Select 2016
What Does It All Mean?
Contractual construction, implied terms and rectification:
a refresher and recent trends
Philip Parish, Partner, Financial Services Litigation
Oliver Wilson, Senior Associate, Corporate
13 October 2016
Agenda
• Refresher on approach to construction of express terms, implied terms
and rectification.
• Review of recent trends: limits on the "commercial common sense"
approach?
• Particular terms
– Duty to act rationally when exercising contractual discretion
– Implied duty to act in good faith
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Express Terms
The "golden rules" for construction of express terms of a contract:
• Ascertaining the "common intention of the parties".
• Done by reference to what a reasonable person in the position of the
parties would understand the words to mean ("the reasonable bystander"
test) (West Bromwich Building Society).
• Meaning of the provision must be sought from the document itself, taken
as a whole.
• Regard had to "factual matrix". But extrinsic evidence of subjective
intention not admissible (parol evidence rule).
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Express Terms (cont'd)
• Ordinary meaning of words to be adopted
• Unambiguous language therefore given effect
"If the Court concludes that the language used is unambiguous, then the Court should apply it, even
though some other result might be thought more commercially reasonable, and even if it gives a result
that is commercially disadvantageous to one of the parties. The Court's function is to interpret the
contract, not to rewrite it". (US Bank Trustees -v- Titan Europe (2014)).
• Departed from in cases of "absurdity" or obvious linguistic mistake. But in
formal/professional documents, a strong case is needed to establish this (Chartbrook).
"Where a term of a contract is open to more than one interpretation, it is generally appropriate to
adopt the interpretation which is the most consistent with business common sense" (Rainy Sky -vKookmin (2011)).
• Only if there is ambiguity are the other rules called into play
• Rules of construction like contra proferentem, ejusdem generis, restriction by express
provision, interpretation of exclusion clauses.
• Evidence of custom, mercantile usage etc.
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The trend towards "commercial purpose" interpretation:
Chartbrook -v- Persimmon
• Agreement to purchase and develop land.
• Price payable by Persimmon to Chartbrook made up of total land value
plus balancing payment.
• Balancing payment defined as "23.4% of the price achieved for each [flat]
in excess of the [land value for each flat] less costs and incentives".
• Assume land value for each flat £53,000 and sold for £200,000, what is
the balancing payment?
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Chartbrook
• Chartbrook argued: take flat selling price, deduct land value and
costs/incentives and calculate 23.4%.
• High Court/Court of Appeal agreed. That's what the words seem to say.
• Supreme Court agreed with Persimmon. Was not the intention of clause.
Do not look at conventional syntax. Intention was to give Chartbrook a
minimum price per flat based on current market assumptions, but allow
for increase if market rose and flats did better than expected.
• Current market assumption was £200,000 per flat. Land value at
£53,000 was 26%. Sale price of £228,000 = 23.4%. Purpose of clause
was that if flats sold for more, Chartbrook entitled to the amount by
which 23.4% of the higher price exceeded the £53,000 land price.
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Chartbrook
• Court prepared to depart from ordinary words where that is at odds with
"commercial purpose"
– Virtually re-write of contract (there was a parallel claim for rectification)
– Lord Hoffman:
"there is not, so to speak, a limit to the amount of red ink or verbal re-arrangement
which the Court is allowed. All that is required is that it should be clear something has
gone wrong with the language and that it should be clear what a reasonable person
would have understood the parties to have meant"
Thus:
– A clear mistake, something which has gone seriously wrong with the language, producing
an irrational or arbitrary outcome
– Must be clear what is needed to correct the mistake
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"Commercial Purpose"
• Stream of different decisions which illustrate the approach
– Re Sigma (insolvency and operation of pari passu rule in securitisation); ING Bank -vRos Roca (engagement letter and calculation of fee); Ostfriesische Volksbank
(construction of quantum); HHY Luxembourg (ability of trustee to release security)
– All cases where literal reading is abandoned in favour of a purposive "commercial"
interpretation
– Re Sigma: "during the Realisation Period the [Receivers] shall so far as possible
discharge on the due dates thereof any Short Term Liabilities falling due for payment
during such period using cash or other realisable or maturing Assets of the Issuer"
(clause 7.6). Held: the parties cannot have intended this to override the normal pari
passu rule on insolvency.
– Court has moved from the need for "ambiguity" or even "irrational or arbitrary"
outcome. Lord Mance: interpretation is "an iterative process" of checking rival meanings
against other provisions and against the commercial consequences
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Arnold -v- Britton (June 2015): Supreme Court
• Interpretation of a service charge on chalets in a caravan park in a 99 year lease.
• "To pay to the Lessor without deduction in addition to the said rent a proportionate
part of the expenses and outgoings incurred by the Lessor in the repair maintenance
renewal and provision of services hereinafter set out the yearly sum of Ninety Pounds
and value added tax (if any) for the first three years of the term hereby granted
increasing thereafter by Ten Pounds per Hundred for every subsequent year or part
thereof [three year period or part thereof]".
• Factual matrix included
– Inflation running at well in excess of 10% at time of grant in 1970s and 1980s
– But recent low inflation
– e.g. 1972 lease, £90 service charge by 2012: £3,366 (annual), £311 (tri-annual), £794 on actual
inflation. In excess of £1m (annual) by 2072
• Appellants argue that such an "absurd" result cannot have been intended: read in the
words "up to" to make these figures a cap. Intention must have been to share the
Landlord's costs "proportionately".
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Arnold -v- Britton
•
Lord Neuberger (4-1 majority)
•
What would the reasonable person have understood from the words used
•
Focus on the actual language used in its documentary, factual and commercial context
•
Natural meaning of the words here were clear: first half of the clause descriptive of the nature of the
charge, and the second half quantifies it
•
Fact that the cost may exceed the parties expectations, or that it was a bad deal was not a reason to give
the clause a different meaning
•
Alternative interpretation would involve the Court "inventing" a lack of clarity in order to depart from the
clear meaning. Nothing had "gone significantly wrong" with the language
•
The parties had taken a bilateral gamble on inflation rates. Far from inconceivable that parties would
have agreed this, given inflation rates at the time
•
Commercial common sense has to be judged at the time the contract was executed. It cannot be done
retrospectively.
•
The less clear the language the more ready the Court might be to depart from the natural meaning. But
the obverse is also true: if the language is clear it should not be departed from.
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Arnold -v- Britton
• Lord Neuberger
"..the reliance placed in some cases on commercial common sense and surrounding
circumstances (e.g. Chartbrook) should not be invoked to undervalue the importance of the
language of the provision which is to be construed. The exercise of interpreting a provision
involves identifying what the parties meant through the eyes of a reasonable reader, and,
save perhaps in a very unusual case, the meaning is most obviously to be gleaned from the
language of the provision. Unlike commercial common sense and the surrounding
circumstances, the parties have control over the language they use in the contract. And,
again save perhaps in a very unusual case, the parties must have been specifically
focussing on the issue covered by the provision when agreeing the wording of that
provision".
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Arnold -v- Britton
• Dissenting judgment (Lord Carnworth)
– Something had gone wrong with the drafting
– Clause imposed an obligation to pay, but with two different and inconsistent descriptions
of the amount payable, namely a "proportionate" amount, and a "yearly sum". Therefore
inherently ambiguous.
– Landlord's interpretation was commercially improbable. Only the clearest words should
lead the Court to uphold such a result.
– The limited addition to the clause did not do violence to the clause
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Arnold -v- Britton
• Conclusions
– Limits to the "commercial common sense" approach. Cannot override the clear language used by the
parties. Unless there is genuine ambiguity, or something has clearly gone wrong with the language,
then the Chartbrook/Rainy Sky approach has no place to operate
– Complaints by the Court about lack of "factual matrix" type evidence. How can the Court truly
determine what made "commercial common sense" in 1972?
"There is a need for caution in relying on arguments of "commercial common sense" particularly
where they conflict with the intent naturally to be inferred from the language which the parties have
chosen to express their bargain….judges are not always the most commercially- minded, let alone
commercially experienced of people" (Tartsinis -v- Navona Management Co (2015)).
– Court should not "invent" ambiguity in order to invoke the commercial common sense approach
– Demonstrates the litigation risk inherent in contractual construction cases: first instance judge found
in favour of tenants, CA for landlord (single judgment), and SC split.
– The "sympathy factor" – the desire to do justice in the instant case (as against the need for
commercial certainty). E.g. Lord Carnworth's references to the regulatory control on services charges:
this was a rare case that fell outside the statutory protection
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Implied Terms: Golden Rules
Traditional tests
• reasonable and equitable
• necessary for business efficiency
• officious bystander test ("goes without saying")
• capable of clear expression
• must not contradict an express term, or deal with matters already covered
expressly
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Implied Terms: Attorney General -v- Belize Telecom
Lord Hoffman: lead judgment in unanimous House of Lords
• A new and more liberal approach to the implication of terms?
• Same approach as constructing an express term: what is the parties'
intention/what would the reasonable bystander understand by the words
• Not a series of independent tests, but a series of ways of answering this
question. Wrong to focus on the details of "business efficacy" or "officious
bystander" tests.
• The process of implying a term is simply a part of the exercise of construction
or interpreting the contract.
Lord Hoffman: "there is only one question: is that what the instrument read as a whole against
the relevant background would reasonably be understood to mean"?
• Followed extensively subsequently in UK and common law jurisdictions
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Marks and Spencer -v- BNP Paribas
Facts:
• Lease agreement due to run until 2018
• 70 pages drafted and negotiated by solicitors
• Rent payable quarterly in advance
• Break clause: tenant terminated on 24 January 2012
• Could the tenant claim back rent paid in advance for 24 January – 24
March 2012
• No provision for repayment in lease
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Marks and Spencer -v- BNP Paribas
Facts:
• Lease agreement due to run until 2018
• 70 pages drafted and negotiated by solicitors
• Rent payable quarterly in advance
• Break clause: tenant terminated on 24 January 2012
• Could the tenant claim back rent paid in advance for 24 January – 24
March 2012
• No provision for repayment in lease
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Marks and Spencer -v- BNP Paribas
• Tenant's arguments
– Rent should be apportioned, otherwise prejudicial to tenant and windfall to landlord
– It is what the parties would have intended
– Commercially reasonable
• Landlord's argument
– Fully negotiated lease, professional advice
– Implied term does not meet necessity test
– Other detailed provisions about repayments; implied term "sits uneasily" with this detail.
– Contradicts normal legal rule of non-apportionment for rent paid in advance
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Marks and Spencer -v- BNP Paribas
Legal analysis
• Widespread mis-understanding of Belize
• No dilution of necessity test. "Business efficacy" or "officious bystander"
tests must be met.
• Task of implying terms is different from "construction" of contracts
• Are they to be sequential exercises? Majority think it is. Carnworth
dissenting.
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Marks and Spencer -v- BNP Paribas
Lord Neuberger guidance / observations
• Not concerned with proof of actual or hypothetical intention of the parties themselves.
The test is what would a hypothetical reasonable person in the position of parties have
understood - at the time of contracting – to have been intended
• Term not to be implied just because it is "fair", or because the parties would have
agreed it if suggested
• Term must be reasonable and equitable, but test rarely adds anything if the other tests
satisfied
• Business efficacy and obviousness are alternatives, not sequential tests
• Officious bystander test: formulate the question with care (i.e. question should be
neutral / not suggestive of a single answer)
• Necessity / business efficacy involves a value judgment. Not a test of absolute
necessity. Would the contract lack commercial coherence without the term?
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Marks and Spencer -v- BNP Paribas
• Belize: not over-ruled, Lord Hoffman is "misunderstood". Belize did not
change the law. Lord Hoffman's view involves giving a "wide" meaning to
"construction"
– Focus on meaning of the contract at the time it was made
– Test remains obviousness or necessity. Mere reasonableness is not enough.
• Constructing and implying all involve determining the scope and meaning
of the contract. But they are different, distinct and sequential processes.
• Hoffman's observations henceforth "to be treated as characteristically
inspired discussion rather than authoritative guidance on the law of
implied terms".
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Further cases 2015 / 2016
• Deutsche Trustee Co -v- Cheyne Capital Management (2015)
– Removal of CMBS Issuer Special Services provider only if rating agencies "have
confirmed that the appointment of the successor Issuer Servicer will not result in an
Adverse Rating Event…"
– Held: Means what it says: cannot be removed if the confirmation is not provided: even if
the rating agency has subsequently introduced a policy of not responding to requests.
• Persimmon Homes -v- Ove Arup (2015)
– "The Consultant's aggregate liability under this Agreement whether in contract, tort
(including negligence)… shall be limited to £12m, with liability for pollution and
contamination limited to £5m in the aggregate. Liability for any claim in relation to
asbestos is excluded".
– Held: Means what it says. Contractor had by negligence contaminated the entire site
with asbestos contamination. The Court did not accept so-called policy reasons or
common sense reasons suggesting otherwise.
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Further cases 2015 / 2016
• Hayfin Opal Luxco 3 SARL -v- Windemere (2016)
– Detailed waterfall provisions in a CMBS. Dispute as to calculation of interest on notes.
Badly drafted. Referred to "Euribor" in calculation but failed to envisage what would
happen if the interest rate swap was cancelled. Can the Court add in words / provisions
to fill defect in the drafting of the calculation i.e. "Euribor or (where no Hedging
Arrangements remain in place), the Fixed Rate or following an Event of Default where
no Hedging Arrangement remains in place), the higher of Euribor and the Fixed Rate".
– Held: No, not permissible to add the underlined words. In some narrow examples, the
Court can imply a term to correct an obvious drafting error, or the Court can rectify the
agreement, but both concepts have strict tests. Words cannot be inserted just because it
is reasonable to do so.
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Further cases 2015 / 2016
• CBRE Loan Servicing -v- Gemini (Eclipse 2006 -3) Plc (2015)
– Securitisation. Documents did not define "Principal" and "Interest". On default, the
recoveries did not fit into either description (eg rent, surrender premiums, sale
proceeds). Junior notes do not get paid until Class A notes had been paid principal in
full. Junior notes therefore want to characterise as much as possible as "interest".
Argued that Court must apply the common law that receipts should be applied to
interest first, then principal.
– Held: Applied a purposive approach. In light of commercial purpose of the
securitisation, such recoveries constituted principal receipts. However, documents
badly drafted so literal approach not an option.
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Rectification
•
Mutual mistake
Parties reach common agreement, but written document does not reflect their accord
•
–
Common intention or understanding
–
Outward expression of accord
–
Intention continued at time of execution
–
By mistake the document did not reflect the common intent
Unilateral mistake
–
Party A believes clause contains or means X
–
Party B is aware of A's mistake: actual knowledge or wilful shutting of eyes
–
Omission to draw mistake to A's intention
–
Mistake calculated to benefit B
•
Relationship with estoppel - where parties negotiate on a mutually understood basis
•
Admissible evidence to prove case
•
Relationship with Chartbrook: pleading cases in the alternative
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Contractual discretion: duty to act rationally
• Express terms giving contractual discretion: on their face unfettered
– But:
• Court will imply duties not to act arbitrarily or oppressively: but rationally and to
exercise discretion for the purpose for which it was granted rather than for other
collateral advantage. (Abu Dhabi National Tanker Co -v- Product Star Shipping Ltd)
• Includes situations where discretion is implicit (eg Bank Charges test case)
• Does not include decisions to exercise a contractual right (e.g. to terminate, to serve a
notice, etc)
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Socimer International Bank Ltd -v- Standard Bank (2008)
• Socimer defaulted on forward sale agreement
• Standard Bank required to value assets at date of default (no guidance on
how)
• Some assets retained; some sold months after default
• Standard Bank gave low valuations as at date of default reflecting market
illiquidity at that time
• Socimer argued for duty to value on a reasonable and objective basis
• Standard Bank argued the only requirement was for an honest but
subjective valuation
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Socimer: Held (Court of Appeal)
• Duty is to act honestly and in good faith, not arbitrarily or capriciously
• No duty on Standard Bank to act with reasonable care towards Socimer
• Subjective valuation, so long as not capricious or arbitrary
• Cases which suggest the test is one of "reasonableness" are interpreted
only as meaning "not perverse"
• Since power had not been exercised at the time of default, Court must
conduct the exercise, based on evidence from Standard Bank as to how it
would have conducted the valuation
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Mid Essex Hospital Services NHS Trust -v- Compass Group
Facts:
• Catering contract for hospital
• Alleged breaches of service standard
• Trust awarded itself payment deduction under the contract, and service
points (relevant to establishing right to terminate)
• Then served notice to terminate
• Compass argued discretion to award deduction of points fettered by Abu
Dhabi type implied term
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Mid Essex Hospital Services NHS Trust -v- Compass Group (cont'd)
Held:
– Authorities limited to situations where discretion involves making an assessment from a
range of options, taking into account the interests of both parties
– Does not apply to the discretion of one party deciding whether to exercise an absolute
contractual right
– There was no discretion in this case as to the calculation that was fixed. Only discretion
was whether the Trust should exercise its rights
– See also Portsmouth CC -v- Ensign (2015): Road maintenance PFI contract. Discretion
on how many service points to award. Follows Mid-Essex. Decision to award points and
decision to terminate unfettered. But decision on how many points to award is subject to
the "Abu Dhabi" type implied term
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Braganza v BP Shipping (2015)
Facts:
• Mr Braganza disappeared from the British Unity, a ship operated by BP
(who was Mr Braganza's employer)
• Employment contract provided for death-in-service benefit – but not
payable if "in the opinion of [BP]" the death resulted from "the officer's
wilful act"
• BP conducted thorough investigation and concluded that suicide was
most likely explanation – so no benefit payable
• Trial judge unable to conclude, on the balance of probabilities, that there
had been suicide (although it was a real possibility)
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Braganza v BP Shipping: Held (Supreme Court)
• "Wednesbury reasonableness" is the correct test to apply where one party to exercise
decision-making function, emphasising the two limbs of that case:
–
Have the right matters been taken into account?
–
Based on those matters, is the decision so outrageous that no reasonable decision-maker could have reached it?
• Split decision (3-2 majority) regarding application to the facts.
• Majority:
–
Emphasised inherent improbability of suicide, and therefore need for stronger evidence to support that conclusion
–
Weight given to BP's size and resources, and the duties of an employer to employee
–
Found that BP hadn't taken into account certain factors, eg his strong Roman Catholic faith (which meant suicide was a
mortal sin)
• Minority:
–
Both possibilities (accident and suicide) were inherently improbable
–
Employer/employee relationship irrelevant
–
Thorough investigation undertaken by BP
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Implied duty to act in good faith:
Yam Seng -v- International Trade Corporation (2013)
Background:
– No general duty to perform contracts in good faith
– Compare to civil law jurisdictions, and even US/Australia
– Piecemeal approach in response to specific situations
• Particular contracts (insurance, fiduciary, employment)
• Duty to act honestly (HIH Casualty -v- Chase Manhattan)
• Fidelity to the bargain (Rainy Sky -v- Kookmin)
• Contractual discretion (Abu Dhabi National Tanker)
• Consent not to be unreasonably withheld cases
• Onerous clauses drawn to other party's attention (Interfoto)
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Yam Seng
Facts:
• Personal relationship between two individuals
• Contract very skeletal – no lawyers involved
• Distribution Agreement: a "relational" contract. Also fairly long term
• Conduct by ITC which undermined the contract, including failure to
supply product, late delivery, failure to register product for sale, offering
same products within the territories at lower prices, mis-statements of
fact
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Yam Seng: Judgment
Held:
– English law not ready for a general wide-ranging duty of good faith in all contracts
(although English law swimming against the tide)
– Not inconsistent on facts to imply a duty to act in good faith, since this was clearly the
parties' mutual intention. Term implied using the usual tests
– Specifically: duty not to undercut prices, and duty not to knowingly give false
information (or to correct once falsity was discovered)
– Additionally, found other repudiatory breaches and misrepresentations
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Yam Seng: Implications
- A step towards a more general overarching good faith requirement?
- Heavily dependant on facts and context
- Based on presumed intent of parties: does not cut across freedom of
contract
- Obiter: capable of being excluded expressly in the contract – but an
unattractive term
- Limited import. Duty of honesty, good faith or "fair dealing". Objective
standard. Limited to fundamental standards of commercial probity,
rather than importing broader requirements of full disclosure etc
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Yam Seng – subsequent cases
• Numerous cases refer to/cite Yam Seng. But most to not follow or
build on the "good faith" implication
– Some are cases where there is already a "good faith" obligation in a clause (e.g. Portsmouth CC
-v- Ensign (2015): but Court reluctant to extend such clause to apply more widely within the
contract
– Other cases decline to imply the term on normal Belize principles e.g. Carewatch -v- Focus
(2015)
– Courts reiterate that Yam Seng is not a basis for implying a general obligation of good faith into
commercial contracts: fact specific
– But: Bristol Groundschool -v- Intelligent Data: an example where the duty was found to exist
and was breached. 10 year contract to collaborate on electronic training for pilots. Breach of
implied duty by downloading materials for IDCs systems without permission
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