RICHARD BISHOP AGAINST 3i INVESTMENTS PLC
OUTER HOUSE, COURT OF SESSION
[2014] CSOH 152
CA81/13
OPINION OF LORD WOOLMAN
In the cause
RICHARD BISHOP
Pursuer;
against
3i INVESTMENTS PLC
Defender:
Pursuer: Clark, QC, Richardson; Pinsent Masons LLP
Defender: Napier, QC, Hardman; Maclay Murray & Spens LLP
10 October 2014
Introduction
[1] Richard Bishop was employed by 3i plc (“3i”) for 22 years. It is part of the 3i group of companies, which includes the defender. He left in May 2011 to join the Business Growth Fund (“BGF”). During the course of his employment with 3i, he invested about £350,000 of his own money in seven profit sharing funds. On his departure, 3i informed him that he was a ‘competing leaver’ in terms of the investment agreements. In consequence, he was no longer entitled to benefit from those funds. Instead 3i proposed to return to him a sum of about £90,000, being the value of his share in those funds at the time he left. In the present action, Mr Bishop challenges that decision. He seeks declarator that he is entitled to receive the profits of his investments.
[2] The decision turns on two issues. First, what is the proper construction of the term “competing leaver”? Second, was Mr Bishop correctly classified as one when he joined BGF?
Background
[3] The factual circumstances are not in dispute. Mr Bishop worked for 3i between 1989 and 2011. He joined it as a trainee investment controller and was steadily promoted to more senior positions. During the course of his employment he acquired a wide range of experience in both types of private equity investment: growth capital and buyouts. In growth capital, the investor injects funds in return for a minority stake in the equity of the investee company. In buyouts, the investor takes a controlling stake in the investee company.
[4] Until 2005, Mr Bishop was involved in the completion of many buyouts. His last role as a dealmaker involved investing £32 million in a company called SLR in 2008. In the same year, he became the first head of the global growth capital portfolio at 3i. In 2009 he became a member of the Growth Leadership Team and the Growth Capital Investment Committee. Mr Dunn, the general counsel and company secretary of 3i, described Mr Bishop as “an experienced and influential investor”. He sat on the boards of various companies in which 3i had made investments.
[5] Investment companies commonly provide an incentive for their employees in the form of “carried interest”. To receive carried interest, members of the fund’s management team must become a member of the carried interest partnership and sign a limited partnership agreement (“LPA”). Each individual contributes a small percentage of the fund’s initial capital. They are also usually required to invest in the investee company. When the fund disposes of an investment, it returns a proportion of the realisation to the investors, including the carried interest partners. In order to retain investment teams, LPAs specify that an employee’s right to receive carried interest will depend upon the circumstances in which he leaves his employment. Between 2004 and 2011, Mr Bishop entered into seven LPAs.
[6] Mr Bishop tendered his resignation to 3i on 3 May 2011. He joined BGF in June as its Head of Investments. Prior to his departure from 3i, Mr Bishop had meetings with the human resources director and the chief executive. They both told him that he would be classed as a competing leaver and therefore would lose his right to share in future profits from his LPAs. He was very disappointed to receive this information. Following a discussion with his immediate boss a few days earlier, he had understood that he would be entitled to receive his carried interest.
[7] Although the chief executive took the final decision, he acted on Mr Dunn’s advice. Mr Dunn explained that he had little information about BGF at the time, and that he derived his knowledge from its Articles of Association and its “embryonic” website.
[8] The establishment of BGF is linked to a change in the commercial activities of 3i. I shall therefore begin with a brief history of the two companies.
History of 3i
[9] In 1929 the government asked Lord Macmillan to chair a committee to consider how best to promote the development of trade and commerce within the United Kingdom. The committee had a number of distinguished members, including John Maynard Keynes and Ernest Bevin. Its 1931 report identified the absence of funding for small and medium-sized enterprises (“SMEs”). This came to be known as the “Macmillan gap”. In 1945, the government established the Industrial and Commercial Finance Corporation (“ICFC”) to bridge that gap. Subsequently, the ICFC changed its name to Investors in Industry and latterly it has been known as 3i.
[10] Since its inception, 3i has provided finance to a wide range of companies. It has, however, moved away from investing in SMEs. Instead it focuses on providing finance to potentially high-growth unquoted companies. It closed its venture capital business, which involved more risky investments, in about 2006 or 2007. Currently it has three ‘business lines’: private equity, infrastructure and debt management.
[11] Until 2009, 3i funded its growth capital investments from its own balance sheet. Following the 2008 financial crisis, however, it established a Growth Capital Fund to raise external funds to contribute towards such investments. All 3i’s documents relating to the Fund state that it will make investments in the range from €25 million to €150 million. That is the information known to investors, investees, staff and shareholders. In the case of investors, it is contained in the Private Placement Memorandum, which was described as 3i’s contract with its investors. With regard to investment staff, in about March 2010 3i distributed an “Eligibility Guide” to all of them setting out the criteria that they had to apply in making investments, including the financial banding of €25 million to €150 million. That document was laminated so that staff could easily have it to hand.
[12] In the last 5 years, 3i has only made one growth capital investment in the UK. It invested £27 million (€32.8 million) in Go Outdoors in 2011. 3i’s 2013 accounts state that its strategic priority is to cut down staff and focus on “harvesting” existing investments. It aims to make five to seven high level investments each year in the global areas in which it operates. Its goal is to secure a return of about 15 to 20 per cent.
History of BGF
[13] After the financial crisis of 2008, the government wished to stimulate the economy by encouraging entrepreneurs. It was again concerned about the lack of funding for SMEs. It asked Mr Chris Rowlands to convene a panel to review the position. He gave helpful evidence in this case. He had himself worked for many years at 3i. When he retired in March 2009, he was a member of its executive team, group investment committee and chairman of 3i Asia. The Rowlands Report, published in November 2009, concluded that the market gap for SMEs is “permanent, not just short-term and cyclical, and exacerbated by recession”.
[14] As part of its review, the panel investigated the role of 3i. It found that 3i had played an important role in attempting to fill the Macmillan gap, but that “3i has gradually shifted away from its initial focus on small businesses to the larger and more commercially viable MBOs/MBIs”. In his oral evidence, Mr Rowlands said that the business community mourned 3i’s departure from the lower end of the market.
[15] The panel recommended that the government should intervene to ensure that growth capital was available in the band between £2 million and £10 million. In other words it recommended intervention to fill the vacuum left by the departure of 3i from that part of the market.
[16] BGF was launched in May 2011 to provide growth capital funding of between £2 million to £10 million to UK SMEs. It cannot take a controlling interest in a company, so it does not fund buyouts. Originally, BGF invested in companies with a minimum turnover of £10 million, but that has now been lowered to £5 million. To date, BGF has made 64 investments, all of them within the specified band. It aims to secure a return of about 8 per cent. It could provide growth capital funding above £10 million, but only by way of ‘top up’ finance. It would not provide initial funding above £10 million.
Definition of Competing Leaver
[17] The LPAs define a competing leaver as:
“an Ordinary Leaver … who, at the time of or within 24 months of becoming an Ordinary Leaver:
- takes or is understood to be intending to take employment in a competitive capacity with, or provides competitive services to, a competitor of [3i]
- …
and for these purposes
- without limiting the foregoing, the taking up employment with, or the provision of services to, any business or fund which is deemed to be a competitor pursuant to (B) below (other than where such employment or provision of services is with or to a part of such business not directly or indirectly involved in any relevant operations) shall be deemed for the purposes of (a) above to be taking employment in a competitive capacity or providing competitive services (as the case may be);
- without limiting the foregoing, any business or fund wherever located in the world shall be deemed to be a competitor if such business … or fund operates or is intended to operate or is likely to operate (whether in whole or in part) in any geographical area(s) and investment product sector(s)/business line(s) (taken together) in which [3i] operates or, as at the Leaving Date in respect of such Ordinary Leaver, is proposing to operate within the next 12 months; and relevant
- “operations”/”operates”/”operate” shall mean making, dealing in, managing or advising as to unquoted equity investments whether for the relevant businesses own account as principal or [otherwise]”
[18] The first LPA, which was made in 2004, does not include “/business line(s)” in (B). According to Mr Dunn, those words were added to reflect that 3i had begun using that terminology. The matter is, however, of no moment as the parties expressly agree that there is no material difference in the two definitions.
Proper approach to Construction
Submissions
[19] Mr Clark contended that the concept of banding lies at the heart of the case. All investment companies must publish the bands in which they operate. This information is important to investors, staff, investees, and shareholders. As BGF operates in a different banding from 3i, the two companies are in different investment product sectors.
[20] Mr Napier submitted that banding has no part to play in the construction of “investment product sector”. The parties clearly intended to apply a wide ranging meaning to the term ‘competing leaver’. The clause had been framed to act as a deterrent to any employee seeking to find employment elsewhere in the growth capital market. Mr Napier suggested that the clause should be read as though there was an oblique between “product” and “sector”. By doing so, that emphasised the totality of the types of competition against which 3i sought protection. He added that if the clause operated harshly on employees, any challenge should be made by reference to the principles of restraint of trade or penalty clauses.
Analysis
[21] The principles relating to contractual construction are well known. They have recently been restated in Growth Investments Ltd v Cape Building Products Ltd [2014] CSIH 43. The court must construe the contract in context and adopt the meaning that best accords with commercial common sense.
[22] The proper interpretation of the relevant provision in this case requires one to unlock the meaning of the key phrase “investment product sector”. It is not trade jargon or otherwise a term of usage in the investment industry. Mr Rowlands said that he was not familiar with it, although he knew and understood each of the individual words.
[23] A sector is defined as an area or portion that is distinct from others. That may relate to the type of economic activity, such as pharmaceuticals or healthcare. But equally, it can also relate to banding. There is clear blue water between a company that only offers investments between €25 million to €150 million and another company that only operates between £2 million and £10 million. The two are distinct. The whole thrust of the evidence, including that of Mr Dunn, was that banding was an important differentiating factor. No investment company operates at all levels of the market. Each publishes information about its investment strategy. The various interested parties need that information to assess both risk and return. A company would have to publish any change in its strategy. Unless and until it does so, it has no mandate to go beyond its banding.
[24] On 3i’s approach, an employee joining another growth capital company is held to be a competing leaver, even if it operates at a completely different banding level. I see no warrant to restrict “sector” in that manner. The reasonable reader would understand that the parties intended to discriminate among the companies that a departing employee might join. It was not a blanket ban. It was constrained in relation to (a) geographical area and (b) investment product sector. Commercial common sense suggests that an employee would be classified as a competing leaver if he took a position with a rival that was going to cause damage to 3i’s business. Further, a contract is intended for parties' mutual benefit. The construction advanced by 3i would impose "an excessive or disproportionate burden” on Mr Bishop (Growth Investments Ltd at para. 11).
[25] I do not accept that it is appropriate to insert an oblique in the manner suggested by Mr Napier. To do so would be to innovate on the words of the parties, particularly as they had chosen to use the same punctuation elsewhere in the same clause.
Was Mr Bishop properly classified as a Competing Leaver?
Actual competition
[26] I am satisfied that there has been no actual competition between BGF and 3i. With regard to investments, 3i has only been involved in one UK transaction since Mr Bishop’s departure. He said that apart from the investments that BGF had made to date, it had also considered hundreds of other potential investments and that 3i had not been interested in any of them.
[27] What about competition for funds and staff? In relation to funds, there is no competition because BGF is funded by five High Street clearing banks, while 3i is funded by external investors and shareholders. There was no evidence of any competition for staff, because 3i has been shedding rather than recruiting staff. Mr Rowlands thought that it had lost hundreds of staff. Apart from Mr Bishop himself, two other former 3i employees now work for BGF, but both of them had been made redundant by 3i.
Deemed Competition
[28] 3i is generally a buyout company that operates at the higher value end of buyout transactions, often abroad. When it has made an investment it provides intense services to the investee, with the intention of securing a higher return. Mr Dunn said that 3i aims to double its money on investments in a period of 4 to 6 years. Currently its focus lies in “harvesting” its existing investments, rather than making new ones. By contrast, BGF invests in SMEs in the UK, only takes a minority shareholding and manages its investments with a light touch.
[29] 3i submits that there is the potential for competition and that is covered in the deeming provision. In Greck v Henderson Asia Pacific Equity Partners (FP) LP [2008] CSOH 2, Lord Glennie considered a similar provision and concluded that it had been included to avoid the uncertainty of knowing whether the business that the employee was joining was or was not a competitor.
[30] The facts of the present case are different. BGF did not operate in the same sector and it was set up expressly to address the gap left by 3i’s departure. Mr Dunn candidly stated that it was unlikely that the two companies would compete, but then added that it was not beyond the bounds of possibility that BGF would be sitting across the table from 3i. I do not accept that rider.
[31] While there is theoretical possibility that BGF and 3i would have competed for staff, it was unlikely. I would be slow to hold that Mr Bishop was a competing leaver because of that outside chance. The provision is mainly directed at investments and investors, rather than staff.
Decision
[32] I conclude that Mr Bishop was not a Competing Leaver for the purposes of the LPAs. Accordingly, I shall sustain the pursuer’s first plea-in-law and grant decree of declarator in terms of the first conclusion. I shall fix a by order hearing to discuss further procedure.