Case Nos: CA-2024-002136 - [2025] EWCA Civ 921

Discussion

In my view, the Judge was correct that, for costs to be “directly incurred” in generating income, there must be “some immediate relationship between the winning of the income and the outlay” and that “those costs which are incurred specifically in relation to the particular income generating activity in question” fall to be distinguished from “those costs which are not specifically incurred in relation to that activity but are the general costs incurred by the organisation as part and parcel of undertaking its activities as a whole”. As was accepted by Mr Justin Mort KC, who appeared for the Council with Mr John McMillan and Mr Tom Coulson, that does not mean that everything that might be described as an “overhead” is necessarily to be disallowed. If, say, a particular facility were used exclusively in the generation of relevant income, costs associated with the facility such as rent or insurance might be “directly incurred” even though they could potentially be termed “overheads”. What matters is whether the cost at issue can in its entirety be traced to the particular income.

That conclusion appears to me to accord with ordinary usage. It is certainly, I think, consistent with how “direct costs” are understood and, while the Project Agreement instead refers to “directly incurred” costs, I do not regard the distinction as significant. I note in this connection that the Oxford English Dictionary gives as a definition of “direct” “Of or pertaining to the work and expenses actually incurred during production as distinct from subsidiary work and overhead charges, i.e. to prime or initial costs or charges”.

As I have mentioned, Ms Parkin argued that “directly incurred” should not be interpreted in this way but rather as requiring a causal connection between the costs and the income. On that basis, it would suffice that income could not be produced without, say, a certain facility. The costs of running the facility would be deductible even if it were not used only to produce income, but also (and perhaps mainly) for other purposes.

I have not been persuaded. Interpretation of a contract involves, of course, assessment of “the objective meaning of the language which the parties have chosen to express their agreement” (to quote Lord Hodge in Wood v Capita Insurance Services Ltd [2017] UKSC 24, [2017] AC 1173, at paragraph 10) or, in the words of Lord Hoffmann in Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896 at 912, “ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract”. To my mind, such a “reasonable person” would not conclude that a causal connection of the kind espoused by Ms Parkin sufficed, and such a construction is not consistent with the “objective meaning of the language”. The imposition of the requirement for costs to be “directly incurred” points to the parties having intended a restriction along the lines of the approach which the Judge adopted. Ms Parkin’s interpretation would seem to leave the word “directly” without any real role. Further, were Ms Parkin’s submissions well-founded, FCCB could potentially be entitled to deduct costs out of all proportion to the income in question and even perhaps the costs of the group’s headquarters in Spain. I do not think the Project Agreement would convey such a meaning to the hypothetical “reasonable person”.

Nor, in my view, is FCCB assisted by reference to the Invitation, SoPC4 or WIDP. Passages to the effect that an operator “needs to be incentivised” and income “shared” are too high level to be informative. After all, there is no obvious contradiction between such statements and the Judge’s interpretation of “directly incurred”. As for WIDP’s references to “additional marginal costs” and “the marginal costs of generating such income”, it seems to me that these, if anything, favour the Council. The Judge in effect required costs to be “marginal” or, in other words, to represent the extra cost occasioned by the income.

Of course, the parties did not in the event adopt the definition of “Third Party Income” offered in WIDP. There is no reason to suppose, however, that a looser approach was intended. To the contrary, it seems fair to infer that the more complex definition found in the Project Agreement was designed to be at least as restrictive of the costs that could be deducted.

During the hearing, there was discussion as to whether FCCB could properly apportion costs so that, say, costs incurred in generating income from third parties and also for other purposes could in part be deducted in the calculation of Third Party Income. It appears to me, however, that the words “directly incurred” preclude such apportionment. They rather require that the expenditure in question was incurred exclusively in relation to achieving the income from third parties. There are also practical reasons for concluding the parties did not intend such apportionment to be possible. Suppose (as in fact happened) that FCCB claimed to deduct part of its head office costs. The Council would be in no position to assess the propriety of the deduction without knowledge of (a) the total head office costs and (b) what other income the head office was helping to generate. There is no mechanism in the Project Agreement, however, for the Council to obtain such information. Nor are the parties likely to have intended that the Council should undertake such investigations.

In the course of the hearing, Ms Parkin referred to certain costs which, she suggested, must be regarded as “directly incurred”. However, the relevant ground of appeal challenges the test which the Judge applied, not his application of it: FCCB’s complaint was that the Judge misconstrued “directly incurred”. Moreover, Mr Mort fairly said that, given the terms of the grounds of appeal, the Council had not come to Court prepared to justify the Judge’s conclusions as to how his approach should be applied as regards particular items. Our concern, therefore, is with how the Judge understood the requirement that costs be “directly incurred”, not with whether his interpretation could or should have yielded different results on the facts.