Brook v Southall (trading as J Elliott Brook Southall & Co) COURT OF APPEAL (CIVIL DIVISION) (Transcript: Smith Bernal) HEARING-DATES: 11 APRIL 1997 11 APRIL 1997 COUNSEL: J McLidden for the Appellant; K Munro for the Respondent PANEL: HIRST, WAITE, PHILLIPS LJJ JUDGMENTBY-1: PHILLIPS LJ JUDGMENT-1: PHILLIPS LJ: This appeal arises out of a dispute between two solicitors. The defendant, Mr Southall, was an equity partner in a firm called J Elliott Brook Southall & Co. In 1988 he engaged the plaintiff, Mr Brook, as a salaried partner. The gross salary to be paid to Mr Brook was agreed. It was further agreed that, from the monthly payments of salary made to Mr Brook, there should be deducted a sum in respect of his liability to income tax. This sum was calculated as if his tax liability fell to be computed, under Sch D, on his gross salary. In fact, his liability to the Inland Revenue fell to be assessed on his proportionate share of the overall profits of the partnership. For all but one year of the time that he was a member of the partnership, it made a loss. This meant that, although he was receiving a salary, he had no liability to the Inland Revenue to pay income tax. Mr Southall, who in due course became the sole equity partner, was liable to fund his salary and to bear the partnership's loss. In the year 1988/89 the position is rather more complex. In that year the partnership made a profit. So far as the Inland Revenue were concerned, tax was payable on this profit. In that tax year, Mr Brook had sustained losses as a member of Lloyds. He was entitled to set-off those losses against his profits as a member of the partnership. The effect of that set-off was to reduce both the total tax payable by the partnership and Mr Brook's share of that tax liability by nearly £10,000. Mr Brook contended that, in these circumstances, he was entitled to recover the deductions that had been made from his salary on account of taxation which never fell due. Mr Southall contended that it had been orally agreed that the deduction on account of taxation would be made on the basis that the partnership would discharge Mr Brook's tax liability, whatever that might prove to be, and that, subject to one proviso, no adjustment would thereafter fall to be made to Mr Brook's salary. The sole issue in the action is whether this term was orally agreed between the parties. The proviso to which I have just referred is that Mr Southall has always accepted that the partnership had no entitlement to benefit from Mr Brook's losses at Lloyds. Unhappily, by the time that this action was pleaded and tried, Mr Southall had not accounted for the £10,000 of tax credit from which the partnership had benefitted. In the result, Mr Brook's claim in this action for repayment of deductions made from his gross salary in respect of tax which never fell due included, in the total claimed of £36,000 odd, the £10,000 that reflected the credit for the Lloyds' losses. Those responsible for the conduct of Mr Southall's case do not appear to have appreciated that he did not assert entitlement to the retention of that sum, and the action proceeded on the basis that Mr Southall denied liability to make any reimbursement at all. The issue that was joined between the parties can, perhaps, best be demonstrated by comparing the relevant passages from their witness statements. I take, first of all, that of Mr Southall in para 4: "During those meetings with Trevor Brook it was agreed that he would be employed as a salaried partner with a view to becoming an equity participating partner within 12 months. He would receive a remuneration package at the rate of £48,000 per annum and part of this package could be taken by way of a car. It was agreed that he would be paid pursuant to PAYE on a Schedule D basis. The package was also to take into account any other benefits, his personal tax allowances and income tax contributions and he would receive the appropriate net figure having taken these into account as monthly drawings. This was to be paid irrespective of whether or not there were sufficient profits generated by the firm to meet such drawings and irrespective of the partnership tax position. Accordingly in event that the partnership tax or other liabilities of the firm were greater than those anticipated Mr Brook would not be required to make a repayment of any part of his drawings. Likewise if the partnership tax or other liabilities of the firm turned out to be less than those anticipated he would not be entitled to increase his drawings." As against that account the account in the witness statement of Mr Brook, beginning at para 9, was as follows: "Simon Southall arranged for Lesley Clarkson to produce a calculation of the amount of the monthly gross and net drawings figures applicable to me. These were shown as calculated at the rate of £48,000 per annum, since it would obviously be sometime before drawings calculated on the basis of the agreed profit share would exceed this. Net monthly drawing figure was calculated by deducting the tax attributable to £48,000, taking into account all usual items deductible for tax, such as married man's personal allowance, pension policy premiums and mortgage interest. National Health Insurance premiums were also shown as deductions as was the apportioned costs of the premiums for the firm's group scheme under Private Patients Plan. The above deductions including the tax provision calculated as above were retained from my monthly drawings. There was no discussion at any time between either the equity partners or myself about what was to happen if the tax eventually calculated as payable by me as a proportion of the firm's profits exceeded or fell short of the amounts retained from my gross drawings on account of tax." The Judgment His Honour Judge Levy QC found in favour of Mr Brook. He awarded him an agreed figure of £36,970.87 together with interest of £11,883.34. His basic reason for doing so was that, having heard oral evidence from both plaintiff and defendant, he preferred that of the plaintiff. The material passages from pages 5 and 6 of the transcript of his judgment read as follows: "The defendant in his evidence said there was such an oral term agreed. Mr Brook says there was no such agreement. Mr Brook said in his evidence: I did not assign tax repayments due to me orally or in writing.' Common sense would dictate that if there was such an important term, someone as meticulous as Mr Brook is - and I have seen that reflected in the later correspondence - would certainly have had that in writing and I am sure that if there was such an oral term agreed it would not have been left in the air to emerge many years later, as it did." A little later in the judgment: "It is always disturbing when one is unable to accept the word of a solicitor and officer of this court, but in this particular case both plaintiff and defendant are officers of this court and I have to make a decision as to which one's evidence I prefer. I have no hesitation, having seen both of them, in preferring the evidence of the plaintiff." The judge referred to one aspect of the evidence which supported his conclusion that the alleged oral agreement was a term of the contract which the defendant sought to introduce well after he made an agreement with the plaintiff.' This was the manner and circumstances in which certain entries had been made in the partnership accounts. The Grounds of Appeal The first ground upon which the decision of the judge is attacked is that he excluded the evidence of a Mr Middleton-Smith, another salaried partner, who would have said that he had agreed with Mr Southall terms essentially identical to those alleged to have been agreed between Mr Southall and Mr Brook, and who would further have said that Mr Southall had told him that Mr Brook's terms were the same as his own. The additional grounds of appeal can be summarised as follows: 1) The judge's conclusion that the alleged oral agreement was first asserted well after Mr Brook was engaged was contrary to the evidence; 2) A number of the judge's comments indicate a failure properly to appreciate the true nature of Mr Southall's case. The evidence of Mr Middleton-Smith Before the judge counsel for Mr Brook objected to this evidence. He submitted that its admission could only be justified if it carried probative weight as evidence of similar facts' - see Mood Music Publishing Co.Ltd v De Woolfe Ltd [1976] Ch.119, [1976] 1 All ER 763 and that it did not satisfy this test. The judge acceded to this submission. He ruled that the fact that an oral contract on certain terms had been concluded between Mr Southall and Mr Middleton Smith gave no support to Mr Southall's evidence that he had concluded a contract on the same terms with Mr Brook. I do not consider that the judge was correct in excluding this evidence on this ground. I put on one side Mr Middleton-Smith's evidence that Mr Southall told him that Mr Brook had been engaged on the same terms. That assertion, in a witness statement, was technically inadmissible as double hearsay. But quite apart from that assertion, it seems to me that one might reasonably expect salaried partners in a firm of solicitors to be engaged on the same basis, and that the terms of Mr Middleton-Smith's engagement lent some support to Mr Southall's contention that he had agreed similar terms with Mr Brook. The weight that that evidence carried was, however, relatively slight compared with the oral evidence of the true protagonists and the inferences to be drawn from the contemporary documents. This is particularly so as, in contradistinction to the case of Mr Brook, the terms upon which Mr Middleton-Smith was engaged were not evidenced by any contemporary documents. My approach to this appeal is to consider all the evidence, including that of Mr Middleton-Smith, in order to see whether cumulatively it impugns the conclusion reached by the judge on the central issue. Terms recorded in writing The starting point, and the natural starting point, adopted by the judge was to consider the terms of the partnership agreement that were reduced into writing. The relevant terms were first set out in a letter from Mr Southall dated 20 July 1988 as follows: "1. Status - you will initially start with the firm as a salaried partner with the view to becoming equity participating within twelve months of starting with the firm. 2. Salary - again as discussed this will commence at the rate of £48,000 per annum and again as discussed with you this will be a remuneration package and we can discuss details as to whether part of this is taken by way of a car being provided etc. As agreed you will not be paid pursuant to PAYE but on a Schedule D basis." Those provisions did not entirely accurately reflect what had been agreed as is apparent from a letter written to Mr Southall by Mr Brook on 17 August 1988 making the following correction which was subsequently accepted by Mr Southall: "1. Salary - to be as stated by you in your letter, save that annual salary will amount to one-third of the fee income earned in the year by my efforts to be assessed at, say, quarterly intervals with a guaranteed minimum of £48,000 per annum. The appointment was with a view to equity participation in the profits of the firm in due course." The crucial words are "as agreed you will not be paid pursuant to PAYE but on a Schedule D basis". In considering the natural meaning of these words, it is relevant to bear in mind the usual arrangement so far as a salaried partner was concerned at the time to which this action relates. Salary would be paid subject to deduction on account of tax computed on the basis of the gross salary. This would ensure that the partnership was put in funds to discharge the collective tax liability of all the partners. When the partnership tax had been assessed and paid, the salaried partners would receive a refund if the tax deducted from their salaries exceeded their share of the tax payable. This is what Mr Brook contends was the position in the present case. In my judgment, the words under consideration naturally reflect such an arrangement. Mr McLidden, who was not instructed below and whose submissions on behalf of Mr Southall gave no hint of the fact that he had received his instructions at a very late stage, accepted that the normal position would have been as I have described it. He argued, however, that the evidence supported Mr Southall's case that a special oral agreement was made in this case that Mr Brook's remuneration would be on a net, tax deducted, basis and that there would thereafter be no adjustment of the tax so deducted. It is convenient to consider this submission in the context of the criticisms of the judgment advanced in the grounds of appeal. The date when the oral agreement was first asserted The partnership accounts recorded, from 1989 onwards, as sums outstanding to the salaried partners, sums deducted from their gross salaries on account of tax which had not, in fact, been paid to the Inland Revenue. The accounts for the period as at 23 January 1993 contained the following note in relation to that item: "These represent contingent liabilities to former salaried partners ... which are not considered to be payable by Mr. Southall." The evidence was that this note was written on instructions given by Mr Southall after 23 January 1993. Mr McLidden accepted that, on Mr Southall's case, these purported liabilities should never have featured in the accounts. He submitted, however, that the judge was wrong to infer that it was only in 1993 that Mr Southall made that point. He referred to the following passage in the witness statement of Mr Brook in relation to a meeting with Mr Johnson, the partnership accountant, on 1 May 1991: "Johnny Johnson said that he had had a meeting with Simon Southall sometime ago at which Simon Southall had said that he was not going to pay salaried partners to balance on their income accounts. Johnny Johnson had then queried what was to happen to those balances but he said that Simon Southall did not answer him." In my judgment, that passage weighs against Mr Southall's case rather than in its favour. If the facts were that the balances on the income accounts of the salaried partners had been included in the accounts in error, one would have expected Mr Southall to have made that point to his accountant as soon as the error came to his attention. In my judgment, the judge was entitled to attach the significance which he did to the lateness in the day that Mr Southall first objected that the accounts were not accurate. The true nature of Mr Southall's case In the course of his judgment, the judge indicated that he understood the claim to relate to tax deductions retained by Mr Southall in relation to tax liabilities which had been off-set by Mr Brook's Lloyds' losses. He quoted Mr Brook's remark that he did not assign to the partnership tax repayments due to him and commented that, had Mr Brook agreed to anything so important, he would have recorded that in writing. Mr McLidden accepted that these passages of the judgment were appropriate in relation to the £10,000 retained which reflected Mr Brook's Lloyds' losses, but submitted that in concentrating exclusively on that aspect of the case, the judge adopted an approach which was fatally unbalanced. He outlined the true scenario that the judge should have considered as follows: At the time that Mr Brook was engaged, the partnership was not prospering. It would be likely to take a year or two to get it on its feet. In the meanwhile, if Mr Brook was correct, Mr Southall had in effect agreed to pay, probably out of his own pocket, Mr Brook's salary on a tax free basis. Such a scenario was so unlikely that, had the judge appreciated it, he could not have reached the conclusion that he did as to what had been agreed. The absence of any hint in the judgment of these considerations urged by Mr McLidden, led this court to enquire of the nature of the submissions made to the judge below. The result was illuminating. Mr Munro, who appeared both below and before us for Mr Brook, lodged with the court below, in accordance with directions, a note of the issues raised by the case. He defined the first issue as follows: "Is the plaintiff entitled to be paid sums retained by the defendant to meet potential liabilities for income tax and national insurance, notwithstanding that by virtue of the Lloyds' losses the plaintiff's liabilities were less than the sums retained?" Counsel then appearing for Mr Southall in his turn submitted a skeleton argument in which he agreed that this issue was correctly formulated. It seems to me that counsel on both sides were misled by the complex accountancy involved in tax computations, into thinking that the effect of the Lloyds' losses was fundamental to the whole of the claim, when in fact this only accounted for £10,000 of the total £36,000 claimed. Mr Southall's counsel's error was further compounded in that it cannot have been made clear to him that, in so far as the effect of the Lloyds' losses were concerned, Mr Southall did not suggest that the partnership had been entitled to benefit from them. The judge, not unnaturally, accepted the case as presented before him by both counsel. Mr McLidden submits that in this unhappy state of affairs, the appropriate course is that the case should be remitted for a retrial. I do not agree for two reasons. The first is the principle that there should be an end to litigation. The amount at stake in this case is not great, and the fact that counsel may have between them induced the judge to misappreciate the background to the case cannot justify reopening the dispute. The second reason is that the misappreciation in question was, indeed, as to background. The evidence indicates that, when Mr Brook joined the firm, Mr Southall told him that the prospects were rosy as a result of family business which would be referred to the firm. Nothing in Mr Southall's witness statement suggests that he did not himself believe that this was the case. In these circumstances, Mr McLidden has not persuaded me that the failure on the part of the judge fully to appreciate the implications of the rival versions of the partnership agreement was critical to a conclusion reached on the basis of his evaluation of the oral evidence given by the plaintiff and the defendant in the light of the contemporary documentation. Having reached this stage I ask myself whether the evidence of Mr Middleton-Smith should or could have disturbed the conclusion reached by the judge. For the reasons given in relation to the weight of that evidence earlier in this judgment, to that question I would give an answer of a firm no. For these reasons, I would dismiss this appeal. JUDGMENTBY-2: WAITE LJ JUDGMENT-2: WAITE LJ: I agree. JUDGMENTBY-3: HIRST LJ JUDGMENT-3: HIRST LJ: I also agree. DISPOSITION: Appeal dismissed with costs SOLICITORS: Southall & Co; Lee & Pembertons