Formulae in finance documents - are worked examples the way forward?

As many of our readers will know, finance documents and other commercial contracts contain a lot of words…!

Some of those words may narrate calculations/formulae regarding amounts to be paid under the contract (e.g. a price adjustment mechanism) or whether or not a particular financial metric has been met (e.g. a loan to value calculation). Sometimes to cut through the wording, and/or to clarify, the parties also include worked examples to illustrate the operation of a formula.

This was the case in Altera Voyageur Production Limited v Premier Oil E&P UK Ltd [2020] EWHC 1891 (Comm). Sadly, the narrative drafting and the two worked examples were inconsistent, producing a USD 15 million discrepancy and triggering a dispute over which prevailed.

What happened?

Premier had leased a ship from Altera and agreed to pay Altera a daily hire fee, calculated and adjusted in accordance with a formula set out in the contract. This fee was shown by a narrative formula, followed by two worked examples. These were inconsistent – the worked examples contained two additional final steps which were not set out in the narrative. Following either option yielded quite different results:

• Altera (using the worked examples) claimed it was owed approximately USD 12 million
• Premier (using the narrative formula) argued it owed less and counterclaimed for USD 3 million in overpaid fees

Premier argued that one of the additional steps in the worked examples double-counted a component of the calculation, producing an illogical result that was inconsistent with the narrative formula and certain other terms of the lease charterparty. Altera argued that the worked examples formed an integral part of the contract and were at the forefront of the parties’ minds as they finalised the deal.

The decision

The High Court gave priority to the two worked examples, concluding that they were an integral part of the contract and prevailed over the narrative formula. The judge, Richard Salter QC, observed:

• The hire contract stated that the daily fee was to be “adjusted from time to time by reference to” the worked examples, suggesting that those examples were crucial
• Both worked examples set out the additional disputed step, suggesting that this was a “deliberate choice” when drafting
• The inclusion of two worked examples indicated that the disputed step could not have been a mere error
• It was “inherently more probable that the parties’ true bargain” would be found in the worked examples and that narrative explanations and formulae may “disguise (or, at least, not make clear) their consequences”. The worked examples were included to demonstrate with clarity the consequences of the formula. The Judge approved of comments in Starbev GP Ltd v Interbrew Central European Holdings BV [2014] EWHC 1311 that “illustrations or examples may deserve particular attention as something to which the parties particularly turned their minds”

This convinced the court that:

• The worked examples should prevail over the narrative formula, and
• The worked examples did not represent what a “reasonable person with all the relevant knowledge” would say Premier and Altera had intended

The Judge was not prepared to disregard the worked examples as this would “re-write the contract”. He reached this conclusion even though:

• The worked examples produced a result which was commercially illogical, and
• The construction clause of the hire contract stated that the main body of the contract (which contained the narrative drafting) took priority over the appendices (containing the worked examples)

What does this mean for me?

Finance documents increasingly contain worked examples, particularly where the scenario in question contains a complex and/or bespoke narrative formula. A worked example evidences the commercial context and the parties’ intentions and allows the parties to see a practical illustration of that formula.

In a facility agreement, you might see a worked example in relation to:

• Determining borrowing limits
• Financial covenant calculations
• Calculating payments/distributions under a waterfall.

In most cases, a worked example will be useful for the parties to include in their finance documents but the Altera case does highlight some key takeaway points to consider when doing so:

• Ensure the examples are consistent with the narrative formula. If changes are made to one, reflect them in the other
• Make it clear which of the formula or the example prevails in the event of any inconsistency
• Think about whether you need to include an example. A simple calculation might not justify an example and introducing one could actually complicate matters – as shown by the Altera dispute.

Andrew Dodds, a partner in the Banking and Finance team at Stevens & Bolton LLP, comments:

“Finance documents often contain narrative formulae which put into words the component parts and results of complex calculations or financial models. We have found that including worked examples in facility agreements in relation to narrative formulae has been beneficial to all parties. Turning to the Altera case, the decision is, like most cases on contractual interpretation, fact-specific and it does not set out a general principle of worked examples prevailing over narrative formula drafting. But it does demonstrate the importance of worked examples and ensuring that those examples are correct and consistent with the operative provision of the contract that they are seeking to illustrate”.