserve sent the Group an invoice for £3,174,819.91 and the Group paid it.
Was the Group's treatment of the Missed Meters charge in accordance with proper accounting principles?
- Macquarie say that the cost of the gas supplied to the missed meters was a liability that should have been recognised both in the Accounts and in the Management Accounts, and that the financial statements were not prepared in accordance with proper accounting principles. Glencore dispute this on the grounds that accounting principles, as stated in the Financial Reporting Standards ("FRSs"), did not require them to recognise the cost because (i) the Group did not have enough evidence of the existence of the item at the relevant time, and (ii) they were not able to measure the item at a monetary value with sufficient reliability. The FRSs are accounting standards issued by the Accounting Standards Board, and are "accounting standards" for the purposes of the Companies Act, 1985.
- Macquarie's original pleaded case was that the Accounts were "not prepared in accordance with the Relevant Accounting Standards, in particular [FRS 18]". FRS 18 provides (at para 26) that "An entity should prepare its financial statements, except for cash flow information, on the accrual basis of accounting", and continues (at para 27) "The accrual basis of accounting requires the non-cash effects of transactions and other events to be reflected, as far as possible, in the financial statements for the accounting period in which they occur … The accruals concept lies at the heart of the definitions of assets and liabilities, which are set out in FRS 5 …". FRS 5 is entitled and directed to "Reporting the Substance of Transactions". It defines "Assets" as "Rights or other access to future economic benefits controlled by an entity as a result of past transactions or events", and defines "Liabilities" as "An entity's obligations to transfer economic benefits as a result of past transactions or events". The definition of "Liabilities" in FRS 12, to which I shall refer, is materially similar. Mr. Lovell did not support Macquarie's case that the Accounts were not prepared in accordance with FRS 18: his view was "… even though Corona recognised no accrual or provision in respect of [the Missed Meters charge], … it has [not] necessarily failed to prepare the Accounts in accordance with FRS 18. This is because Corona has an accounting policy, as required by FRS 18, of preparing its accounts on the accruals basis of accounting, albeit it can be argued that it made an error in applying the policy by not providing for the liability to xoserve". He concluded, however, that the Accounts had not been prepared in accordance with FRS 5 and FRS 12, and this criticism was the focus of Mr. Fealy's argument at trial. Without formally abandoning it, he did not pursue the complaint that the Accounts were not prepared in accordance with FRS 18, and, for the reasons explained by Mr Lovell, I reject it.
- FRS 5 provides (at para 20) that:
"Where a transaction results in an item that meets the definition of an asset or a liability, that item should be recognised in the balance sheet if –
(a) there is sufficient evidence of the existence of the item (including, where appropriate, evidence that a future inflow or outflow of benefit will occur), and
(b) the item can be measured at a monetary value with sufficient reliability."
- FRS 12 is entitled and concerns "Provisions, Contingent Liabilities and Contingent Assets". A provision is defined as "A liability of uncertain timing or amount", and FRS 12 states (at para 14) that:
"A provision should be recognised when:
(a) an entity has a present obligation (legal or constructive) as a result of a past event;
(b) it is probable that a transfer of economic benefits will be required to settle the obligation; and
(c) a reliable estimate can be made of the amount of the obligation.
If these conditions are not met, no provision should be recognised."
FRS 12 (at paras 27 and 28) also provides that, if a liability is contingent, it should not be recognised in a balance sheet but should be disclosed "unless the possibility of a transfer of economic benefits is remote". More specifically (at FRS 12 para 91), it is stated:
"Unless the possibility of any transfer of benefit is remote, an entity should disclose for each class of contingent liability at the balance sheet date a brief description of the nature of the contingent liability and, where practicable:
(a) an estimate of its financial effect …;
(b) an indication of the uncertainties relating to the amount or timing of any outflow; and
(c) the possibility of any reimbursement".
A contingent liability is defined in FRS 12 as follows:
"(a) A possible obligation that arises from past events and whose existence will be confirmed only by the occurrence of one or more uncertain future events not wholly within the entity's control; or
(b) a present obligation that arises from past events but is not recognised because:
(i) it is not probable that a transfer of economic benefits will be required to settle the obligation; or
(ii) the amount of the obligation cannot be measured with sufficient reliability".
- Macquarie complain that the Missed Meters charge should have been recognised in the Accounts and the Management Accounts as a liability: there is no alternative complaint that it should have been disclosed as a contingent liability. The question, therefore, is whether, at the relevant time, there was sufficient evidence of the item and the amount of it could be measured as a monetary value with sufficient reliability. The relevant date for this enquiry is, for practical purposes, 15 September 2006, the date when the SPA was completed: if there was not sufficient evidence and information at that date, then it follows a fortiori that there was not when the SPA was made or at any other material time.
- FRS 5 contemplates an objective test whether there is sufficient evidence of the existence of an asset or liability, which does not depend upon the subjective appreciation of those preparing the financial statements. There was some discussion in submissions about whose knowledge of evidence of the Missed Meters charge is relevant, since Mr Crosland and the recipients of the minutes of the Forum's meeting on 7 June 2006 did not pass on information about what was said to Mr Russell or to anyone responsible for preparing the financial statements in the Accounts and the Management Accounts. I am not aware of guidance about this in the FRSs: the guidance in FRS 5 para 20 supposes, as it seems to me, that those preparing the statements are aware of the item and are faced with deciding whether to recognise it in the balance sheet. However, in principle it seems to me that what matters is the evidence available to the entity whose accounts are signed. Since there is no dispute that the information from the meeting and in the minutes was received by the appropriate representatives of the Group, that evidence was available to the Group. Mr Southern accepted that no relevant distinction is to be drawn between the evidence and information available to the Group and the different companies in it.
- However, what is, in my judgment, more important for present purposes is that in order for an item to be recognised as an asset or a liability there should be sufficient evidence of its existence. No doubt evidence will be sufficient for this purpose if, while not itself demonstrating the existence of the item, it sufficiently indicates it to call for enquiries about the position and reasonable and proportionate enquiries would provide sufficient evidence of its existence. But it does not seem to me that extravagant and disproportionate investigations are demanded, or that there is sufficient evidence of an item if its existence might be established only by investigations which the entity or those preparing its financial statements could not be expected to conduct if exercising reasonable diligence and making sensible enquiries. I accept Mr Southern's submission that "accounting standards … require the company to have sufficient evidence rather than the tip-off that might be required to conduct an investigation to lead to it".
- In the course of cross-examination and submissions, counsel sought to draw analogies with other situations in which entities preparing financial statements might be unaware of matters that affect the value of their business (such as the example of a stud horse suffering an undiagnosed illness, and the case of a business unaware of the activities of a rogue trader in its employ). Although they were helpful illustrations of the sort of considerations that might arise in deciding whether there is sufficient evidence for an asset or liability to be recognised, in the end the enquiry is a fact-sensitive one and it would not be useful for me to opine about how other questions arising on other facts might be answered.
- The assessed D+5 consumption figures received from Xoserve did not themselves provide the Group with any reason to suppose that they did not include all the meters registered to the Group or that the Group might not be being charged for all the gas consumed through those meters. The figures were not presented on a meter by meter basis.
- Macquarie's pleaded case is that by 7 June 2006 at the latest, following the meeting of the Forum attended by Mr. Crosland, the Group had sufficient evidence of the existence of a liability to Xoserve in respect of the missed meters, and had information to make a sufficiently reliable estimate of it, because they knew that on 2 and 3 October 2006 there had been an error at Xoserve in recording in the Gemini system meters gained and lost by them and "Corona could have identified from their own records the relevant meters and the financial impact of Xoserve's error".
- Mr Lovell considered that the Group had further evidence of the Missed Meters charge from the pattern of adjustments from the assessments of consumption made from the ESI system to the D+5 assessments. Mr Russell accepted in his evidence that investigation of this would not have enabled the Group to identify the Gemini error. Macquarie submitted that, had the information from the 7 June 2006 meeting of the Forum and the minutes of the meeting been disseminated, the significance of the adjustments would have been appreciated, as it was by Ms Wren in November 2006. I do not consider that these figures could realistically have been treated by the Group without the benefit of hindsight as evidence of the Missed Meters charge. The fact is that there is always a discrepancy between the ESI figures and the D+5 figures; as I have said, the missed meters only partly explain the pattern of adjustments; and nothing said at the Forum or in the minutes would have indicated that the discrepancies that Xoserve had found would have financial implication on anything like the scale that would explain the adjustments.
- One of the two "scenarios" that, as the minutes report, Xoserve put forward at the June meeting of the Forum to explain the discrepancies that they had observed was a failure to load information on to the Gemini system on 2 and 3 October 2005. However, the problem was unprecedented and it took Xoserve many months to understand it. Whatever precisely was said at the meeting on 7 June 2006, Xoserve did not convey its potential financial significance to the Group or, as I conclude, to anyone else who was present or received the minutes. When Scottish Power, whose representative had attended in June, and Centrica complained about this at the meeting of the Forum on 6 December 2006, Xoserve acknowledged that they had been slow to understand the problem, and they also acknowledged to Mr Simpson on 7 December 2006 that they had sought to avoid causing shippers "unnecessary alarm", until, as I interpret Mr Simpson's note of 7 December 2006, at least 27 September 2006.
- Neither Mr Crosland nor any of the other five recipients of the minutes thought what was said of sufficient importance to mention it to Mr Russell or those in the Group's financial department. Macquarie did not call evidence from any of them to explain why they did not do so: there is no evidence about whether there was any discussion within the Operations Team about what was said at the meeting. I infer that they, like the representatives of Scottish Power and Centrica, did not understand from Xoserve that the discrepancies might give rise to a liability of any significance. This is understandable: the Forum had been told by Xoserve in February 2006 that their investigations indicated that the "energy and financial values are not significant", and a similar message was given at the April meeting: both minutes record this. At the June meeting, there was no suggestion, as far as the minutes indicate, that the picture had changed: on the contrary, Xoserve estimated the financial implications of the discrepancy would be £63.03 if the first "scenario" explained it (which, of course, turned out not to be the case).
- The minutes of the meeting of 7 June 2006 did not themselves provide sufficient evidence of the existence of a liability to justify the Group including the item in their Accounts and Management Accounts. Macquarie argue, however, that, if the Operations Team had responded appropriately to what they were told, this would have led to an investigation by Mr Russell and others in the Finance Department, which would have led them to understand what had happened and its financial implications.
- I am not persuaded that the Operations Team or anyone else had information that should reasonably have led them so to report what Xoserve had said to the Finance Department. As I have said, Xoserve's email under cover of which the minutes were distributed drew attention to three matters other than the discrepancies. There is a danger of being misled by hindsight into reading too much into the minutes, and therefore I emphasise four points:
i) The explanation for the discrepancies as a failure to load information was presented only as one possible scenario. Xoserve did not claim that they resolved how the discrepancies arose.
ii) Nothing in the minutes indicates the extent of the problem: Xoserve are not recorded as saying how many meters might be affected by the failure to load information, whether all the shippers were affected, or whether the problem affected all meters that were lost on 2 October 2005 and all meters that were gained on 3 October 2005.
iii) Xoserve did not, as far as the minutes indicate, explain that the missed meters were still not loaded on to the Gemini system and that therefore the error (assuming that it was the explanation for the discrepancies) continued to affect the charges that Xoserve were making to shippers nine months after the problem arose. The reference to a "datafix" being required would, I think, naturally have been understood to refer to the need to correct the records of the days immediately affected, and this in itself would not have conveyed that the effects of the failure were continuing: indeed the apparent lack of urgency on Xoserve's part would have suggested that it was not, So too would the information in the minutes of the April meeting of the Forum that the problem had affected Exit Commodity invoices in the four months to January 2006, but not, apparently, thereafter. The rather cryptic answer at the February meeting about the "factors" always being incorrect did not, to my mind, significantly indicate otherwise.
iv) There was nothing in the minutes that indicated that the financial implications of the second scenario would be dramatically different from those of the first scenario.
- The six employees who received the minutes were not - or at least not all – junior administrators: Mr Simpson was the Head of Operations, responsible for both the Operations Team and the Energy Team that bought gas and managed gas balancing on a daily basis. Mr Crosland was described by Mr Russell as "an expert in the operations field in terms of all the relationships with Xoserve". Their reaction is the more understandable because, as I conclude, no-one in the Group knew or had reason to suppose that Xoserve operated separate databases: as Mr Russell explained, "our accounting … assumes Xoserve using only one Corona portfolio, not two". In these circumstances, the Group could not have been expected to detect the nature or extent of the problem given that they were reconciling the consumption after meters were read and reconciling transportation invoices. It is possible that more information was provided by Xoserve at the meeting itself, but I am not prepared to infer this, not least because Macquarie did not adduce evidence about the meeting other than the minutes.
- Nor am I able to accept that, had Mr Russell or the Finance Department been informed about what was said at the June meeting, this would have led to the discovery of the Gemini error or the potential Missed Meters charge to which it would give rise. Admittedly, when Mr Russell and Ms Wren became aware of the problem on 22 November 2006, they soon realised what might have caused it. However, they then had more information from Xoserve than was made available in June (or at any time before the SPA was completed) and, indeed, more than Xoserve could have made available. Specifically, Mr Russell was provided by Xoserve in November 2006 with a list of the meters affected by the Gemini error and told the approximate amount of money involved. Xoserve were not in a position to provide that information, as I conclude, at any time before the SPA was completed; and, even if Xoserve had identified the meters affected by the Gemini error, there is no proper basis to suppose that they would have been willing to disclose that information earlier than they did.
- Mr Russell gave evidence that, within an hour of requesting it from the "Supply Administration Team" on 23 November 2006, he had received a list of the meters gained and lost by the Group on 2 and 3 October 2005, and that with this information he could have obtained from the ESI system the AQ for those meters, and therefore he could have estimated from the System Average Price what the Missed Meter charge would be. However, there is no evidence that I accept that this could have been ascertained without knowing, or assuming, that the Gemini error affected all the Group's registered meters lost on 2 October and gained on 3 October 2005, and without knowing, or assuming, that the effect of the error impacted upon what Xoserve had charged for all the gas supplied according to their D+5 assessment until the end of September 2006. It was suggested that the Group could have seen from the pattern of the amounts transferred to the profit and loss account in and after October 2005 compared with the earlier pattern that the impact of the Gemini error was continuing and the error had not been corrected. As I have said, I cannot accept that it is realistic to think that the Group was in a position to associate the second "scenario" referred to in the minutes with what was in any case only a partial explanation for the changed pattern.
- Even with the information that they learned in November 2006, Mr Russell and Ms Wren found the problem puzzling because they did not know about Xoserve's various computer systems. I am not persuaded that without knowing this either the Operations Team or the Finance Team or anyone else in the Group could have discovered that a failure such as the Gemini error would result in them being undercharged for the D+5 assessment for those meters. If after the meeting on 7 June 2006 or receiving the minutes of it they had considered the possibility that information had not been loaded on to the Gemini system, they would have assessed it in the knowledge that the meter readings from individual meters had been reconciled when submitted to Xoserve and that transportation invoices had also been verified; and they would, as I infer, reasonably have concluded either that the problem was not as described in the second scenario or that it did not affect the Group's meters.
- In my judgment, there was not sufficient evidence available to the Group at any time before 15 September 2006 of the existence of the Missing Meters charge for them properly to recognise it as a liability in the Accounts or the Management Accounts. Indeed, I do not consider that they could have discovered such evidence if they had sought it.
- If I am wrong in this conclusion and there was evidence about the Group's liability for the Missed Meters charge, then the question arises whether it could be "measured at a monetary value with sufficient reliability". Mr Lovell drew attention to FRS 12 paras 25 and 26, which make it clear that it is rare that an obligation cannot be so measured:
"The use of estimates is an essential part of the preparation of financial statements and does not undermine their reliability. This is especially true in the case of provisions, which by their nature are more uncertain than most other balance sheet items. Except in extremely rare cases, an entity will be able to determine a range of possible outcomes and can therefore make an estimate of the obligation that is sufficiently reliable to use in recognising a provision. In the extremely rare case where no reliable estimate can be made, a liability exists that cannot be recognised. That liability will be disclosed as a contingent liability."
As I have said, there is no claim based upon the Missed Meter charge not being disclosed as a contingent liability.
- Glencore point out that even in the course of the litigation Macquarie have had difficulty in stating the amount that should have been brought into the Accounts. Having pleaded that it should have been £962,000, then £434,000 and then £474,441, they now argue that it is £566,000. They say that a board of directors could properly have concluded that no sufficiently reliable measure of the amount of any obligation to bring it into the Accounts as a liability.
- I do not attach much importance to the fact that these different assessments have been made by Macquarie. They were made when it was known that none of the 276 of the meters gained on 3 October 2005 had been recorded on the Gemini system and that the Gemini error remained uncorrected so as to affect what was charged for D+5 assessments of gas consumed until the end of September 2006. But I do not accept that without that information, which was not available before the SPA was completed, the Group could have measured the Missing Meters charge as a monetary value with sufficient reliability to treat it as a (non-contingent) liability, even if they had had evidence of its existence.
- I conclude that the Missing Meters charge was properly not recognised as a liability in the Accounts and the Management Accounts.
Was the treatment of the Mod 640 charges in accordance with proper accounting principles?
- Macquarie submit that Corona had by 30 June 2006 sufficient knowledge of the Mod 640 charges to treat them as a liability for accounting purposes, and that they should, in accordance with proper accounting principles, have been recognised as such in the Management Accounts. Macquarie plead an alternative case (although this was not an argument developed by Mr Fealy in submissions) that it should have been treated as a contingent liability and should have been disclosed as such. Their submission is that the Mod 640 charges were made for and in respect of the gas consumed over the course of the year from 1 October 2005 to 30 September 2006 by the "threshold crosser" meters: the meters that Xoserve considered in October 2006 should have an AQ of more than 73,200 kWh and that they classified as Larger Supply Points.
- Glencore contend that accounting principles did not require Corona to recognise the Mod 640 charges because:
i) They arose from the new designation of meters which took place after 15 September 2006, and therefore the Mod 640 charges were not at the relevant times obligations that arose "as a result of past transactions or events" so as to be within the definition of a liability in FRS 5;
ii) If they were any sort of liability, they were a contingent liability because their existence would be confirmed only by an uncertain future event; and
iii) In any case, at the relevant time the Group were not in a position to measure the amount of the Mod 640 charges with sufficient reliability for them to be a liability rather than a contingent liability.
- The Mod 640 charges arose under the UNC, which provides at section E 7.4.3, "Where, as a result of the revision of the Annual Quantity of a Smaller Supply Point … the Supply Point becomes a Larger Supply Point" there is a System Clearing Contract giving rise to a Mod 640 charge. Although increased consumption of gas through a Smaller Supply Point starts a chain of events that gives rise to a Mod 640 charge, it does not of itself occasion a Mod 640 charge and does not make a charge inevitable: for example, it will not be made if the customer changes supplier before the end of the gas year. Moreover:
i) the consumption assessed by Xoserve in the AQ review process is made on the basis of readings up to about April in any gas year, and so the consumption upon which the assessment is made is not the actual consumption during the previous gas year; and
ii) the amount of the Mod 640 charge is based not on the consumption in the year before a supply point is reclassified as a Larger Supply Point but upon the difference between the new AQ and the old AQ.
- Glencore's contention is that the Mod 640 charges therefore fell outside the definition of a liability in FRS 5: they were not an obligation "as a result of past transactions or events". Mr Lovell rejected that view: as he saw it, the Mod 640 charges were in substance a charge made for gas consumed during the gas year to 30 September 2006, and therefore he considered that Glencore's argument fails to recognise two basic accounting principles:
i) That "the substance of an entity's transactions is reported in its financial statements": FRS 5 para 1. What matters is not the legal form of transactions but their substance, and in order to determine the substance of a transaction, "all its aspects and implications should be identified and greater weight given to those more likely to have a commercial effect in practice": FRS 5 para 14.
ii) That "An entity should prepare its financial statements, except for cash flow information, on the accrual basis of accounting" (FRS 18 para 26), and "The accruals basis of accounting requires the non-cash effects of transactions and other events to be reflected, as far as possible, in the financial statements for the accounting period in which they occur, and not, for example, in the period in which any cash involved is received or paid. The accruals concept lies at the heart of the definitions of assets and liabilities, which are set out in FRS 5 … Accordingly, the use of those definitions to determine items to be recognised in an entity's balance sheet is consistent with the accruals concept" (FRS 18 para 27).
- I see the force of this reasoning, but it depends upon the view that a Mod 640 charge is in substance a charge for gas consumed during the gas year before a supply point is re-designated as a Larger Supply Point. I do not consider that an entity in the Group's position would be obliged to take that view of a Mod 640 charge: it could, in my judgment, properly conclude that, before the new AQs were set, a Mod 640 charge is not a liability (as defined by FRS 5). As Mr Southern rightly observed, the question is not whether the analysis put forward by Macquarie and supported by Mr Lovell is the correct one. It is whether a board of directors which considered that no liability for the Mod 640 charges arose until October 2006 would be adopting a position that no board of directors could properly take. In my judgment, a board, properly advised and properly understanding the substance of the Mod 640 charges, could conclude that no liability arose until then.
- I am reinforced in this conclusion because it is supported by the evidence and opinion of Mr Dickerson. He reached it after a careful examination of the circumstances in which a Mod 640 charge can arise, and he is not, in my judgment, an accountant who would take a lax view of what is permitted by accounting standards.
- I also find some (small) support for this conclusion in the Group's own treatment of Mod 640 charges. In March 2005, Corona 1, Corona 2 and Corona 4 had paid invoices of £277,000 in respect of Mod 640 charges arising from Xoserve's October 2004 review and in the spring of 2006 they had paid invoices of £225,000 in respect of Mod 640 charges arising from their review of October 2005. The Group had not made prior provision in their accounts or in their management accounts for these charges. Glencore say that the Group had therefore adopted a policy of not making prior provision for these charges. Mr Russell's evidence was that they failed to make a provision through oversight and it did not reflect an accounting policy that had been adopted; that, although the invoices came to his attention, he made no conscious decision not to accrue for Mod 640 charges in the following year. It appears that the Group's auditors raised no complaint about there being no provision for the Mod 640 charges.
- Furthermore, no relevant accrual was made in respect of the Mod 640 charges that were invoiced in March 2007 until February 2007 when £329,000 was accrued in the management accounts. (In fact, the Management Accounts included an accrual of £1,810 in respect of three of the meters that were "threshold crossers" in the year to 30 September 2006 in respect of which the Mod 640 charges were claimed, and this led to a corresponding accrual in the Exchange Accounts of £2,006. It was inadvertent and is of no relevance for present purposes.) As I conclude from an email dated 2 March 2007 from Mr Mark Pearce, the Group's Operations Manager, to Mr Russell and an email dated 29 March 2007 from Mr Mark Darby of the Operations Department to Mr Simpson, this accrual of £329,000 comprised (i) £277,525 representing a calculation of what would have been the Mod 640 charges without the changes made in Mod 94 and Mod 95 and (ii) additional amounts of about £5,000 and £47,000 resulting from Mod 94 and Mod 95 respectively. Mr Darby acknowledged an error in the calculation of the £277,525 because of a typing error, and re-calculated the correct figure to be £382,392. The calculation was made on the basis of the difference between the old and the new AQ's assigned to "threshold crossers", multiplying it by the System Average Price and adding a percentage to take account of transportation charges.
- There is an issue about when Mr Russell learned of the calculation of £277,525. Macquarie have disclosed no documents about it before the email of 2 March 2007, and that email does not specifically state when the calculation was made. However, in the email of 2 March 2007, Mr Pearce referred to it as being in respect of "Threshold crossers identified in August 2006", and wrote to Mr Russell, "As you may be aware there are two mods (94 & 95) that may impact on the analysis we provided you with last year regarding the retrospective reconciliation [the Group] would receive from Xoserve". Although Mr Russell accepted that the figure of £277,525 was calculated in August 2006, he said in cross-examination that he did not recall being provided with it, and that he did not know of it at the time.
- Nevertheless, I conclude that Mr Russell did receive the calculation in August 2006. When he received the email of 2 March 2007, he did not, as I find, respond that Mr Pearce had not provided any previous calculation of what the Mod 640 charges might be. In his fourth witness statement he commented upon how the £277,525 was calculated without indicating that, despite the email, he had not been provided with it when it was made.
- I also cannot accept that it was through simple oversight that the Group did not make any accrual or provision for Mod 640 charges until February 2007, and I reject Mr Russell's evidence about that. I do not find that the Group deliberately and consciously decided against accruing or providing for them, but in my judgment Mr Russell was well aware that Mod 640 charges were to be invoiced against the Group, and, as I conclude, it never occurred to him, despite his considerable experience as an accountant working in the industry, that they should be regarded as a charge for gas which was being consumed in the course of the gas year before the revised AQ that gave rise to them and which, as such, gave rise to a liability to be recognised in the accounts.
- A further difficulty faces Macquarie's argument: if the Group had a liability for Mod 640 charges before the completion of the SPA on 15 September 2006, when did it arise? In his written opening Mr Fealy said that the event that gives rise to a Mod 640 charge is the actual consumption recorded through the meter. In his oral opening, he said that a Mod 640 charge arises from the reading of the meter, that is to say the last meter reading that potentially led to a revision of the classification of the supply point as a Larger Supply point. In his written closing, Mr Fealy said that it is "the submitting by Corona to Xoserve of meter readings for a Smaller Supply Point covering a period of at least six months in the year from 1 October, which show annual consumption in excess of 2,500 therms"; and he did not maintain that the increased consumption of gas gives rise to a liability for the Mod 640 charges. In his oral closing he put the matter on the basis that the "event" giving rise to a liability within the definition in FRS 5 was when the Group "was in a position to identify the likely candidates for threshold crossing and to make a provision for them". It is no criticism of Mr Fealy that he was driven to suggest these different tests: it reflects a difficulty in Macquarie's case.
- I conclude that it was in accordance with proper accounting principles not to recognise the Mod 640 charges as a liability in the Accounts and the Management Accounts.
- Further, if, contrary to my conclusion, the Mod 640 charges gave rise to some sort of liability before 15 September 2006, in my judgment they are properly to be regarded as a contingent liability, and so should have been the subject of disclosure but not a provision in the accounts. If the charges were to be regarded as arising from "past events", they became obligations only if and when confirmed by Xoserve's AQ review. This depended, for example, upon whether the customer changed supplier and upon the new AQ set by Xoserve in light of, for example, anticipated weather patterns.
- There is a second reason that, to my mind, the Mod 640 charges might properly be regarded, if as a liability at all, as a contingent liability: because their amount could not be measured with sufficient reliability at the relevant time.
- Mr Russell observed that the method used by Mr Darby could not have been used until the proposed new AQs were received from Xoserve in about August 2006. What assessment could the Group have made for inclusion in the Management Accounts for June 2006? Mr Russell said that, because the annual AQ review is based upon actual consumption through meters until March or April, therefore "by April in any particular year, Corona had the actual meters readings necessary to calculate which sites with an AQ currently below 2,500 therms could increase to above 2,500 therms as of the coming October, as such being re-designated Larger Supply Points, and therefore require a corresponding provision in respect of that liability". He said that the appropriate way to provide for Mod 640 charges is to examine for all Smaller Supply Points the meter readings which had not been used for a previous AQ review, to calculate from them a revised AQ and, if that calculation indicates consumption of a Larger Supply Point, to calculate an anticipated Mod 640 charge.
- I am not persuaded by this evidence:
i) First, it depends upon the Group having enough information to make assessment of their own about which of the Smaller Supply Points are likely to be threshold crossers. The UNC requires that in order to re-assess the AQ of a supply point and re-designate it as a Larger Supply point, there should be meter readings over six months in the relevant gas year. By April, six months of the gas year have passed and therefore the Group would have readings in the gas year over six months for some meters, but not for all of them. There was no evidence about the proportion of meters for which the Group would have the required readings. But, even for those, it is not apparent that the Group could make appropriately reliable estimates about what new AQs would given by Xoserve.
ii) Secondly, even if the task described by Mr Russell were feasible, it would, on the face of it, be enormous. Mr Russell understood that the Group carries out such an exercise annually, probably in May, but his evidence about this was vague and I found it unpersuasive.
- Mr Russell produced a document setting out the accruals for Mod 640 charges made by the Group since that of £329,000 in February 2007. Mr Russell's evidence was that the provisions are calculated by the Operations Team, usually by Mr Crosland, using the method that I have described, an exercise that, he said, took them a number of days. Mr Crosland had no written instructions about how this was to be done and no documents relating to any such exercise have been disclosed.
- The only accrual made before the Mod 640 charges for £743,173 of March 2007 was that of £329,000. The Group accrued £300,000 in May 2007, and this amount was increased by £33,000 in July, August and September 2007: these were for Mod 640 charges that resulted from the new AQs for the gas year from 1 October 2007. Then, between October 2007 and January 2008, the Group accrued provisions shared between those Mod 640 charges and those which would arise for the subsequent year: these provisions amounted to £716,000 in January 2008. In February 2008 a separate provision of £549,000 was reinstated for Mod 640 charges resulting from the AQs for the year from 1 October 2007, for which an invoice of £465,356 was received in March 2008. As for the invoice for Mod 640 charges in the sum of £1,022,334 received in March 2009, it suffices to say that by October 2008 a provision of £1,345,000 had been made, but, as Mr Dickerson rightly observed, there were apparently not regular monthly re-calculations of what provision would be required, but lump sums provided at quarterly intervals.
- I see nothing in the accruals that have been made in respect of Mod 640 charges since February 2007 that supports this part of Macquarie's case. Mr Russell was unable to identify quite which of the provisions reflects an exercise by Mr Crosland such as he described
- There is no evidence that I accept that it would have been practicable or reasonably possible for the Group to have made before October 2006 any reliable assessment of the amount that Xoserve would charge by way of Mod 640 charges as a result of new AQs for the year beginning 1 October 2006. In support of Macquarie's contention that the Group had enough evidence to do so in around June 2006, Mr Fealy argued that in June 2007, with comparable information available, the Group estimated their Mod 640 charges at £300,000, whereas the actual charge for which they were eventually invoiced was £564,356, and in June 2008 they made an estimate of £978,000, the actual charge being £1,022,334. I do not find this argument persuasive because there is no proper information about how the amounts of £300,000 and £978,000 were calculated or estimated, but in any case, on Mr Fealy's submission as to what the £300,000 was designed to represent, the assessment in June 2008 underestimated the charges by almost 50%.
- Moreover, if the Group had attempted before October 2006 to estimate the prospective charges, they would have assessed them at something less than £400,000. In my judgment, the best indication of what estimate would have been made is the assessment of £277,525.28 made by Mr Pearce, subject only to increasing it to £382,391.82 because of his acknowledged errors. However, as far as the evidence goes, this was an assessment in August 2006 of what the charges were likely to be, and it was not designed to measure how much of it was attributable to gas consumed (or gas consumption recorded in meter readings, or gas consumption recorded in meter readings submitted to Xoserve) either by 30 June 2006 or by 31 July 2006.
- I therefore conclude that:
i) Even if the Group were applying accounting principles in preparing the Management Accounts as strictly as required for statutory accounts, those principles would not have required the Group to recognise the Mod 640 charges as a liability. The interpretation and the application of accounting principles often involve an element of judgment, and entities can properly take different views about what is required. In my judgment, it was in accordance with accounting principles not to treat the Mod 640 charges as a liability at the times that the SPA was made and completed.
ii) Even if the Mod 640 charges were to be treated as a liability of some sort, it was, or at the least it could properly have been treated as, a contingent liability, both because its existence would be confirmed only by the occurrence of a future event not in the Group's control and because of the uncertainty about measuring it at a monetary amount.
iii) If the Group had concluded that the nature of the Mod 640 charges was such that they should be recognised as a liability in the Management Accounts, they would have assessed it as being something less than £400,000.
The Sale and Purchase Agreement
- Before the SPA was concluded on 31 July 2006, the sellers had had other discussions about selling their shares. In about February 2005 entities called Essent and Gazprom had expressed interest in Corona, and in August 2005 Essent made an offer of around £30 million. However, when the gas markets had a turbulent period in late 2005, which caused Corona (and other companies in the industry) losses, Essent reduced their offer and it was rejected by the shareholders. Mr. Russell and Mr. Spellman considered the possibility of a management buyout, and discussed with Macquarie whether they would support one. In the event, Macquarie decided to make their own offer, which was accepted by the shareholders. Thus, from early 2005, the Group were aware that Corona might be sold.
- By clause 6 of the SPA, Glencore gave Macquarie certain "Core Warranties" and "Non-Core Warranties", which were set out in schedule 3 to the SPA. They were said to be given "as at" 31 July 2006, and Glencore also warranted to Macquarie that the Core Warranties would be "true and accurate at Completion by reference to the facts and circumstances then subsisting and, for this purpose, the Core Warranties shall be deemed to be repeated at Completion as if any express or implied reference in the Core Warranties to the date of this Agreement was replaced by a reference to the Completion Date". The Core Warranties included warranties about the Accounts and the Management Accounts. The Non-Core Warranties included a warranty headed "Books and records properly maintained".
- By Clause 6.3 it was agreed inter alia, that, "each of the Warranties is separate from and independent of any other Warranty and (except as otherwise provided in this Agreement…) … shall not be limited by any other provision of this Agreement ...". I do not consider that, in any way relevant to what I have to decide, this means that the warranties should not be construed in the context of the SPA as a whole, or that one warranty cannot properly be considered when determining the meaning and proper application of another. More specific wording would be required if this were the parties' intention. At any rate (and this suffices for present purposes) I consider that the provisions of para 4.1 of schedule 4 to the SPA, which concerns the Accounts, and para 4.2 of the schedule, which concerns the Management Accounts, are each to be regarded as a single warranty and to be considered as a whole: certainly, that is the proper approach to interpreting the provisions of a single sentence in those paragraphs.
- Clause 6.4 provided, inter alia, that, "the sole remedy of the Purchaser for breach of the Warranties or any other provision of this Agreement shall be damages....".
- Clause 6.7 provided that, "The Sellers acknowledge that, in entering into this Agreement, the Purchaser has relied upon the Warranties."
- Schedule 4 to the SPA placed various limitations upon Glencore's liability. No claim might be brought unless Macquarie had given Glencore written notice before 16 September 2007, and legal proceedings had to be issued and served within nine months of written notice of the claim. It set out the threshold amounts for a warranty claim: the amount recoverable in respect of the claim must exceed £50,000, and in aggregate with other claims must exceed a threshold of £250,000; but, if the threshold of £250,000 was satisfied, then the full amount of the claim was recoverable, and not only the excess over the threshold amounts. Schedule 4 also provided that Macquarie were not entitled to make a warranty claim, "if and to the extent that: ... the subject matter of the claim has been noted, provided for or otherwise taken into account in the Accounts, the Management Accounts or the Exchange Accounts" (para 3.1(d)(vi)). Para 3.2 of Schedule 4 precluded claims in respect of matters that had been disclosed to Macquarie, and I shall refer to this provision further below. I have already referred to para 7, which concerned "set off for over provision".
- Under clause 3.1 of the SPA the purchase price for the shares was £5,551,000 adjusted by reference to any sum by which the "Exchange Net Worth" exceeded or fell below £5,751,000. £5,751,000 was the net asset value of the Group according to the Management Accounts as at 30 June 2006. The Exchange Net Worth was "… the amount, determined by reference to the Exchange Accounts, as representing the sum of: (a) all the assets of [the Group] less (b) the aggregate of all Liabilities, in each case as at" 31 July 2006. "Liabilities", as defined in the SPA, had the meaning ascribed to it in the Relevant Accounting Standard, defined to include "any applicable Statement of Standard Accounting Practice, Financial Reporting Standard, … or Statement of Recommended Practice issued by the Accounting Standards Board … or any committee of it or body recognised by it".
- The SPA provided that Exchange Accounts were to be prepared, and for them to be agreed or any dispute about them to be resolved by expert determination. The sellers were required to procure that the Group prepare and deliver the Draft Exchange Accounts to Macquarie. If Macquarie did not notify the sellers within 15 business days of items that were disputed, they were deemed to have accepted the Draft Exchange Accounts: those Accounts and the Draft Exchange Net Worth constituted the Final Exchange Accounts and the Final Exchange Net Worth respectively, and both were "final and binding" on Macquarie and the Sellers. If Macquarie raised Disputed Items, the SPA provided for a period of twenty business days to reach agreement, failing which the Disputed Items were to be referred to a firm of independent chartered accountants for a final and binding expert determination.
- The Sellers delivered Draft Exchange Accounts to Macquarie on 17 August 2006. They were the Group's July 2006 management accounts, with an upward adjustment for revenue recognition that had been made in the Accounts, but not in the Management Accounts. They showed a net asset value of £5,741,000 for the Group, and made no provision for the Missed Meters charge or the Mod 640 charges.
- Macquarie were obliged under the SPA to submit the Draft Exchange Accounts to PricewaterhouseCoopers ("PwC") "on the basis that [PwC] conduct an audit thereof". By a letter dated 8 September 2006, Macquarie submitted to the vendors PwC's engagement letter and report, and raised two Disputed Items in the Draft Exchange Accounts. The engagement letter provided that PwC would not carry out an audit. In the event, Macquarie and the vendors reached agreement on the Disputed Items and Macquarie accepted the Draft Exchange Accounts of 17 August 2006.
- Accordingly, in September 2006 Macquarie, Glencore and the other vendors agreed that the Exchange Net Worth of the Group was £5,741,000. The Purchase Price paid by Macquarie for the shares was £5,541,000 (being £5,551,000 minus the difference of £10,000 between the Target Net Worth and the Exchange Net Worth.)
The Warranties about the Accounts
- The Core Warranties included (at para 4.1 of Schedule 3) the following in relation to the Accounts:
"The Accounts:
(a) have been prepared in accordance with Relevant Accounting Standards and in a manner consistent with that adopted in the preparation of the annual accounts of the Group and/or the Company or Subsidiary to which they relate (as the case may be) for the Financial Years ended 31 December 2003 and 31 December 2004;
(b) give a true and fair view of the assets and liabilities of the Group and/or the Company or the Subsidiary to which they relate as at the Accounts Date [sc. 31 December 2005] and the profits and losses of the Group and/or the Company or the Subsidiary to which they relate (as the case may be) for the Financial Year ended on the Accounts Date (including all related party transactions);
(c) comply with the requirements of the Companies Act;
(d) make appropriate provision for or note or otherwise disclose all material actual liabilities and all material contingent, deferred and disputed liabilities … and all outstanding capital commitments of which the Group and/or Company or Subsidiary to which they relate was aware as at [31 December 2005] and in respect of which disclosure or provision is required under the Relevant Accounting Standards; and
(e) make adequate provision for debts then known or believed to be bad or doubtful".
Thus, the provisions in sub-paragraphs (d) and (e) are qualified by reference to the knowledge of the reporting entities. The provisions upon which Macquarie specifically rely in sub-paragraphs (a) and (b) are not so qualified.
- The definition of the "Accounts" included in relation to the Group and the subsidiary companies the draft audited balance sheet as at 31 December 2005 in respect of the financial year ended on 31 December 2005 and the draft audited profit and loss account and the draft cash flow statement of the Group in respect of that financial year.
- Macquarie allege breaches of warranty in respect of the Accounts because (i) they had not been prepared in accordance with the "Relevant Accounting Standards", as required by schedule 3 para 4.1(a) of the SPA; and (ii) they did not show a true and fair view, as required by para 4.1(b). The former complaint is that such standards required the Group to recognise the Missed Meters charge as a liability. I have rejected the basis for that complaint.
- As I understand their submissions, Macquarie contend that sub-paragraphs (a) and (b) of para 4.1 contain two distinct warranties, and therefore clause 6.3 requires that they be given effect separately and independently from each other. Sub-paragraph 4.1(a), they say, is concerned with the "process" of compiling the accounts and sub-paragraph 4.1(b) is concerned with the "outcome of that process"; and accordingly, for the purposes of determining whether the Accounts give a true and fair view, it is irrelevant whether the Group knew of, or had evidence of, the Missed Meters charge when the Accounts were compiled and signed.
- I cannot accept that, because of clause 6.3 or any other reason, accepted accounting principles are not important in deciding whether the Accounts showed a true and fair view. As I have said, I consider that the provisions in para 4.1, although divided into five sub-paragraphs, constitute a single warranty: the different requirements are stated in a single sentence. Even if I am wrong about this, however, the expression "true and fair view" has become established and accepted and given statutory force as a standard for preparing financial statements, and must be understood and given effect in light of generally accepted accounting practices, which are reflected in Financial Reporting Standards and other statements falling within the definition in the SPA of Relevant Accounting Standard. As a matter of language, para 4.1 of Schedule 3 to the SPA undoubtedly distinguishes between the requirement that the Accounts be prepared in accordance with Relevant Accounting Standards and the requirement that they give a true and fair view of the assets and liabilities and of profit and loss. However, in substance the sub-paragraphs are intimately connected. I find support for this in what May J said of a similarly structured clause in Senate Electrical Wholesalers Ltd v STC Submarine Systems Ltd., (unreported) 20 December 1996. (There was a successful appeal, [1999] 2 Lloyd's Rep 423, but it did not affect the passage of the judgment that is relevant for present purposes.) May J said this:
"Although Senate are obviously correct to submit that sub-clauses (a) [which provided that management accounts had been diligently and carefully prepared in accordance with generally accepted accounting principles and practices and were true and accurate in all material respects] and (b) [which provided that they gave a true and fair view of all the assets and liabilities, financial position and results of the business] of clause 11.1.5.1 linguistically contain separate warranties, it is scarcely useful to distinguish their substance. Generally accepted accounting principles and practices" tend to import "true and fair view" and vice versa."
- Lord Hoffmann put it this way in Revenue and Customs Commrs v William Grant & Sons Distillers Ltd, [2007] UKHL 15, [2007] 1 WLR 1448 (at para 2):
"Although the requirement that the initial computation shall give a true and fair view involves the application of a legal standard, the courts are guided as to its content by the expert opinions of accountants as to what the best current accounting practice requires. The experts will in turn be guided by authoritative statements of accounting practice issued or adopted by the Accounting Standards Board, which are given statutory recognition by section 256 of and paragraph 36A of Schedule 4 to the Companies Act 1985 (inserted by section 4(2) of and paragraph 7 of Schedule 1 to the Companies Act 1989."
Lord Hope said (at para 38),
"The golden rule is that the profits of a trading company must be computed in accordance with currently accepted accounting principles. They are the best guide as to a true and fair view of the profit and loss of the company in the relevant accounting period."
- There is a close relationship between the accounting policies that an entity adopts, which to some extent are matters of judgment, and the question whether its accounts give a true and fair view. This is reflected in FRS 18, which states in para 14 that, "An entity should adopt accounting policies that enable its financial statements to give a true and fair view"; and at para 17, "Where it is necessary to choose between accounting policies that satisfy the conditions of paragraph 14, an entity should select whichever of those accounting policies is judged by the entity to be most appropriate to its particular circumstances for the purpose of giving a true and fair view". There is no complaint in this case that the Group and companies in it did not adopt appropriate accounting policies: Macquarie argued that the treatment of the Charges did not reflect accounting policies that had been adopted.
- The SPA does not define the expression "true and fair view", but it reflects, of course, the wording of the Companies Acts: section 226A(2) of the Companies Act 1985 provides that "the balance sheet must give a true and fair view of the state of affairs of the company as at the end of the financial year, and the profits and loss account must give a true and fair view of the profit and loss of the company for the financial year". Section 227A(2) contains a comparable obligation with regard to group accounts, again using the expression "true and fair view". Mr Fealy submitted that the expression in para 4.1(b) of Schedule 3 has the same meaning as it has in the Companies Acts, and I agree.
- Although it might be that the quality of being "true" is directed to the accuracy of statements of fact and the quality of being "fair" reflects that accounts involve matters of assessment and judgment, it would be an arid and unhelpful exercise to decide whether financial statements are (i) true and (ii) fair as if they were separate questions. The sensible and generally accepted approach is to recognise that "true and fair" is a composite phrase, and the requirement that financial statements be "true and fair" is a single, indivisible requirement.
- The concept of a "true and fair view" was considered by Mr. Leonard Hoffmann QC and Ms Mary Arden in a Joint Opinion written for the Accounting Standards Committee (the predecessor of the Accounting Standards Board) and dated 13 September 1983. It explains the view that Lord Hoffmann later expressed judicially. Having observed (at para 6) that "the courts have never attempted to define "true and fair" in the sense of offering a paraphrase in other languages", they wrote (at paras 7 and 8):
"It is however important to observe that the application of the concept involves judgment in questions of degree. The information contained in accounts must be accurate and comprehensive (to mention two of the most obvious elements which contribute to a true and fair view) to within acceptable limits. What is acceptable and how is this to be achieved? Reasonable businessmen and accountants may differ over the degree of accuracy or comprehensiveness which in particular cases the accounts should attain. Equally, there may sometimes be room for differences over the method to adopt in order to give a true and fair view, cases in which there may be more than one "true and fair view" of the same financial position. Again, because "true and fair view" involves questions of degree, we think that cost-effectiveness must play a part in deciding the amount of information which is sufficient to make accounts true and fair.
In the end, as we have said, the question of whether accounts give a true and fair view in compliance with Companies Acts must be decided by a judge. But the courts look for guidance on this question to the ordinary practices of professional accountants. This is not merely because accounts are expressed in a language which judges find difficult to understand. This may sometimes be true but it is a minor reason for the importance which the courts attach to evidence of accountancy practice. The important reason is inherent in the nature of the "true and fair" concept. Accounts will not be true and fair unless the information they contain is sufficient in quantity and quality to satisfy the reasonable expectations of the readers to whom they are addressed. On this question, accountants can express an informed professional opinion on what, in current circumstances, it is thought that accounts should reasonably contain. But they can do more than that. The readership of accounts will consist of businessmen, investors, bankers and so forth, as well as professional accountants. But the expectations of the readers will have been moulded by the practices of accountants because by [and] large they will expect [to] get what they ordinarily get and that in turn will depend upon the normal practices of accountants."
- I have set out this passage from the Joint Opinion at some length because it explains why the "true and fair" concept necessarily relates to the expectations that accounting practices generate. It is of some interest that Mr Hoffmann and Ms Arden recognise that the application of the "true and fair" concept involves "judgment in questions of degree" and observe that cost-effectiveness is relevant to deciding what information is required in order to prepare financial statements that give a true and fair view. So too, as I have explained, it seems to me that both judgment and the cost-effectiveness and proportionality of potential investigations are relevant to deciding whether there is sufficient evidence to recognise an item as an asset or a liability.
- None of this means that financial statements that are prepared in accordance with FRSs necessarily give a true and fair view. In the case of statutory accounts, the requirement in sections 226A and 227A of the Companies Act 1985 (as amended) that accounts give a true and fair view of the state of affairs of the company and, where applicable, the group at the end of the financial year in question and of the profit or loss of the company or group for that financial year are overriding, and in exceptional cases may override a requirement to comply with accounting standards. This is recognised in the Foreword to Accounting Standards issued or adopted by the Accounting Standards Board, which states at para 19:
"If in exceptional circumstances compliance with the requirements of an accounting standard is inconsistent with the requirement to give a true and fair view, the requirements of the accounting standard should be departed from to the extent necessary to give a true and fair view … Particulars of any material departure from an accounting standard, the reasons for it and its financial effects should be disclosed in the financial statements".
- However, I cannot accept that there are such exceptional circumstances in this case. I find it difficult to envisage circumstances in which, because an entity has no or no sufficient evidence of a liability and therefore does not provide for it in its financial statements, they would on that account fail to give a true and fair view of the entity's financial position. I have already concluded that the Accounts were prepared in accordance with Relevant Accounting Standards, and I cannot accept that, this being so, the Accounts did not give a true and fair view of the assets and liabilities of the Group and of Corona 2 because they did not provide for the Missed Meters charge. Similarly, although this does not arise for decision because no complaint about the Accounts is pursued in respect of the Mod 640 charges, having concluded that they were treated in the Accounts in accordance with Relevant Accounting Standards, it does not seem to me that their treatment could have meant that the Accounts do not give a true and fair view of the assets and liabilities.
The Warranties about the Management Accounts
- The Core Warranties also included (at para 4.2 of Schedule 3) the following in relation to the Management Accounts:
"The Management Accounts have been diligently prepared in accordance with Relevant Accounting Standards and in a manner consistent with that adopted in the preparation of the management accounts of the Group for each month during the twelve months prior to the Accounts Date. On the basis of the accounting bases, practices and policies used in their preparation and having regard to the purpose for which they were prepared, the Management Accounts:
(a) fairly reflect the financial position of the Group as at 30 June 2006;
(b) fairly reflect the cash and working capital position of the Group as at 30 June 2006; and
(c) are not misleading in any material respect".
The "Management Accounts" were the unaudited management accounts for the Group for the period of January to June 2006.
There was also a non-core warranty that since 30 June 2006 there had been no material adverse change in the financial position of the Group taken as a whole. Macquarie say that in this way the warranties cover the period between 30 June and 31 July 2006 and that the financial position of Corona was effectively warranted by reference to the Management Accounts. As with the Accounts, the warranties upon which Macquarie rely are not restricted to matters about which the Group were or should have been aware.
- I have concluded that the Management Accounts were prepared in accordance with Relevant Accounting Standards. There is no allegation that the Management Accounts were not prepared in a manner consistent with that adopted for previous management account of the Group. Macquarie do not submit that the reference in the warranty to them being prepared diligently in accordance with such standards imposes any more onerous obligation upon Glencore than would otherwise be the case. It follows that Glencore were not in breach of the requirement in the first sentence of para 4.2 of Schedule 3.
- Macquarie were right not to rely upon the word "diligently": it modifies, rather than aggravates, the warranty, and Mr Southern argued on behalf of Glencore that, even if the Management Accounts were not prepared in accordance with Relevant Accounting Standards, they were prepared with proper diligence to comply with them. Mr Lovell accepted in cross-examination that, as far as his investigations went, he considered that the Management Accounts had been prepared diligently. In view of my other conclusions, Glencore do not need to rely upon this argument. However, it seems to me to provide another answer to any complaint that Glencore were in breach of the first sentence of para 4.2, at least as far as the complaint is based upon the Missed Meter charge. It cannot, to my mind, be said that the Group did not prepare the Management Accounts with the required diligence because they did not investigate what was said at the Forum on 7 June 2006 and thereby discover (and quantify) the Missed Meters charge. Even if in some way Relevant Accounting Standards required that the Group should have recognised as a liability the Missed Meters charge notwithstanding that they could not have been aware of it through the exercise of proper diligence, nevertheless the Management Accounts were still prepared diligently to comply with those standards.
- The requirements in the second sentence of paragraph 4.2 must be judged:
i) "On the basis of the accounting bases, practices and policies used in [the Management Accounts] preparation"; and
ii) "Having regard to the purpose for which they were prepared".
- I have concluded that the Group had not made any accrual or provision in respect of the Mod 640 charges until February 2007, and that this was not attributable to simple oversight. I do not consider that the Group made a considered decision not to do so, or that, as a matter of ordinary and natural use of language, the Group used a "policy" in preparing the Management Accounts not to include such a provision. However, by the time that the Management Accounts of June 2006 were prepared, it was, in my judgment, the "practice … used in [the] preparation" not to do so.
- FRS 18 (at para 55) requires disclosure in financial statements by way of "a description of each of the accounting policies that is material in the context of the entity's financial statements". Mr Fealy submitted that any policy that the Group had adopted should have been disclosed. I do not consider this relevant: a failure to disclose would not mean that a policy must be disregarded in deciding whether there was a breach of warranty. Moreover, it applies only when a policy is material, and there is no reason to think that the Group did or would have so regarded the Mod 640 charges. In any case FRS 18 applies to policies adopted in preparing statutory accounts, rather than practices adopted in preparing management accounts.
- The reference to "the accounting bases, practices and policies used in [the] preparation" of the Management Accounts is also relevant to the Missed Meters charge. There was a note in the Executive Summary with the Management Accounts, to which I shall refer further later, that the Management Accounts took the gas consumed to be what was stated by Xoserve in their D+5 assessments; and adjusted the volume when Xoserve revised their estimate. Mr Southern submitted that the note explained the basis upon which the Management Accounts were prepared, and the explanation in the note is relevant when considering whether they reflected the position of the Group and whether they were misleading. It is convenient to refer further to this argument, with other arguments that are based upon the Executive Summary, later in this judgment.
- The reference to "the accounting bases, practices and policies" might have another significance: if (contrary to my own view) the first and second sentences of para 4.2 are separate warranties and if, therefore, because of clause 4.3 of the SPA the first sentence cannot be considered when determining the true meaning and effect of the second sentence, nevertheless because the Group had adopted Relevant Accounting Standards in preparing the management accounts over the months before the June 2006 Management Accounts, this is the basis upon which it is to be decided whether they complied with the requirements of the second sentence of para 4.2.
- The question whether the Management Accounts fairly reflected the position of the Group and whether they were misleading in any way is also to be judged by reference to the purpose for which they were prepared. Macquarie say that the Management Accounts were prepared for the purpose of the SPA. I disagree: Mr Russell's evidence was that they were produced for "the usual management purposes", albeit there came a time that he realised that they would also be used for the purposes of the SPA. It is one thing for them to be so used, or even to be prepared in the knowledge that they would be so used; the purpose (or a purpose) for which they were prepared is another. As a rule, management accounts are prepared for the purpose of managing a business, and the information in them depends upon the requirements of the business. There is no reason to think that the management accounts routinely prepared for the Group were prepared for anything other than internal management purposes, and there is no reason to think that the Management Accounts for the period to June 2006 were prepared for any other purpose. I so conclude notwithstanding that there had been other expressions of interest in purchasing Corona before Macquarie bought it. I agree with Mr Southern that it is irrelevant for the purpose of construing and giving effect to the warranties that the Management Accounts were used as a basis for determining the price to be paid by Macquarie.
- I have explained why, in my judgment, the Accounts gave a true and fair view of the assets and liabilities of the Group given that they complied with Relevant Accounting Standards. For similar reasons I conclude that, being prepared in accordance with Relevant Accounting Standards, the Management Accounts gave a true and fair view of the Group's financial position. This is, however, a more stringent test than is required by the warranty about the Management Accounts. Apart from the qualification to the warranty in the opening words of the second sentence of paragraph 4.2 of schedule 3, the requirement is that the Management Accounts should "fairly reflect" the financial position of the Group. As I interpret this, the parties intended that there should be a less demanding stipulation with regard to the Management Accounts than that they should give a true and fair view: they did not require that more time or more industry be spent in preparing them or that they be prepared to more demanding standards because they were the subject of the warranty than would normally be spent upon accounts prepared for internal management purpose in accordance with properly diligent standards.
- The Management Accounts were also warranted not to be misleading in any material respect. I interpret this as requiring them not to be so misleading to a reader who is reasonably well informed about business, about ordinary accounting practices and about the usual purpose and precision of management accounts. Macquarie's allegation is that they were misleading because, by reason of the Missed Meters charge, the Group "made a loss before tax of approximately £2m in the six months ended 30 June 2006 and the omission from the Management Accounts of [the Missed Meters charge] rendered them misleading …"; and also that they were misleading with regard to the Mod 640 charges. Thus, no separate argument is advanced in respect of this requirement and, in my judgment, the Management Accounts, being in accordance with proper accounting principles and fairly reflecting the Group's financial position, were not misleading.
- I add that the warranty about the Management Accounts, like the warranty about the Accounts, was repeated at completion. As Mr Southern submitted (and as I do not understand Mr Fealy to dispute), Glencore therefore warranted on completion on 15 September 2006, as they did when the SPA was made on 31 July 2006, that the Management Accounts fairly reflected the financial position as at 30 June 2006. They did not warrant that they represented the financial position as at 15 September 2006: clearly the position would have altered in the period between 30 June 2006 and 15 September 2006.
The warranty about "books and records"
- The other warranty upon which Macquarie rely is in para 10 of Schedule 3 of the SPA, which is headed "Records etc". It is a Non-Core Warranty and provides that:
"Books and records of the activities of [Corona] have been maintained at all material times so as fairly to present and reflect the business affairs and financial position of and all material transactions entered into and material liabilities incurred by the Company or to which it has become a party and such books and records have been retained by the Company for such periods as may be required by the law of the country of incorporation of the Company"
Like the other provisions in the warranties upon which Macquarie rely, it is not qualified by reference to the knowledge of Corona or Glencore.
- Macquarie submit that the books and records covered by this provision include the Accounts and the Management Accounts, and therefore there was a breach of the warranty in that the Accounts and the Management Accounts omitted material liabilities.
- I do not consider that the expression "books and records", which is neither a statutory expression, nor, according to Mr Dickerson's evidence, which I accept, an established accounting expression, is naturally to be understood to include the Accounts or the Management Accounts. I do not consider that the expression is naturally to be interpreted as covering a company's, or a group's, statutory accounts, the more so in the context of an agreement which include specific provisions about the statutory accounts; and it does not seem to me to cover management accounts, which are more naturally regarded as a product of the books and records of a business than the books and records themselves. As Mr Southern put it, Macquarie's complaint is of accounting errors, but not of record keeping errors.
- But in any case, I do not consider, and I do not understand Macquarie to contend, that there could a breach of this warranty if Glencore were not in breach of the warranties directed to the Accounts or to the Management Accounts. The pleaded breach about the Missed Meters charge is that a "liability" to Xoserve was not recorded, and the pleaded breach about the Mod 640 charges is similarly that that they did not record or evidence a "liability or contingent liability to Xoserve". Therefore, having rejected the complaints of breach of the warranties directed to the Accounts and Management Accounts, I also reject this complaint.
Were the Charges material?
- Although if I am right in the conclusions that I have reached the claim fails in any event, I shall also consider whether the Charges were material to the financial statements in the Accounts or the Management Accounts. This question arises for several reasons. The requirement that the Management Accounts should not be misleading is expressly qualified by reference to what is material, and the warranty about books and records refers to all material transactions and all material liabilities. The question of materiality is also relevant both to whether the Accounts and the Management Accounts were in accordance with Relevant Accounting Standards and to whether the Accounts gave a true and fair view and whether the Management Account fairly reflected the financial position. In paragraph 13 of the Foreword to Accounting Standards issued or adopted by the Accounting Standards Board, it is stated: "Accounting standards are applicable to financial statements of a reporting entity that are intended to give a true and fair view of its state of affairs at the balance sheet date and of its profit or loss (or income and expenditure) for the financial period ending on that date. Accounting standards need not be applied to immaterial items".
- It was suggested by Mr Fealy that what is material depends in part upon other provisions of the SPA, and in particular the financial threshold limits for a claim. I do not agree: in my judgment, materiality to the financial statements in the Accounts and the Management Accounts cannot be informed by the terms of the SPA, and it is also irrelevant that the parties set the price by reference to the Exchange Accounts and so indirectly the Management Accounts. Materiality, at least for purposes relevant to what I have to decide, is to be assessed objectively and what is material is not affected by the particular reader or user of the financial statements.
- The concept of materiality was considered by Nelson J in Bairstow v Queen's Moat Houses plc, (unrep BAILII: [1997] EWCA Civ 2168 ) 23 July 1999. He referred to a dictionary definition of "materiality", and said of an amount or item, "As a general rule, if it will affect the reasonable reader's view of the accounts it will be important and hence material". He considered, and I respectfully agree, that "a test of "important to the reasonable reader" is more appropriate as a definition of materiality than the application of a rigid percentage".
- Nelson J also said that, "The test of materiality is an objective one. A company itself cannot be the sole determiner of what is material". If by this he meant that the question whether an item is material turns upon its potential importance to the reader of the accounts, then the observation is uncontroversial and I readily accept it. However, it will often be a matter for the judgment of the preparer of the accounts whether or not an item is material and there will often be a margin of discretion in this regard. This could, I think, be of some importance in determining whether there had been breach of a warranty of this kind: it seems to me that Glencore have a strong argument that an item would only properly be regarded as material to the financial statements, and so its omission would only give rise to a breach of warranty, if a person signing the accounts could not properly regard it as immaterial. However, my conclusions about the materiality of the Charges have not depended upon this.
- Moreover, the question is not, of course, whether a person preparing accounts, or a reasonable Finance Director in Mr Russell's position, or a reasonable Board of Directors, would provide for an item in accounts or management accounts if they knew about it: often they would have do so even through the item is immaterial, but it does not follow that its omission means that the accounts do not give a true and fair view. This is so even though it is sometimes desirable to omit reference to what is immaterial: the Statement of Principles for Financial Reporting issued by the Accounting Standards Board states (at para 3.29) that "… when immaterial information is given in the financial statements, the resulting clutter can impair the understandability of the other information provided. In such circumstances, the immaterial information will need to be excluded."
- The Statement continues to give an explanation of what is "material", that both expert witnesses regarded as authoritative and that I accept as authoritative: "An item of information is material to the financial statements if its misstatement or omission might reasonably be expected to influence the economic decisions of users of those financial statements, including their assessment of management's stewardship". (The question is whether it might reasonably be expected to influence the decisions of users of accounts. This does not mean that an item is material because it would or might affect the amount that a buyer of shares such as Macquarie would have to pay under a formula for determining the price such as that in the SPA). The Statement includes "potential investors" among the "users of [the] financial statements": para 1.3.
- Mr Lovell also referred to a statement issued by the Council of the Institute of Chartered Accountants for England and Wales under the title "The Interpretation of Materiality in Financial Reporting" in 1996 under the reference 32/96 (the "Materiality Statement"). It included guidance about the draft of the Statement of Principles that was published in November 1995 and, I was told, was still current in 2005 and 2006. The draft of the Statement of Principles, in a paragraph set out in the Guidance, differed from the final version in that it said, "Information is material if it could influence users' decisions taken on the basis of financial statements" (emphasis added), and Mr Lovell took this, rather than the published Statement of Principles, to inform what was material to the Accounts and the Management Accounts. However, neither he nor, as I understood his evidence, Mr Dickerson attached significance to the difference of wording. If it be important, I would prefer to adopt the test set out in the Statement of Principles itself rather than the draft, but in my judgment it makes no difference to what I have to decide which formulation is taken.
- As is observed in the Materiality Statement, "users can be assumed to have a reasonable knowledge of business and economic activities and accounting and a willingness to study information with reasonable diligence": para 16. The question is not what a casual reader of accounts might understand from reading them: rather it is what a reasonably knowledgeable and diligent person might be willing to have influence his decisions. As it is put at para 17 of the Materiality Statement:
"It is … envisaged that judgements about materiality can generally be made on the basis of the needs of classes of knowledgeable and diligent investors who are reasonable in their use of and reliance on financial statements and other information. Such investors recognise the inherent limitations of financial statements and other information requiring the use of estimates and the consideration of future events. It is also important when there are large numbers of users in a group to consider representative users. Preparers should not seek to address a single hypothetical user, especially one on the brink of making a decision to buy or sell, whose decision might be changed by even a small change in a reported number or disclosure".
- The Materiality Statement discusses the relevance of the size of an item, its nature and its context in considering whether it is material. It points out that, "Whilst the quantification of materiality is fundamental and unavoidable, materiality can never be judged purely on the basis of absolute size … In some cases the nature and circumstances of an item can be of such importance to users that a size threshold is of little practical significance in determining materiality": para 20. It is also pointed out that, "The financial statements of a single period for a single entity are of limited value and users generally consider such information in a wider context", and that accordingly materiality needed to be considered in light of, among other things, comparative figures and trend information and industry background information: para 26.
- In order to consider whether the Missed Meters charge is material to the Accounts, it must be seen in relation to other figures in them. I set out below the relevant figures in the Accounts for the Group and for Corona 2 as stated by Mr Lovell, and I also state in square brackets in the column to the right what the figure would be if a Missed Meters charge of £566,000 had been recognised.
| The Group |
|
|
| |
(in £'000s) |
(in £'000s) |
| Turnover: |
224,720 |
[225,117] |
| Gross profit: |
7,186 |
[6,620] |
| Profit (loss) before tax: |
142 |
[(424)] |
| Net current assets (liabilities) |
1,706 |
[1,140] |
| Net assets ( liabilities) |
1,053 |
[487] |
| |
|
|
| Corona 2 |
|
|
| Turnover: |
92,380 |
[92,777] |
| Gross profit: |
3,214 |
[2,648] |
| Profit (loss) before tax: |
* |
[(566)] |
| Net current assets (liabilities) |
(3,654) |
[(4,220)] |
| Net assets ( liabilities) |
(1,053) |
[(3,486)] |
* The profit before tax was £140.
- Thus, Mr Fealy observed that the recognition of the Missed Meters charge would reduce the net asset value of the Group by something like 50% and would produce a loss of some £424,000 rather than a small profit.
- The impact that Mr Lovell stated provision for the Missed Meters charge would have had on the Management Accounts is set out below in a similar format, on the basis that £1,779,000 of the charge would be attributable to the period of 6 months to June 2006.
| |
£'000s |
£'000s |
| Turnover: |
191,942 |
[192,094] |
| Gross profit: |
1,894 |
[115] |
| Profit (loss) before tax: |
(2,025) |
[(3,854)] |
| Net current assets (liabilities) |
(2,220) |
[(4,565)] |
| Net assets ( liabilities) |
5,751 |
[3,406] |
- Mr Fealy observed that the impact of recognising the Missed Meters charge would be to reduce the net asset value by some 40%, and the loss before tax would be increased by some 95%.
- Mr Lovell's evidence was that the impact on the Management Accounts if the Mod 640 charges had been recognised would have been as set out below:
| |
£'000s |
£'000s |
| Turnover: |
191,942 |
[191,942] |
| Gross profit: |
1,894 |
[1,425] |
| Profit (loss) before tax: |
(2,025) |
[(2,544)] |
| Net current assets (liabilities) |
(2,220) |
[(2,689)] |
| Net assets ( liabilities) |
5,751 |
[5,208] |
- Mr Fealy observed that the impact of recognising the Mod 640 charges would be to reduce the net asset value by some 10%, and to increase the loss before tax by some 25%.
- I have set out the figures from Mr Lovell's report. They may not be entirely uncontroversial, but they usefully set the scene in order to explain and to assess the parties' submissions about the materiality of the Charges that Macquarie say should have been recognised. I accept that they are sufficiently accurate for that purpose.
- Macquarie's argument about the materiality of the Charges concentrated upon the impact that their recognition would have had on the net asset value and the profit or loss shown in the Accounts and the Management Accounts. The impact on the turnover and costs of sales recorded in the Accounts would have been insignificant: recognition of the Missed Meters charge would have made a difference of about 0.5% upon Corona 2's statements and less upon the Group's statements. The impact upon the comparable figures in the Management Accounts would have been of the order of 1%. The impact of the Mod 640 charges on these figures in the Management Accounts would have been much smaller, something of the order of 0.25%.
- Mr Lovell's opinion was that:
i) The Missed Meters charge was material at 31 December 2005 to both the statutory accounts of Corona 2 and those of the Group, and that therefore the Accounts did not give a true and fair view of the assets and liabilities and the profits and loss of Corona 2 and the Group; and
ii) Both the Missed Meters charge and the Mod 640 charges were material to the Management Accounts, and thus the Management Accounts did not fairly reflect the financial position of the Group as at 30 June 2006 or as at 15 September 2006, and they were also at both dates misleading in a material respect.
In support of this view, Mr Lovell pointed out that the adjustment to the Accounts required to take account of the Missed Meters charge would have the effect of turning into a loss the profit shown in the statements of both Corona 2 and the Group; and that the adjustment to the Management Accounts required to take account of the Missed Meters charge is material because of its impact on the reported gross profit and loss before tax, and the adjustment to the Management Accounts required to take account of the Mod 640 charges is similarly material.
- In support of Macquarie's arguments that the amount of these adjustments would be material, Mr Fealy referred to observation in the Materiality Statement (at para 35) that: "The staff of the US Securities and Exchange Commission has an informal rule of thumb that items and errors of more than 10% are material, those between 5% and 10% may be material and those under 5% are usually not material. These percentages are normally applied to gross profit, net income, equity and any specific line item in the financial statements that is potentially misstated". However, this rule of thumb is not referred to in the revised Guidance on Materiality published by the Institute of Chartered Accountants in June 2008. In any case, it is only a rule of thumb, and Mr Lovell accepted that "rules of thumb are rather dangerous to use in assessing items of materiality, although they often are". Indeed, he accepted that it is not necessarily the case that an item is material if its recognition would turn a loss into a profit (as clearly a very small item might do), although if an item would have this effect, accountants would generally adopt a lower threshold of materiality because this could have a significant impact upon the reader and user of the accounts and their decisions based upon them
- Mr Dickerson did not consider that the adjustments that the Charges would require would be material. In his judgment, an adjustment to the profit or loss of £5 million would be material, an adjustment of less than £2.5 million would not be and an adjustment between the figures might or might not be material, depending upon the precise circumstances. He emphasised the question of materiality must be seen in the context of:
i) What would be of interest to potential users of the accounts;
ii) The nature of the industry concerned; and
iii) The inherent limitations of the statements of the entity in question.
All three considerations are, to my mind, of considerable importance.
- Mr Dickerson considered that the properly informed potential investor, and, as I infer, vendor of shares, would be more interested in the (apparently increasing) number of customers of the Group and its turnover than whether accounts showed a small profit or loss. For practical purposes, as Mr Dickerson pointed out, the Group had no assets and was making no profits. A purchaser would not be interested in acquiring Corona with a view to continuing to manage it as it had been managed, but with a view to turning the business round. It might, as Mr Dickerson recognised, have been different if the Group were making profits because then a purchaser might be interested in acquiring it with a view to continuing the pattern of business, and so be concerned about the trend of profitability. He was not, of course, saying that only the customer base and the turnover of the Group were of importance to the question of materiality, but he disagreed with Mr Lovell's excessive emphasis (as he saw it) about whether the Accounts and Management Accounts showed a profit or a loss.
- Mr Dickerson's opinion was that it would be unreasonable for a reader to expect the Group's statements to be prepared with the precision that Mr Lovell suggested, given the industry in which the Group were engaged. They are retail gas shippers, and those engaged in the industry realise, and users and potential users of their financial statements are to be taken to realise, that measurements and estimates in them cannot be expected to be precise, particularly in management accounts. In other words, the inherent limitations in financial information in this industry are an important consideration when determining an appropriate level of materiality. Further, the Group are engaged in a business that operates on high turnover and low margins, and so a minor inaccuracy in the costs of sales can have a disproportionate affect on the profit margin and the asset position.
- The point is further illustrated in relation to the Group's statements by a change of accounting policy to adopt a more aggressive approach to recognising out of contract variances. It was described in the Accounts in the note 1.13 (bis) to the Financial Statements of Corona for the year ended 31 December 2005: "The group policy on revenue recognition was driven primarily by the realisation concept in that revenue was recognised in such a way that only profits that were reasonably certain and unlikely to reverse were included in the profit and loss account. The change in policy has resulted in a prior year adjustment such that the profit and loss reserve at 31 December 2004 has increased by £1,112,700". The revised accounting policy also increased net assets in relation to 2005 by £529,798, and so in all it meant that the stated value of net assets was increased by £1,642,498. Changes in accounting policy are made when accounts prepared according to the previous and the new policy would both give a true and fair view, but the new policy is considered by the preparers of the accounts to be more appropriate. Mr Lovell accepted that both the previous and the new accounting policies were legitimate. This illustrates the scope for matters of judgment in determining the Group's financial position, and so the margin that should be allowed by a properly informed reader when assessing their statements.
- Mr Fealy criticised Mr Dickerson's opinion about materiality on the grounds that it does not give due weight to the potential importance of net profit and net asset value in the context of a sale of shares, pointing out that the SPA itself was an agreement to buy and sell at net asset value. He referred to the observation in Materiality Statement (at para 31) that sometimes an assessment of the requirements of some users of accounts might require "very low levels of materiality and potentially unrealistic demands for accuracy, eg where … profits become losses … or identified individuals are deciding whether to buy or sell shares". I do not accept this criticism. The Materiality Statement does not indicate that, where the users need such accuracy, financial statements can or should accommodate, or purport to accommodate, "potentially unrealistic demands for accuracy". Rather, it requires preparers of accounts to adopt an even-handed approach, to be particularly sensitive that the cumulative effect of individually immaterial errors might be misleading and to consider whether the reliability of the information in relation to its potential use calls for it to be accompanied by "a clear statement of the circumstances of its preparation and its inherent limitations". Macquarie do not complain in this case that there was no such statement.
- I should mention another argument of Glencore. They point out that Corona did not restate the position with regard to the liabilities as at 31 December 2005 in their accounts for the next accounting period, a 15 months period to 31 March 2007: those accounts were signed by Mr Russell on 29 January 2008. FRS 3, which deals, inter alia, with prior period adjustments, states (at para 29), "Prior period adjustments should be accounted for by restating the comparative figures for the preceding period in the primary statements and notes and adjusting the opening balance of reserves for the cumulative effect…" Further (at para 60),
"The majority of items relating to prior periods arise mainly from the corrections and adjustments which are the natural result of estimates inherent in accounting and more particularly in the periodic preparation of financial statements. They are dealt with in the profit and loss account of the period in which they are identified and their effect is stated where material … Prior period adjustments, that is prior period items which should be adjusted against the opening balance of retained profits or reserves, are rare and limited to items arising from changes in accounting policies or from the correction of fundamental errors"
The position is further explained at para 63:
"In exceptional circumstances it may be found that financial statements of prior periods have been issued containing errors which are of such significance as to destroy the true and fair view and hence the validity of those financial statements. The correction of such fundamental errors and the cumulative adjustments applicable to prior periods have no bearing on the results of the current period and they are therefore not included in arriving at the profit or loss of the current period. They are accounted for by restating prior periods, with the result that the opening balance of retained profits will be adjusted accordingly, and highlighted in the reconciliation of movements in shareholders' funds. As the cumulative adjustments are recognised in the current period, they should also be noted at the foot of the statement of total recognised gains and losses of the current period".
Thus, Mr Southern submitted that if the directors of Corona considered that the Accounts did not give a true and fair view, they were obliged to restate the figures.
- I accept the argument to this point. However, I am unable to accept that, as Mr Southern submitted, it is therefore to be inferred that the directors concluded that the Charges were not material to the Accounts. Mr Russell's evidence was that he considered that they formed a small proportion of the losses for the 15 months to 31 March 2007 and, without giving the matter "any particular thought", he considered it appropriate to state them in the 2007 accounts. He also said that he recalled no discussion about this with the directors or the auditors. I accept that evidence. Whether or not Mr Russell and Corona were right so to deal with the accounts to 31 March 2007 is beside the point; This does not throw light upon whether the Charges were material to the Accounts. Indeed, Mr Southern accepted that the point was, as he put it, forensic.
- However, otherwise I accept the evidence of Mr Dickerson and the arguments of Glencore about whether the Missed Meters charge was material to the Accounts. I can take the Missed Meters charge to be £566,000 for this purpose, and I do not consider that this is anything like a large enough item to be material to the Accounts either of the Group or of Corona 2.
- I have had more difficulty in deciding whether the Missed Meters charge was material to the Management Accounts. It would have been an item of less than £2.5 million, and I have concluded, in view of the considerations identified by Mr Dickerson and which I have explained, that it was not material for inclusion in the Management Accounts.
- It follows a fortiori that I also conclude that the Mod 640 charges were also not material for inclusion in the Management Accounts.
- I add that the materiality of the Charges in aggregate does not arise for consideration. The Technical Guidance issued by the Council of the Institute of Chartered Accountants for England and Wales under the title "The Interpretation of Materiality in Financial Reporting" states (at para 22): "… the materiality of items of a similar nature should be considered in aggregate, eg. if a number of sales have not been recorded, their materiality should be considered in the aggregate". Hence it goes without saying that materiality of the accounting treatment of the 276 missed meters is to be considered in the aggregate, and so is the accounting treatment of all the Mod 640 adjustments, but there is no dispute that the materiality of the Missed Meters charge and the materiality of the Mod 640 charges are to be considered separately and not aggregated: they are not of a similar nature in any relevant sense.
The Executive Summary of the Management Accounts
- I have explained that the Group produced two documents, consolidated management accounts themselves and an Executive Summary. The Executive Summary of the June 2006 Management Accounts included this explanation at a bullet point note under the heading "Background":
"Offtake volumes are derived from Transco's estimate of gas consumed (commonly referred to as "D+5") by our customer base. These volumes are adjusted as and when Transco revise their previous estimates of offtake if considered appropriate. Such revisions ("reconciliation invoices") can occur up to 18 months after the month in question".
There is no dispute that in this note "Transco" is a reference to Xoserve. Glencore say that the note is part of the Management Accounts and rely on it in support of their submission that they fairly reflect Corona's financial position and are not misleading.
- The Management Accounts are defined in the SPA as "the unaudited consolidated accounts of the Group for the period of January to June 2006, a copy of which are appended to this Agreement and initialled by the parties for identification". There was no evidence about whether the Executive Summary was included among documents so appended and initialled. I asked about this in the course of the closing submissions. I was told that no original copy of the SPA was available, and although I allowed the parties time after the trial to produce further information about this, I understand that no Management Accounts with appended documents (whether or not including the Executive Summary) has been found by either party.
- The copy of the Executive Summary before the court appears to have initials or signatures of two people on the front page, but not initials or signatures of all the parties to the SPA; and there are no comparable markings on the Management Accounts themselves. I have been told that a copy of the Management Accounts which has been initialled has been found, but it has not been produced and I do not know whether the initials correspond. Neither party invites me to attach any significance to it.
- I observe that, while the definition of "Accounts" in the SPA includes, as well as the accounts themselves, "any notes, reports and statements included in or annexed to them", the definition of "Management Accounts" contains no such expansive provision.
- I confess that I harbour some doubt about whether the Executive Summary is truly within the definition of Management Accounts. However, Glencore pleaded in their Defence that the Management Accounts stated what was in the note in the Executive Summary that I have set out, and Macquarie admitted this in their Reply. Macquarie have not applied to withdraw that admission, and I must determine the case on that basis.
- The SPA provided at schedule 4, para 3.2 that: "The Purchaser shall not be entitled to claim against the Warrantor under the Warranties in respect of any matters fairly disclosed or referred to in this Agreement (or arising from implementation of the same) or the Disclosure Letter or the Disclosure Documents". There was a disclosure letter dated 31 July 2006, enclosing some "Disclosure Documents", and the letter stated that the letter, its appendix and the Disclosure Documents should "be deemed to qualify the Warranties to the extent that the matter is fairly disclosed". One matter stated in the Appendix to the disclosure letter was that "Save for [the Gas Supply Agreement between the Group and a company associated with Glencore], there are no agreement or arrangements to which [Corona] is party for the supply to it of natural gas. National Grid … do, as Systems Operator, take final balancing action (buy or sell) at the end of the gas day to balance the net position of [Corona] to system demand. This involves credits or debits through the energy balancing invoice in accordance with the" UNC: and stated where the UNC could be found on the internet.
- Glencore say that the note in the Executive Summary provides a number of answers to the claim: it is convenient first to consider its meaning. Clearly the first sentence explains the source of the "offtake volumes" from Xoserve's D+5 assessments. It goes on to say that those assessments may be adjusted if and when Xoserve revise them, and points out that there can be adjustments up to 18 months after the "month in question".
- Glencore submitted that the reference to "reconciliation invoices" in the note is not to Reconciliation Invoices as defined in the UNC, but is more general and is directed to any reconciliation between the price for gas that had been paid and what should have been paid. They argued that in this case the Missed Meters charge is covered by the note because:
i) the offtake volumes used to measure the cost of gas in the Management Accounts were based upon D+5 assessments;
ii) Xoserve later revised the estimate by issuing a "reconciliation invoice" for the Missed Meters charge, and provision had not been made for it in the Management Accounts; and
iii) the invoice was issued within 18 months of the earliest relevant D+5 assessments.
- Macquarie argue that this gives the note too generous a meaning and application. They say that it refers only to what the UNC called a "Reconciliation Invoice", that is to say an invoice in respect of one of four types of charge: "a Reconciliation Clearing Charge", a "Reconciliation Transportation Charge Adjustment", a "User Aggregate Reconciliation Clearing Charge" or a "User Aggregate Transportation Charge Adjustment". Thus, a Reconciliation Invoice is concerned with reconciliation of the D+5 assessment of an individual Larger Supply Point with the consumption invoiced to the customer and with aggregate reconciliation by differences for that purpose for Smaller Supply Points, and also with comparable reconciliations in respect of transportation charges. Although the invoice for the Missed Meter charge was referred to in some internal Group documents as being in respect of a "reconciliation adjustment", it was not a "Reconciliation Invoice" in this sense. It was not for a revised assessment of what was consumed through meters but for an assessment of the consumption of meters originally omitted from charging altogether.
- There is support for Glencore's submission in the wording of the note. Mr Southern observed that the first sentence refers to estimates of consumption "by our customer base", and argued that this indicates that the note is concerned with aggregate consumption rather than that of individual meters. Further, the note refers to revisions by Xoseve of their estimates of offtake, whereas Reconciliation Invoices in the limited UNC sense are triggered by information provided to Xoserve by the shipper rather than by Xoserve revising their assessments.
- More importantly, the reference to 18 months tells against Macquarie's contention that the note refers only to "Reconciliation Invoices" in the narrow sense of the UNC. The UNC provides that generally, in the absence of fraud and contrary agreement between the parties, Xoserve cannot make an adjustment to an invoiced amount after the expiry of 18 months from the Invoice Due Date, but this rule is "without prejudice to the provisions of the Code pursuant to which determination of quantities delivered to and offtaken from the Total System are made final": see section S, 1.8.4. As Mr Fealy acknowledged, the time limits for presenting Reconciliation Invoices under the UNC are longer: the UNC contemplates that at least some Larger Supply Point meters will be read annually and may not be read for up to 24 months: see UNC section M, 3.5.1, and, although other meters are read more frequently, no 18 months period comes into these procedures under the UNC.
- Glencore have a further argument: they say that because the Management Accounts, being drawn up on an "accruals basis", took account of ordinary reconciliations of the D+5 assessed consumption to the invoiced amount, therefore the note must be taken to be referring to other adjustments: otherwise it would be "fundamentally contradicting that accounting policy". I do not find that argument persuasive: the note can readily be understood as explaining the implications and application of accounting on an accruals basis.
- In support of Macquarie's interpretation of the note, Mr Fealy drew attention to the next note in the Executive Summary, which uses the expression "reconciliation invoice" in the sense for which Macquarie contend: "Turnover per the Profit and Loss account generates accrued revenue, with related volumes, in the Balance Sheet. As customers are billed, accrued revenue is reduced while debtors in the Balance Sheet are increased. In this way, detailed analysis of the accrued revenue account can help to identify, for example, over billing by [Xoserve] (leading to a later reconciliation invoice) or under billing by the Company". In this note, the expression "reconciliation invoice" is a reference to the invoice that Xoserve would render upon submission to them of a meter reading. Later in the Executive Summary there is further reference to reconciliation invoices of this kind: "[Xoserve] Reconciliations (£2.3 million unfavourable) – variance due to unwinding of some of the benefits derived from the management of meter read submissions (YTD [sc. year to date] shows a favourable variance of £1.9 million)." This is followed by a further note about such reconciliations. Moreover, the note in the Management Accounts is, in my judgment, to be interpreted on the basis that the reader of the Management Accounts would be familiar with the UNC and its use of the expression "Reconciliation Invoice": this is the more clearly so in the case of the parties to the SPA in view of the reference to the UNC in the Appendix to the Disclosure Letter.
- Thus, Macquarie submitted that the note in the Executive Summary is not concerned with consumption that was to be included in Xoserve's invoices for D+5 consumption, from which the consumption from the 276 missed meters was omitted, and that the Missed Meter charge was not to do with "reconciliation". They further supported this submission by reference to the Disclosure Documents and the information in them about how gas is charged for, how differences are reconciled and how discrepancies are resolved It suffices to mention, as well as the statement in the Appendix to the Disclosure Letter, these documents:
i) A document entitled "Questions for Corona Energy" that described the Group's policy towards energy balancing and said that the Group's "total imbalance on most days is typically less than 2,000 therms", and said that "Corona always aims to leave its end-of-day balance on the system as close to zero as possible (mostly within +/- 2,000 therms)…". This, as Macquarie point out, indicates that the imbalance charge is determined once the D+5 quantity was ascertained. The document explained the reconciliation procedures and how meters readings were suppressed.
ii) A document about "Transco [sc Xoerve] Reconciliation as at 31 December 2005", which included notes about the practice with regard to accruing for reconciliation invoices and about suppressed meter readings.
- Although the interpretation of the note is not, to my mind, straightforward, if I had to determine the meaning of the note as a matter of contractual construction or analogously thereto, I would give it Glencore's interpretation. However, as I see it, that question does not arise upon the various arguments that might be based upon the note. They are these:
i) First, Glencore say that, since the note is part of them, the Management Accounts, read as a whole and including the note, fairly reflect the financial position of the Group and are not misleading.
ii) Secondly, they say that the note states an accounting practice or policy and the question whether Management Accounts fairly reflect the financial position or are misleading must be considered on that basis.
iii) Thirdly, there is a question whether the note provides an answer to the claim under Schedule 4 para 3.2 of the SPA, which provides that "[Macquarie] shall not be entitled to claim against [Glencore] under the Warranties in respect of any matters fairly disclosed or referred to in this Agreement (or arising from the implementation of the same) or the Disclosure Letter or the Disclosure Documents".
iv) Fourthly, as I have said, Schedule 4 provides at para 3.1 that Macquarie were not entitled to claim under the warranties if and to the extent that the "subject matter of the claim" had been noted in the Management Accounts.
v) Fifthly, the note might answer any complaint that, if they were a contingent liability, the Mod 640 charges should have been disclosed.
- None of these questions turns simply upon the true construction of the note. If the Management Accounts did not otherwise fairly reflect the Group's financial position or were otherwise misleading because of the Charges, to my mind the obscure note in the Executive Summary would not fairly remedy this, particularly in view of what was said in the Disclosure Documents. This, as it seems to me, answers the first three arguments. Nor can it be said that the note disclosed the "subject matter" of the claim (either about the Missed Meters charge or about the Mod 640 charges): it was too vague and general. As for disclosure of the Mod 640 charges if they were a contingent liability, what is required by FRS 12 para 91 is, inter alia, "a brief description of the contingent liability", which the note does not provide.
- I should refer briefly to the evidence about the meaning or intended meaning of the note to the Executive Summary. Mr Russell said that he wrote the Executive Summary and his purpose was "simply to provide contextual information" and that he was not "setting an accounting policy". Mr Southern objected that this evidence is inadmissible, and I agree in so far as it is directed to what the note means; but in any case, the evidence did not assist upon the questions that I have to decide. I also agree with Mr Southern that the expert evidence about this was not admissible and in any event not of assistance.
- Mr Southern submitted that the note in the Executive Summary also answers the complaint that the Accounts did not give a true and fair view. I reject that argument for similar reasons to those concerning the Management Accounts.
PwC audit
- Glencore have a further argument if, contrary to their primary case, the Group had evidence such that the Missed Meters charge was a liability. Macquarie were, under the terms of the SPA, to have provided the Draft Exchange Accounts to PwC on the basis that PwC would audit them and then Macquarie give notice of any Disputed Items. No relevant Disputed Item being notified, the Draft Exchange Accounts became final and binding. In the event PwC were not required to carry out an audit, although they did produce a report upon the Exchange Accounts. Glencore argue that this was contrary to the SPA, and that, since the Charges would have been identified in an audit, Macquarie cannot now complain that the Exchange Accounts should have provided for the Charge.
- The argument depends, as it seems to me, upon Glencore establishing that, had PwC carried out an audit, they would have concluded that the Charges should be recognised as liabilities. I should in any case have rejected the argument for a further reason: it assumes that PwC would have considered the minutes of the meeting of the Forum on 7 June 2006 had they carried out an audit, and I see no reason that they should have done so.
The "commercial reality"
- I do not overlook Macquarie's general submission that Corona's financial position as at June 2006 was that they had obligations amounting to some £2.9 million for which they had made no provision, and so the shares were worth nothing like what they paid for them but something less than £3 million; and that it would fly in the face of commercial reality that Glencore were not in breach of the warranties. I disagree: when interpreting and giving effect to an agreement such as the SPA the court proceeds on the basis that the parties intended to distribute risks of this kind according to the terms of the contact, and, unless the parties agree otherwise, the principle of "caveat emptor" applies.
Damages
- I therefore conclude that the claim fails. I should, however, refer briefly to the quantum of damages had it succeeded. The claim for damages is put on the basis of the reduction in what was paid rather than upon the basis that the shares in Corona would have been more valuable but for breach of the warranties. As I have said, the price paid by Macquarie under the SPA depended upon the Exchange Net Worth which required the determination by reference to the Exchange Accounts of "all the assets of [the Corona group]" and "the aggregate of all Liabilities". Glencore gave no warranty about the Exchange Accounts themselves: Macquarie's case is that, but for the breaches of warranty by Glencore in relation to the Accounts, the Managements Accounts and the "books and records", the "aggregate of all Liabilities" as determined by reference to the Exchange Accounts would have included the Missed Meters charge and the Mod 640 charge. As I have pointed out, the sum of £5,751,000, which went to determine what Macquarie were to pay under the SPA, derived from the net asset value of Corona as stated in the Management Accounts. It is said that, if the Charges had been recognised by the Group in the Management Accounts, then the Exchange Accounts would have reflected not only the Charges referable to the months covered by the Management Accounts, but also the part of the missed Meters charge referable to the period before the Management Accounts and covered by the Accounts. This would have resulted in a reduction of the Exchange Net Worth produced by the Exchange Accounts of something over £3 million: had I been determining damages, I should have sought assistance about the exact amount of the reduction, which I understand to be uncontentious, subject to specific points taken by Glencore to which I shall refer.
- Mr Southern submitted that (if, contrary to Glencore's primary case, there was a breach of warranty) the important question for the purpose of assessing damages is not what charges were later made by Xoserve, but what provision the Group would have recognised at the relevant time. I agree, but generally the prima facie assumption will be that "the range of possible forecasts will be distributed around the figure which was the actual outcome", Lion Nathan Ltd. v CC Bottlers Ltd., [1996] 1 WLR 1438 at p.1447D per Lord Hoffmann. However, this prima facie assumption may be displaced (see the Lion Nathan case (loc cit) at p.1447E) and, as I have said, had the Group made an assessment of the Mod 640 charges when preparing the Management Accounts, the assessment would have been of no more than £400,000. I also consider, since this derives from Mr Pearce's assessment that was provided to Mr Russell in August 2006, no more than that would have been reflected in the Exchange Accounts. Had I had to assess damages in respect of the Mod 640 charges, I should have invited further submissions about the exact amount of damages in light of these conclusions.
- I also observe that Macquarie's formulation of the claim for damages in respect of the Mod 640 charges, as I see it, assumes that it should have been recognised as a liability, and not as a contingent liability. There is no evidence from which it could be inferred that disclosure, or further disclosure, of such a contingent liability would have affected the Exchange Accounts or affected the amount paid by Macquarie under the SPA, and it was not argued that such an inference should be drawn.
- Subject to these points, Glencore do not, as I understand it, take issue with Macquarie's approach to assessing damages for a breach of warranty in respect of the Management Accounts. There was only one issue between the parties about the quantum of these damages: Glencore say that they are entitled to set off against the claim £22,778.89, which represents credits resulting from the Gemini error of £21,830.09 received by Corona 4 in respect of gas supplied and of £948.80 in respect of transportation costs. I agree with Mr Southern that Glencore's pleaded defence, although it lacks particularity, sufficiently covers this argument: it is pleaded at paragraph 35(b) of the Defence that "… Xoserve … must have issued balancing credit reconciliation adjustments to all other shippers, including members of the Corona Group and Corona 2, for which credit must be given against the claim accordingly".
- Macquarie argue against this that the Group were also liable for transportation costs of £41,685 because of the Gemini error; that they made no claim for this (for reasons that have not been explained), but that they are entitled to bring this into account to extinguish the credit of £22,778.89. Glencore say that they are precluded from doing so because schedule 4 paragraph 2.1 of the SPA provides that, "No claim shall be brought by [Macquarie] under the Warranties … and any other provision of [the SPA] unless it shall have given notice in writing of that claim … not later than the expiry of a period of one year commencing on [15 September 2006]". Paragraph 2.2 provides that, "The liability of the Sellers in respect of a claim notified in accordance with Paragraph 2.1 shall absolutely terminate … if legal proceedings in respect of that claim containing full particulars of it shall not have been properly issued and validly served on the relevant Sellers within nine (9) months of the date of service of that notice".
- Macquarie's claim about transportation charges was not the subject of the requisite notice, and the question is whether, nevertheless, Macquarie can rely upon it by way of a set off against the £22,778.89 credit. They say that they can, citing Derham, The Law of Set-Off (2003) 3rd Ed at para 4.39 in support of the proposition that "Equitable set-off … is a substantive defence which does not require an order of the court for its enforcement. As a consequence, an equitable set-off may be asserted notwithstanding that the cross-demand upon which it is based is no longer enforceable by action because of the expiration of a limitation period". Even assuming this to be so where a period of limitation extinguishes the remedy to enforce a right, the argument is not available to Macquarie in this case because paragraph 2.2 makes it clear that, if notice of a claim is not given, not only the remedy but the liability giving rise to a claim is extinguished.
- There is a further and more fundamental question about the measure of damages for breach of the warranty about the Accounts. Macquarie say that, if the Accounts had been as warranted, then they would themselves have provided for the Missed Meters charge, and further, given that the charge had been recognised in the Accounts, it is to be inferred that there would also have been provision for it in the Management Accounts. Glencore dispute that this is a correct measure of damages. I did not hear full submissions on this point (which would be of significance only if Macquarie's claim succeeded on the Accounts but failed on the Management Accounts), and express no view about it.
- Nor did I hear submissions about damages if there had been a breach only of the warranty about books and records, and again I express no view about the appropriate measure in those circumstances.
Conclusion
- I therefore conclude that Glencore were not in breach of warranty and that the claim is to be dismissed.
