Unforeseen circumstances present difficulties in the construction and performance of contracts. They are most likely to arise where the contract in question runs for many years or even decades and in which changes in applicable laws and regulations may be both inevitable and impossible to predict. The point is well illustrated by the decision of the UK Supreme Court in the Scottish case Lloyds TSB Foundation for Scotland v Lloyds Banking Group plc [2013] UKSC 3, [2013] 1 WLR 366.

  • By a deed made (most recently) in 1997, the claimant was entitled to the greater of (a) a specified percentage of the defendant bank’s pre-tax profits (after deducting pre-tax losses) and (b) £38,920.
  • “pre-tax profits” and “pre-tax losses” were defined to mean “the group profit before taxation and the group loss before taxation … shown in the audited accounts”.
  • In January 2005 new EU regulations required consolidated income statements to show negative goodwill as a gain on acquisition in such statements.
  • In 2009 the bank acquired the share capital of HBOS at half its book value (in anticipation of substantial asset losses) with the result that the 2009 accounts disclosed a substantial pre-tax profit and which appeared to entitle the claimant to receive £3,543,333.
  • Without the negative goodwill the accounts would have disclosed a pre-tax loss and the claimant would have been entitled to £38,920.

The question then was whether pre-tax profits ought to include the figure for negative goodwill. On a narrow (literal) view the answer was clearly yes because in 2009 pre-tax profit properly did so according to prevailing accounting standards. However, the Supreme Court held that in 1997 (and previously) the parties would only have been concerned with the realised profits or losses before taxation for the relevant accounting period and that the 2005 change in accounting practice was not only outside the parties' original contemplation but would not have been accepted had it been foreseen (according to a rather handy finding of fact by the first instance judge). The proper approach was therefore to use group profit and loss before taxation in the (realised) sense intended by the deed.

There were clearly powerful arguments both ways, indeed Lord Clarke JSC began his concurring judgment with the following candid words:

“48. I have found this to be a very difficult case. My mind fluctuated a good deal in the course of the argument. At the end of the argument I was inclined to accept the submissions made by the Dean of Faculty on behalf of the Foundation. [ie in favour of the claimant’s entitlement to £3,543,333] ....

49. However, having read Lord Mance JSC's judgment, I have now reached the conclusion that that is not the correct result on the true construction of the deed. I have done so essentially for the reasons he gives.”

He referred to the decision of the Court of Appeal in Debenhams Retail Plc v Sun Alliance and London Assurance Co Ltd [2006] 1 P & CR 123 where the question was what was meant by “additional rent” in a lease where rent was a proportion of turnover and whether, for the purposes of the lease, turnover included VAT in circumstances where VAT did not exist when the lease was concluded in 1965 (it was not introduced until 1973). There Mance LJ (at p 130) said that

“no one suggests that the lease cannot or should not apply in the changed circumstances. We have to promote the purposes and values which are expressed or implicit in the wording, and to reach an interpretation which applies the wording to the changed circumstances in the manner most consistent with them.”

In Lloyds TSB the “manner most consistent” with the “purposes and values” of the deed excluded the unforeseeable change in accounting practice.