Cavendish Corporate Finance has lost its recent Court of Appeal battle with GIL Investments. The dispute concerned Cavendish's entitlement to a higher transaction fee on the sale of shares in Tractiv Group, a tractor and agricultural machinery parts distributor. If Cavendish had kept the fee section of its engagement letter simple and specific, it probably would have recovered a higher fee.

Engagement Letter

GIL was one of three shareholders in Tractiv, the others being Close Brothers Private Equity and Mr Anthony Howat. Tractiv had liabilities to its bank, which exceeded £5 million, as well as hire purchase liabilities of about £700,000. In early 2006, the three shareholders instructed Cavendish to assist in arranging a sale of the shares in Tractiv. Cavendish explained in its engagement letter, the way in which it would operate a trade sale:

"Based on our specific experience of the sector and our wide experience of selling businesses, we would expect a private company of Tractiv's size to attract an earnings multiple of between 6 to 7 times earnings before interest and tax. Based on the adjusted profits before taxation of £2.1 million for the year to 31 March 2005, we would expect a value for Tractiv of between £14 million and £15 million."

The engagement letter then dealt with the basis of Cavendish's fees. Apart from a non-refundable retainer, and out of pocket expenses, the transaction fee was to be 1.65% of the consideration up to £13.5 million, and 5% thereafter, with a basic minimum fee of £200,000. This required a definition of consideration, for which the letter included the following paragraph:

"For the purposes of calculating the Transaction Fee, purchase consideration is defined as the gross amounts received by the shareholders in cash or in kind, including the settlement or assumption of any shareholder liabilities and bank loans and pre-acquisition dividends or other payments made to shareholders to extract cash from Tractiv prior to disposal."

Share Sale

Mr Howat decided not to sell his shares, but GIL and Close Brothers Private Equity sold their 77.5% shareholding in 2007. The price paid by the purchasers was stated as £2,452,100 in the share purchase agreement, but after adjustment came to £2,110,864. £5,281,304 was payable to an associated company of Close Brothers Private Equity by way of repayment of loans notes.

Dispute

Neither of the parties disputed that Cavendish was entitled to commission in relation to the £5,281,304, however, GIL disputed that Cavendish was entitled to commission on any other sum apart from the cash actually received. Cavendish claimed its transaction fee on the basis of the consideration of £14.6 million i.e. the enterprise value. GIL disputed this and contended that the consideration consisted of the price payable for the shares themselves, together with the amount payable for the Close loan notes, but not (a) the sum outstanding to its bank, either on loan notes or on the overdraft (£5,063,000 and £792,000 respectively), nor (b) the hire purchase liabilities (£704,000), (c) £36,000 in respect of an audit fee, or (d) the notional sum attributable to Mr Howat's shares (£612,832). The judge at first instance found that the overdraft, hire purchase liabilities and the value referable to Mr Howat's shares were to be included in the sum to which Cavendish was entitled to commission i.e. the enterprise value.

The Court of Appeal reversed the above decision. Lord Justice Lloyd did not agree that Cavendish's fee should be calculated on Tractiv's enterprise value, as not all of the elements of this figure were sums received by the shareholders:

". . . I do not find it possible to draw that out of the definition of consideration or to reconcile it with the deliberate choice of the reference to amounts received by the shareholders, however widely one interprets such receipts. The notional value of the Howat shares and the £36,000 extraordinary costs adjustment were not received by anyone. The bank loans and the HP liabilities were not received by any shareholder, and were not, as I see it, settled or assumed by anyone as part of the transaction in such a way as to count as a receipt by a shareholder."

Keep it Simple

When drafting an engagement letter, it is difficult to envisage every possible sale scenario. Corporate finance advisors should therefore seek to keep the fee section of the letter as simple as possible. The judge held in this case that all of the parties well understood concepts such as enterprise value. If this was the case, then if Cavendish had intended that the consideration should be the enterprise value, they should have said so much more simply and specifically.

Litigation against professional advisors is on the rise, and the engagement letter is one of the principal ways that an advisor can protect its position. Corporate finance advisors are well advised to ensure that their engagement letters at least cover the following areas:

Scope and duration of work and responsibilities

* Clear record of the work you agree to undertake within a certain timeframe
* Define the work which is outside your remit e.g. legal, due diligence etc

Fees

* The structure of your fee
* Minimum fee entitlement
* Basis on which the fee is calculated (remember, keep it simple and specific)
* Entitlement to an abort fee

Expenses

* Who bears any expenses you incur in connection with the transaction

Fiduciary duties

* You owe various fiduciary duties such as the duty not to profit from your position at your client's expense and not to place yourself in a position of conflict
* Consider express modifications to your fiduciary duties, such as that you may have other clients whose interests conflict with those of the client

Limitations on liability and indemnity

* Set out any limitations on liability
* Consider including an indemnity in your favour for losses arising out of your appointment (other than as a result of your own negligence or wilful default)

Termination

* How and in what circumstances the engagement can be terminated

For further information on this dispute, or for general advice on engagement letters, please contact James Hutchinson on 020 7240 3474 or at j.hutchinson@beale-law.com.