Shafi v Rutherford

The Court of Appeal considered the construction and enforceability of a contractual expert accountant's determination under clause 6 and Schedule 4 of a share purchase agreement. The central issue was whether paragraph 1.4 of Part II of Schedule 4 required the expert to replicate the actual treatment of leases in the company's 2008 accounts or to apply the correct accounting policies (FRSSE) and treat the leases according to their proper character (finance lease or operating lease). The court held that the completion accounts were to be prepared by reference to the correct accounting policies and practices stated to be adopted (FRSSE) rather than to preserve an incorrect treatment in the earlier accounts.

The expert had concluded the leases were finance leases but considered himself prevented by the agreement from adjusting the 2008 accounts and therefore excluded any lease liability from his computations. The deputy judge held that this was an error of interpretation of the expert's remit (and arguably a manifest error) and that the determination was not valid and enforceable. The Court of Appeal agreed and dismissed the appeal, leaving in place an order for a fresh determination on the correct principles.

Background and parties:

• The appellant, Ms Sofia Shafi, and the respondent, Dr Alexandra Rutherford, formed a dental practice company in 2007 and each held 50% of the shares. Equipment had been acquired under leases from Close Asset Finance (the Braemar leases).
• In December 2009 the parties entered into an agreement by which the appellant sold her shares and her beneficial interest in premises to the respondent for a base figure of £136,500 adjusted by reference to Completion Liabilities calculated in Completion Accounts prepared pursuant to Schedule 4 and clause 6 of the agreement.

Nature of the application and procedural posture:

• A dispute arose about whether the Braemar leases were operating or finance leases and the treatment required in the Completion Accounts. The contract allowed reference of unresolved disputes to an independent expert accountant whose decision was to be "final and binding" in the absence of manifest error (clause 6.5.2).
• The parties jointly appointed an expert. The expert concluded the leases were finance leases and that the 2008 accounts did not comply with FRSSE, but also concluded he was prevented by the terms of the agreement from amending the 2008 accounts and therefore excluded any lease liability when calculating the consideration.
• The appellant sought a declaration that the expert's determination was valid and enforceable. A preliminary issue was tried below on whether the determination bound the parties. The deputy judge (Mr Philip Marshall QC sitting as a deputy High Court judge) declared the determination was not valid and enforceable. The matter was appealed to the Court of Appeal.

Issues framed by the court:

• How paragraph 1.4 of Part II of Schedule 4 should be construed: whether it required the expert to apply the actual accounting treatment in the 2008 accounts or to apply the correct accounting policies and practices (FRSSE) in preparing Completion Accounts.
• Whether the expert had wrongly interpreted or exceeded his jurisdiction or committed manifest error such that his decision was susceptible to court intervention and not enforceable.
• Whether the determination was "final and binding".

Court's reasoning and disposition:

• The court analysed the contractual language of Schedule 4, Part II and III and the defined term "the Accounts" (the company's financial statements prepared in accordance with the Companies Act 2006 and FRSSE as at the accounts date 30 June 2008).
• The Court of Appeal accepted the deputy judge's construction that paragraph 1.4 refers to accounting policies, principles, practices and procedures that the company stated it was adopting (i.e. the professional accounting rules and correct application under FRSSE), not to a perpetuation of any erroneous treatment in the 2008 accounts.
• The court held that it was commercially unlikely the parties intended the expert to carry forward an erroneous accounting treatment into the Completion Accounts; rather the expert should apply the proper accounting policy and FRSSE as stated in the accounts. The expert's conclusion that he was prevented from applying the correct policy was an error in interpreting his remit (or alternatively a manifest error), justifying court intervention.
• The Court of Appeal dismissed the appeal and left in place the order directing a fresh determination on the correct principles. The court did not need to decide finally whether the report was "final and binding" given the error in scope.

Appeal dismissed. The Court of Appeal upheld the deputy judge's conclusion that the expert had erred in interpreting his remit by treating himself as prevented from applying the correct accounting policy (FRSSE) rather than correcting an erroneous treatment in the 2008 accounts; that error justified court intervention and meant the determination was not valid and enforceable. A fresh determination on the correct principles was to be directed.

Appeal from the judgment and order of Mr Philip Marshall QC sitting as a deputy High Court judge (Leeds District Registry) determining a preliminary issue whether an expert accountant's determination was valid and enforceable; preliminary issue was originally ordered for trial by His Honour Judge Raeside on 19 April 2013. (Neutral citation of this Court of Appeal judgment: [2014] EWCA Civ 1186.)