The Evolving Landscape of Contractual Interpretations

Recent cases examining the principles to be applied when construing contracts demonstrate the English Court’s propensity to adopt a more commercially sensitive approach to contractual interpretation in circumstances where provisions are ambiguous or propose more than one possible meaning.  In instances where contractual provisions have displayed a clear defect in the drafting, the Court has, rather than rigidly adhering to the grammar and syntax appearing in a contract, shown a willingness to interpret such provisions in order to avoid a result that cannot have been intended by the parties on account of it making no commercial sense.  Recent case law, however, clearly demonstrates that the Court remains mindful to avoid imposing its own definition of “sense” on parties to a contract where that contract has a clear meaning even if that meaning does not necessarily make the most commercial sense.

Defects/Ambiguity in Drafting

Chartbrook Ltd v Persimmon Homes Ltd and Ors [2009] UKHL 38 concerned a dispute over a clause requiring an additional payment in a land development contract to the Claimant.  The Claimant contended that the meaning of the relevant clause was simple and clearly set out the mechanism by which the payment was to be calculated.  The Defendant, however, argued that the effect of the construction favoured by the Claimant would be inconsistent with the purpose of the clause and provided the Claimant with a far greater payment than envisaged.  Reversing the decisions of the Court of Appeal and the judge at first instance, Lord Hoffman stated that “to interpret the definition of ARP [the payment] in accordance with ordinary rules of syntax makes no commercial sense.”  Lord Hoffman set out in Chartbrook a two-limb test to be employed in ascertaining whether the Court can interpret a provision to remedy a clear mistake in the drafting:

(i) it must be clear that something has gone wrong with the language; and

(ii) it should be clear what a reasonable person would have understood the parties to have meant.

This test built on the principles articulated in Investors Compensation Scheme Ltd v West Bromwich Building Society (No.1) [1998] 1 WLR 896.  In that case, Lord Hoffman considered that the process of contractual interpretation sought not to identify the subjective intentions of the parties to a contract, but to ascertain what a reasonable person, fully appraised of the relevant background information reasonably available to the parties at the time of contracting, would understand the document to mean.  Subject to the requirement that such information had been reasonably available, and to restrictions imposed by law on what background information is admissible (evidence of negotiations not being admissible save in an action for rectification or a plea of conventional estoppel), Lord Hoffman stated that the factual background “includes absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man.

Requirement for a “clear” defect in drafting

The trap that the Court is keen to avoid falling into when construing problematic drafting is imposing on the parties its own view of what would have seemed commercially sensible.  While one particular outcome might seem absurd to the Court, in light of the facts known to the parties at the time, it might nevertheless have been the consequence the parties intended.

In ING Bank NV v Ros Roca SA [2011] EWCA Civ 353 the Court of Appeal reviewed a decision concerning the calculation of an additional fee for the provision of financial services.  In order to calculate the fee the relevant provision contained a reference to a company’s “EBITDA 2006”, though the transaction did not conclude until 2007, and therefore the value was no longer current.  Applying Lord Hoffman’s test in Chartbrook, the first instance judge, concluding that something had gone wrong with the drafting, substituted the contested reference for EBITDA so as not to link it to a specified year on the basis that he found it “impossible to detect any rational basis upon which the parties could have concluded that upon the premise that EBITDA 2006 might no longer be current at the time of the Transaction it should nevertheless be used for the purpose of calculating the additional fee”.

On appeal, the judgment on this point was overturned (though as ING Bank NV was estopped from relying on its construction of the clause, Ros Roca SA retained its success at trial).  Adopting the same starting position as the trial judge (the test in Chartbrook), Carnwath LJ did not consider that the inclusion of a reference to EBITDA 2006 was sufficient to engage the first part of the test: there was no problem with the language used and it was clear that the reference to EBITDA 2006 was intentional.  Had the transaction concluded within the expected timeframe, the use of the 2006 value for EBITDA would have been unremarkable.  Carnwath LJ stated that “[t]he mistake was not in the language, but in failing to anticipate its consequences”.  In his view, it was understandable that the parties should have adopted the figure for 2006, given their reasonable expectation that the transaction would be concluded while that value remained relevant and “[t]he fact that no-one may have contemplated the actual transaction being delayed beyond that time is not in itself a reason for rewriting the agreed formula.

Unlike in Chartbrook, there was no clear mistake in the drafting and Rix LJ confirmed that the Court was not prepared to amend the contract “on the basis of what the [Court] consider[s] would have been reasonable, or more sensible, for the contract to have said.

Provisions with more than one meaning

The approach in Investors Compensation Scheme Ltd and Chartbrook was followed by the Supreme Court in Rainy Sky SA & Ors v Kookmin Bank [2011] UKSC 50.  Noting that the language used in a contract could often bear more than one meaning, the Court sought to ascertain what a reasonable person, being someone with the relevant background knowledge that would reasonably have been available to the parties in the situation they were at the time of the contract, would have understood the parties to have meant.  Lord Clarke considered that, in order for the Court to form its view, it needed to have regard to “all the relevant surrounding circumstances.”  Aware of the relevant factual background, if there were two possible constructions, the Court was entitled to prefer the construction which was consistent with business common sense and to reject the other.  Allowing the appeal, the Supreme Court rejected the judgment of Patten LJ in the Court below.  Patten LJ’s view was that wording in a contract should be ascribed its natural meaning unless the results were so extreme they could not have been intended. However, the Supreme Court held that this risked ignoring another potential meaning that could be gleaned from examination of the factual background and that the parties actually intended.

Implied Terms: Mistakes arising from omissions

Greater caution is exercised by the Court when it is asked to imply a term into a contract to correct an apparent mistake arising from an omission.  The tests to be satisfied before the Court will imply a term were examined in the Privy Council case of Attorney General of Belize and others v Belize Telecom Ltd [2009] UKPC 10.  According to the Board, the key question to be asked when considering the term to be implied, was: is that what the instrument, read as a whole against the relevant background, would reasonably be understood to mean?  However, as was stressed by the Court of Appeal in Mediterranean Salvage and Towage Limited v Seamar Trading and Commerce Inc [2009] EWCA Civ 531, there should not be read in Belize a departure from the accepted position that a term will only be implied where it is necessary to give business efficacy to a contract.  In articulating the key question, the Board in Belize sought to emphasise that implying terms is only one part of the broader process of interpretation.  At the start of the opinion, Lord Hoffman reiterated the Court’s reluctance to imply terms into a contract: “[t]he question of implication arises when the instrument does not expressly provide for what is to happen when some event occurs. The most usual inference in such a case is that nothing is to happen. If the parties had intended something to happen, the instrument would have said so.

The Court of Appeal recently revisited both the issues of business sense and implied terms whilst considering a preliminary issue in the dispute between Sir David and Sir Frederick Barclay (and their associated entities) and Irish property developer, Patrick McKillen over the ownership of three prestigious hotels (Claridges, The Connaught and The Berkeley) (Patrick McKillen v Misland (Cyprus) Investments Limited & Ors [2012] EWCA Civ 179).  The dispute concerned a shareholders’ agreement, the parties to which were bound by pre-emption provisions requiring them to offer their shares to existing shareholders in the event they were exiting the company, Coroin Limited.  All of the shareholders in Coroin Limited were individuals save one, Misland.  The shareholders’ agreement was silent on what pre-emption provisions, if any, should be adhered to in the event that the shares in Misland were sold.  Mr McKillen argued that the pre-emption provisions were designed to retain control of the shares in Coroin Limited within a specified group of people (whether held directly or indirectly) and therefore asked the Court to imply into the contract a provision that certain of the pre-emption provisions apply to the shares in Misland.  In essence, Mr McKillen’s case was that the alleged intended purpose of the pre-emption provisions would effectively be circumvented if they were not applied to the shares held in Misland.

Citing the opinion of the Board in Belize, Rimer LJ stated that, although the Court had the power to read into a document words that were not there, it would only do so “in a case in which it is satisfied that it is necessary to do so in order to reflect what it is satisfied was its true meaning.”  Rimer LJ was unable to conclude with confidence that this apparent hole in the drafting had not been foreseen by the parties (and was in fact therefore their intention).  The exception complained of by Mr McKillen was an obvious omission from the provisions of a clause.  “How,” asked Rimer LJ, “… could the reasonable man safely conclude that the Misland exclusion was a mere drafting mistake?  How could he reject the possibility that, whilst such exclusion may be perceived as being unfavourable to Mr McKillen, it was not simply the outcome of the exchanges in the course of negotiation between the parties[?]

The Court of Appeal was not provided with an abundance of background knowledge to inform its decision.  Its decision came back to Lord Hoffman’s test in Chartbrook.  Rimer LJ was not able to satisfy himself that there was a mistake in the drafting, nor was he able to conclude that the shareholders’ agreement did not operate in exactly the way it was intended.  The Misland exception was all the more likely to have been deliberately left open as the parties were sophisticated investors, properly advised.

Conclusion

The Court remains unprepared to interfere with unambiguous, precisely drafted contractual provisions that produce a certain result where that outcome was intended by the parties (or at least cannot be said to have not been intended) at the time the contract was formed even if that outcome does not necessarily make commercial sense.  It is not its function to select, with hindsight, a meaning that appears more commercially sensible.

However, where language is unclear such that the Court, assisted by factual evidence, is able to identify more than one possible meaning to a provision, it is entitled to select the interpretation that it believes that a reasonable person would have understood the contract to have meant in the light of the relevant background facts.

By Hannah Field-Lowes and Victoria Burton of Weil, Gotshal & Manges (who represented Sir David Barclay and Sir Frederick Barclay and their associated entities in the above referenced proceedings of Patrick McKillen v Misland (Cyprus) Investments Limited & Ors).