Exercising Options Carefully – Guidance on when “Time is of the Essence”

In an interesting judgment on the exercise of options, the English courts have found that time is of the essence for a call option agreement but not for the completion of the resulting contract to purchase the shares, i.e. the option contract. Equity may, in certain circumstances, treat time being as of the essence for contracts for the sales and purchase of shares, for example, if the share price is fluctuating or the market is particularly volatile. However, whether the courts will exercise their discretion to apply equitable principles in such cases will depend on the construction of the particular contract, the words used set in the factual context in which the contract is made and the subject matter of the contract.

The judgment underscores the importance of setting realistic timelines for the completion of option contracts. It also serves as a reminder that the court may order specific performance of such contracts involving shares in a private company, which are not readily available on the open market, rather than damages for breach.

Background

In Aymes International Ltd v Nutrition 4U BV [2023] EWHC 1452 (Ch), Aymes International Limited (“Aymes”), the Claimant, was a company that supplied nutritional supplements in the UK and Ireland. The three Defendants were Dutch companies Nutrition4U BV (“Nutrition4U”) and NutriMedical BV (“NutriMedical”), as well as Mr Alexander (known as Sander) Ketelaar. NutriMedical specialised in the development and marketing of nutritional products and was a wholly owned subsidiary of Nutrition4U. Mr Ketelaar was the CEO of NutriMedical and director and sole shareholder of Nutrition4U.

Aymes and Nutrition4U entered into a call option agreement dated 31 August 2016 (the “Call Option Agreement”), which gave Aymes an exclusive right to exercise the option to purchase the entire issued share capital of NutriMedical from Nutrition4U (the “Option”) within a specific period (the “Option Period”). It was common ground between the parties that Aymes validly exercised the Option within the Option Period by serving its notice on 1 April 2020 (the “Exercise Notice”).

The dispute related to the resulting contract to purchase NutriMedical’s shares following Aymes’s exercise of the Option (the “Option Contract”). The Call Option Agreement stipulated that Aymes’s Exercise Notice should state the date of completion of the Option Contract “which is no less than twenty one (21) and no more than fifty (50) Business Days after the date of the Exercise Notice” (the “Completion Date”). Aymes’s Exercise Notice accordingly provided for a Completion Date of 29 May 2020. However, the Option Contract was not concluded largely due to the parties’ differences on how the value of NutriMedical should be calculated and therefore, the consideration payable by Aymes for the Option shares.

Aymes sought specific performance by Nutrition4U of the Option Contract, asserting that Nutrition4U was in breach by missing the Completion Date. The Defendants argued that the parties were no longer bound by the Option Contract, which had lapsed on the Completion Date. The Court was also asked to decide the correct construction of the relevant provisions in the Call Option Agreement as to the calculation of NutriMedical’s “Company Value” and “Relevant Margin” (as defined in that agreement) for the purposes of determining the price Aymes should pay for the Option shares (see Issue 2 below).

Another key area of contention was the terms on which Mr Ketelaar would be retained as NutriMedical CEO, which was provided for in the Call Option Agreement. NutriMedical and Mr Ketelaar were joined to the proceedings so that they would be bound by any declaration in relation to Mr Ketelaar’s appointment after completion of the sale of the Option shares.

Decision

There were three key issues which the Court needed to decide, namely:

1. Was time was of the essence of completion of the Option Contract?
2. Should the consideration paid for the grant of the Option be included in calculating the purchase price for the Option shares?
3. Was Aymes entitled to specific performance of the Option Contract?

Issue 1: Was time was of the essence of completion of the Option Contract?

HHJ Hodge KC (sitting as a Judge of the High Court) held that the terms of the Call Option Agreement clearly recognised that time was not of the essence of completion of the Option Contract. One such provision was that Aymes and Nutrition4U were to use “reasonable endeavours” to procure that metrics to compute the consideration payable by Aymes be determined no later than the Completion Date, failing which the matter would be referred to an independent accountant. This appointed expert would then have one month to provide their expert opinion.

HHJ Hodge noted that the time taken to nominate an expert was not within the parties’ control, which showed that the Call Option Agreement contemplated that completion of the sale of Option shares might not be achievable before the Completion Date. Furthermore, in contrast to contractual provisions that provided for the lapse of the Option (as to which time was expressly made of the essence) and its consequences, no equivalent provisions were included in relation to the Option Contract.

One other question was whether equity would treat time as being of the essence of the Option Contract. In equity, time is not normally of the essence of a contractual term. However, in certain cases, time is of the essence in equity. For example, it has been established that time is of the essence both at law and in equity with regard to contracts for the sale of shares, given that the share price may fluctuate from day to day. Reviewing the legal authorities (helpfully summarised in MSAS Global Logistics Ltd v Power Packaging Inc [2003] EWHC 1393 (Ch)), there were generally three types of cases in which time is of the essence in equity: (i) where the contract expressly stipulates this; (ii) where the circumstances of the case or the subject matter of the contract indicate that the time for completion is of the essence; and (iii) where a valid notice to complete has been given. Ultimately, however, the question was one of the interpretation of the particular contract, the words used set in the factual context in which the contract was made and the subject matter of the contract.

HHJ Hodge found that equity would not treat time as of the essence of completion of the Option Contract. The call option had been in existence for more than three years prior to the Option Contract and there was no objective commercial imperative to achieve completion by any particular date. The consideration for the purchase of the Option shares was not affected by any delay in completion so there was no question of any relevant volatility in the value of the Option shares. Furthermore, the express terms of the Call Option Agreement did not indicate that time should ever be of the essence of completion of the Option Contract. In any event, it was immaterial whether time was of the essence as Nutrition4U had not purported to terminate the Option Contract by reason of Aymes’s repudiatory breach and the parties were in limbo.

Issue 2: Should the consideration paid for the grant of the Option be included in calculating the purchase price for the Option shares?

Schedule 1 to the Call Option Agreement provided a formula for the “Calculation of Company Value”. NutriMedical’s “Company Value” was to be calculated by reference to the “Relevant Margin” multiplied by 6 plus net assets. The “Relevant Margin” was the sum equal to the Turnover less “the direct cost of goods (excluding those goods sold to the buyer) and any logistics costs; sales and marketing costs (excluding those related to New Products)” and €150,000 for CEO salary for the penultimate financial year preceding the exercise of the Option. “Turnover” was not a defined term in the Call Option Agreement. NutriMedical had no appreciable fixed assets; its value was derived from its intellectual property and the goodwill in its products.

The parties accepted that Aymes had paid a total of €537,500 as consideration for the call option in annual instalments of €150,000 across a period of 3 years and 7 months (the “Option Consideration”). The dispute centred on whether the Option Consideration fell to be deducted from “Turnover” as a capital contribution or as sales to Aymes, an issue which both sides’ experts acknowledged was a matter of legal interpretation rather than accountancy practice.

Aymes asserted that the consideration payable for the share capital of NutriMedical was separate and to be calculated by reference to relevant provision of the Call Option Agreement, the effect of which was that if the “Company Value” at the date of exercise of the Option was zero or a negative figure, the consideration payable for the Option shares was €1; if the “Company Value” was a positive figure, Aymes would issue shares in itself to Nutrition4U to satisfy the amount due.

The Defendants’ case was that the Option Consideration was paid to NutriMedical (not to Nutrition4U as the holder of the Option shares) because it was in lieu of a profit margin on sales made by NutriMedical to Aymes. The Defendants disagreed that NutriMedical should be valued at €1.

HHJ Hodge found in favour of the Defendants on this issue, agreeing that the commercial purpose of the Call Option Agreement, its factual matrix and commercial common sense pointed to the inclusion of the Option Consideration in NutriMedical’s Turnover. He rejected Aymes’s argument that it was counter-intuitive for the consideration paid for the grant of a share purchase option to be treated as part of the turnover of the company when calculating the price to be paid for that company’s shares. NutriMedical received the annual payments of €150,000 by virtue of the Call Option Agreement, which provided for sales of products and services between Aymes and Nutrition4U and by extension, NutriMedical, to be at cost with no additional margin applied by either party.

Issue 3: Was Aymes entitled to specific performance of the Option Contract?

The Defendants argued that Aymes should not be entitled to specific performance of the Option Contract as Aymes had not acted in good faith, it had delayed seeking such relief and it had not come to equity with “clean hands” due to its prejudice against the Defendants.

HHJ Hodge held that both parties to the Option Contract were equally liable for the failure to complete. Aymes was late in providing the Defendants with the transaction documentation. The parties should have agreed a later date for completion and promptly referred their disagreement over the calculation of NutriMedical’s valuation as soon as it became apparent that this could not be resolved by the Completion Date. However, even if the parties had promptly invoked the expert determination provision, completion could not have taken place in time as the dispute about “Company Value” raised issues of law that an accountant would not be able to determine. Specific performance was therefore not denied on the basis of delay. HHJ Hodge did not agree that the matters raised by the Defendants amounted to conduct that was so reprehensible or unfair as to preclude specific performance on the basis that Aymes lacked “clean hands”.

Comment

The decision shows that the courts will look closely at the factual matrix surrounding the case before exercising their equitable discretion that time is of the essence of a specific contract. In contracts relating to the sale and purchase of sales, one cannot always assume that time will be of the essence. The best practice is to clearly state that time is of the essence in the contract and to list the consequences of the completion date lapsing. Serving valid notice will also strengthen a party’s case that time is of the essence in a given context. 

Finally, although the judge recognised that an order for specific performance “may be a precursor to yet further expensive litigation”, parties should be mindful that the courts may force them to comply with and perform their contractual obligations, rather than pay damages. This means that parties who fall out may still be obliged to complete their deal, however unpalatable that may be.