Brightsea UK Ltd v Drachs Investments No. 3 Ltd

Contractual powers to control a company’s pre-completion tax affairs must be read with their express limits and the transaction’s allocation of tax liabilities and reliefs. A power to direct claims, elections or surrenders cannot be used to reallocate reliefs already reflected in the completion accounts merely to recover an overprovision for tax, where that would alter the economic allocation agreed by the parties. An indemnity for additional tax liabilities does not arise from an unauthorised direction. On appeal, the court may make consequential orders restoring benefits lost through compliance with an order later set aside, including repayment of directly obtained financial benefits where reversal is impracticable.

Brightsea acquired companies from Drachs Investments No. 3 Ltd under a sale agreement and bespoke Tax Deed. The completion balance sheet allocated group relief between sold and retained companies and included a provision for corporation tax. After completion, the vendors directed Brightsea to amend tax returns and transfer group relief from a sold company, Mulgate, to a retained company, Astra. The purpose was to eliminate an overprovision in the completion accounts.

The Commercial Court declared that the direction was authorised and ordered compliance. Brightsea supplied the forms while the order was stayed and appealed. The central issues were whether the direction was prohibited by paragraph 1.9(a) of Schedule 2 to the Tax Deed and, if so, whether the Court of Appeal could grant effective consequential relief.

1. Appeal allowed. The Tax Deed was construed as preserving the allocation of tax liabilities and reliefs reflected in the completion balance sheet. Although paragraph 1.1 of Schedule 2 conferred wide powers to direct tax returns, claims, elections and surrenders, paragraph 1.9(a) prevented their use to change that agreed allocation.
2. The reference in paragraph 1.9(a) to the allocation of liability to taxation and entitlement to use reliefs referred to the group-relief allocation forming the basis of the completion balance sheet. The reliefs were assets acquired by the purchaser. Transferring group relief from Mulgate to Astra would redistribute that asset and alter the economic consequences of the sale.
3. Clauses 2, 6 and 8 did not support the vendors’ construction. Clause 2 addressed unexpected adverse tax movements, while clauses 6 and 8 gave limited set-off rights dependent on a liability under clause 2. They did not create a general power to correct an overprovision by reallocating existing reliefs. The tax repayment was therefore largely irrelevant to construction.
4. The direction was unauthorised, had no contractual effect, and did not engage the clause 2 indemnity. The reference in clause 4(i) to a request made under the deed did not give the vendors carte blanche to create an indemnifiable liability.
5. Applying Nykredit Mortgage Bank Plc v Edward Erdman Group Limited (No. 2) [1997] 1 WLR 1627, the Court of Appeal possessed an inherent consequential jurisdiction to restore, so far as reasonably practicable, the position resulting from an order subsequently set aside. The general rule identified in Hillgate House Ltd v Expert Clothing Services & Sales Ltd [1987] 1 EGLR 65 did not prevent such consequential relief. Accepting unchallenged evidence that Brightsea complied because of the judge’s ruling, the court could order reversal of the group-relief surrender or, if HMRC would not permit that, require Drachs No. 3 to pay the resulting tax loss.

• Court of Appeal (Civil Division): allowed Brightsea’s appeal against the order dated 1 July 2011 of HH Judge Chambers QC, set aside the order, and made consequential relief orders.
• Commercial Court: declared that Drachs Investments No. 3 Ltd was entitled to direct the amendment of the tax returns and ordered Brightsea to deliver the executed forms.