You wait ages for a decision on manifest error in an expert determination and then two come along at once!

In the recent case of WH Holdings Limited v London Stadium LLP, the Court of Appeal confirmed the applicable test for a manifest error in an expert determination, and found that the test was not satisfied in that matter.

Hot on its heels, the Commercial Court reached the opposite conclusion in the case of Hamid Nawaz-Khan & Ors v UAP Limited, finding that the expert determination was manifestly erroneous, this time in the context of a completion accounts adjustment under a share purchase agreement.

Our commercial disputes lawyers take a look at the decision and highlight the key issues arising.

What happened in Hamid Nawaz-Khan & Ors v UAP Limited?

The case concerned a dispute arising from a share purchase agreement dated 5 December 2022 (the SPA). Under the terms of the SPA the Claimants / Sellers (Hamid Nawaz-Khan and others) sold their group of companies, the Alltrust Group (the Company) to the Defendants / Buyers (UAP Limited).

The SPA provided a mechanism for determination of the Purchase Price and its payment in stages. Completion Consideration of £2,906,179 was payable on the Completion Date (based on good faith estimates) and Deferred Consideration was to follow in two further tranches. The final Purchase Price was to be established via a completion accounts mechanism set out in the SPA, under which the Sellers would prepare draft Completion Accounts and a draft Purchase Price Statement to be agreed with the Buyer. In the event of a dispute between the parties, a Dispute Notice was to be served by the Buyer and the Purchase Price would then be determined by expert determination.

Completion took place on 5 December 2022, and the Completion Consideration was paid. In September 2023 the Sellers served a Draft Completion Account and a Draft Purchase Price Statement on the Buyers. These were not accepted and the Buyers served a Dispute Notice on the Sellers as required. The claim arose in the context of the Sellers seeking to recover the First and Second Deferred Consideration payments totalling £747,497.46, as well as an 'adjustment amount' of £84,409.95.

In accordance with the SPA, upon a dispute arising between the parties, the calculation of the amounts payable had been referred to an Expert. The Buyers denied the claim by the Sellers for additional sums on the ground that the expert determination was flawed and not binding. The Sellers issued proceedings in the Commercial Court seeking enforcement of the expert determination, which was then challenged by the Buyers.

The Commercial Court decision

The Buyers argued that the expert determination was not legally binding on three grounds:

  1. the Expert had exceeded his jurisdiction;
  2. the Determination involved manifest errors; and
  3. the Expert had failed to give adequate reasons.

Challenges on these grounds were made primarily in relation to the Expert's treatment of the Claims Provision and the Deferred Fee Income in the Purchase Price Formula (PPF), although challenges were also made in relation to the Expert's decision on the question of whether the Completion Accounts had been prepared as required by the SPA.

Purchase price formula challenge

The PPF in the SPA provided for the calculation of a figure based on a multiple of Combined Turnover, to which Cash, Claims Provision, and Deferred Fee Income sums were then added, before Third Party Debt was deducted. "Claims Provision" was defined as "the amount held by the Company in relation to the potential professional indemnity claims in respect of services provided by the Company and/or its Subsidiaries," and "Deferred Fee Income" was defined as "the amount held by the Company in relation to the deferred fee income of the Company and its Subsidiaries".

The key issue was whether these terms – Claims Provision and Deferred Fee Income – referred to actual assets (i.e. funds that had been set aside and held by the Company) or simply to balance sheet entries representing liabilities or provisions.

The Expert had determined that the word "held" was a commonly used accounting term referring to balances recognised on the balance sheet and that the SPA did not explicitly state the amounts were to be held as cash. The PPF provided for deductions to be made in respect of 'Third Party Debt', whereas the Claims Provision of £350,000 and the Deferred Fee Income of £158,622 were recognised as balances 'held' on the balance sheet – accordingly, in the expert's view, they should be added as positive figures when calculating the Purchase Price.

The Court started its analysis by assessing, as a matter of construction of the SPA, what it considered to be the correct interpretation of the Purchase Price in the SPA (and what should, and should not, be included within the calculation). The Court concluded that "[i]t is obvious both that there was a problem with the drafting of the SPA and what the problem was. The inclusion of Claims Provision and Deferred Fee Income (as defined) in the Purchase Price was premised on each expression corresponding to an asset, whereas in fact there was no such asset."

In essence, the Court found that the plain and obvious meaning of the PPF was that additional amounts were to be paid for things that increased the value of the Company (assets), whilst reductions were to be made for things that decreased its value (liabilities). To interpret "Claims Provision" as referring simply to the estimated number of potential claims, so that the Buyer would pay the Seller for liabilities it was inheriting, was contrary to common sense. The same was true in relation to the Deferred Fee Income. The Company held no assets corresponding to 'Claims Provision' or 'Deferred Fee Income' and it was erroneous to consider that the Buyer should be expected to pay for such non-existent assets.

In assessing the challenge to the Expert's Determination on this issue the Court found as follows;

1. Exceeding jurisdiction

The Buyers had argued that the true meaning of the PPF was a matter of construction – a question of law that only had one correct answer. The Expert, having misconstrued the relevant provisions, had therefore gone outside the limits of his decision-making authority and had exceeded his jurisdiction in calculating the Completion Consideration in the way that he did. The Court rejected this argument. The scope of the Expert's decision-making authority under the SPA necessarily involved construction of the PPF - and previous case law had already rejected the proposition that an expert had jurisdiction only if he exercised the construction correctly. The Expert had not exceeded his jurisdiction in getting the formula wrong. While careful drafting around the scope of an expert's jurisdiction is always an important consideration, it remains a notoriously difficult ground upon which to challenge a determination.

2. Manifest error

The Court then looked at whether the Determination was based on a manifest error in the construction of the PPF by the Expert, noting that under the terms of the SPA, the Determination was binding save in the event of "manifest error or fraud". The Court held (without reference to the recent WH Holdings case) that previous case law confirmed the formulation that a manifest error is one that is "obvious or easily demonstrable without extensive investigation," and that manifest errors were "oversights and blunders so obvious and obviously capable of affecting the determination as to admit of no difference of opinion".

The Court, applying that test, held that the Expert's construction of the PPF was manifestly wrong for two reasons. First, it was obvious that Claims Provision and Deferred Fee Income, as included in the formula, referred to (supposed) assets held by the Company in the usual sense of the word, not to mere entries on a balance sheet.

Second, even accepting the Expert's interpretation that the items were balance sheet entries, it was irrational then to add figures to the Purchase Consideration without any regard to the fact that those figures had a negative value. It was, in the Court's view, manifestly inappropriate to increase the price as a result of things that diminished the value of the acquisition. The Court went so far as to deem the Expert's approach "arithmetically incorrect … and manifestly inappropriate". Accordingly, the Expert's Determination regarding Claims Provision and Deferred Fee Income did not bind the parties and the Total Consideration was reduced by £350,000 and £158,622 respectively.

Preparation of the completion accounts challenge

The Buyers had objected to the Completion Accounts on the basis that they were prepared on a policy for the recognition of income (the 67% policy), which was not in accordance with FRS 102 (the Financial Reporting Standard applicable to the UK).

A challenge was made by the Buyers in relation to the Expert's decision that it was not necessary for the Draft Completion Accounts to be prepared in accordance with FRS 102 – as long as they were prepared applying the same accounting standards that were used in preparation of the previous Company Accounts (as provided for by the SPA).

This challenge was not accepted by the Court. Paragraph 4 of Schedule 8 to the SPA set out the basis for the preparation of the Completion Accounts, in hierarchical order. The Completion Accounts were prepared using the same accounting standards as were used in preparing the earlier Company Accounts and as such met the requirements of paragraph 4(b). Paragraph 4(c) included the requirement for the Completion Accounts to be prepared in accordance with FRS 102. Adopting the hierarchical accounting treatment waterfall, paragraph 4(c) only applied if the requirements of paragraphs 4(a) or 4(b) had not been met.

As the same accounting standards, principles, policies and practices were used in the preparation of both the Draft Completion Accounts and the earlier Company Accounts the Court's conclusion was that the expert determination could not be challenged on this point.

The failure of the Sellers to comply with FRS 102 in preparing the earlier accounts did, however, amount to a breach of one of the warranties given by the Sellers (i.e. that the accounts had been prepared in accordance with FRS 102). The Buyers were therefore successful in a breach of warranty claim against the Sellers on this issue and were awarded damages. (Although only a rather modest award of £12,862.50 was made, the finding does illustrate the risks of manipulating revenue recognition in the run-up to a sale).

The Court noted that it was unclear whether the Buyers were maintaining a submission on this issue that the Determination was not binding on grounds of insufficiency of reasons, or whether they were relying on the lack of reasoning as evidence that the decision was manifestly wrong. In either case, the Court regarded the Expert's reasons as adequate, confirming that a decision-maker required to give reasons is not obliged to deal with every point raised, but only with the main issues in dispute. Reasons can be briefly stated provided they enable the reader to understand why the issue was decided as it was. There was no manifest error by the Expert and the reasons given by him were sufficient.

Alternative cases: Rectification and estoppel

The Buyer had also claimed in the alternative for rectification of the SPA on the basis of unilateral mistake, in that they believed the PPF provided for payment for actual assets in respect of both the Claims Provision and the Deferred Fee Income. The Court held that the Sellers either shared that misunderstanding or they knew of the Buyer's misunderstanding and did nothing to correct it. If the challenge to the expert determination had not been successful the Court would therefore have accepted the Seller's claim for rectification on this issue.

On the same basis the further, alternative, estoppel claim made by the Buyers would also have succeeded. If the Expert's Determination had not been found to be manifestly erroneous the Sellers would have been estopped from disputing that the Claims Provision and the Deferred Fee Income in the PPF referred to assets in the nature of reserves held by the Company as provision against future claims and deferred fee income. The Sellers were responsible for instilling this belief in the Buyers and the Buyers had suffered to their detriment by paying a substantial amount for what was in effect "fresh air".

Key takeaways

While this case does provide an example of an expert determination being overturned as a result of a manifest error challenge, it does not in any way reduce the very high threshold required to establish manifest error. The Court of Appeal test as set out in WH Holding Limited (WHH) v London Stadium LLP (LS) is the applicable test for manifest error in an expert determination.

This Expert's Determination (in Hamid Nawaz-Khan & Ors v UAP Limited) was held to be manifestly wrong on the basis that it was so obviously wrong that it could not be disputed. The decision involved the Court's own legal interpretation of the relevant provisions of the SPA, and its conclusion that the Seller's construction of the PPF did not make commercial common sense (as it would have resulted in the Buyer paying twice for the same asset). The Court held that the expert had ignored the obvious meaning of the clause and had therefore followed an 'irrational', 'arithmetically incorrect' and 'manifestly inappropriate' calculation – meaning the high threshold for a successful challenge was met.

This case is also a great example of the need for clear and unambiguous drafting, in SPAs and more generally. Key terms must be defined with precision to ensure there is no scope for alternative meanings. If the SPA in this case had clearly specified the Claims Provision and Deferred Fee Income as balance sheet entries and not actual assets the dispute may have been avoided. While our focus in this article is on the treatment of expert determination and the manifest error threshold, Our Corporate Team's companion article focuses on the important drafting considerations arising: What Nawaz-Khan v UAP tells us about drafting completion accounts mechanisms.

If you would like to discuss this case further, or any issues arising in relation to expert determinations, M&A disputes or disputes in general please contact our dispute resolution partners Sean Adams or Tom Cox.