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DEVELOPMENTS IN THE
INTERPRETATION OF CONTRACTS
James Howlett
1 Oxford Street, Nottingham, NG1 5BH.
Tel +44 (0) 115 941 8851 Fax +44 (0) 115 941 4169
DX 10042 Nottingham
96a New Walk, Leicester, LE1 7EA.
Tel +44 (0) 116 298 7500 Fax +44 (0) 116 298 7501
DX 17003 Leicester 2
[email protected]
www.kchgardensquare.co.uk
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Developments in the
Interpretation of Contracts
This article was going to be titled “Recent Developments in the
Interpretation of Contracts” but it is salutary to remember
that it is now over fifteen years since Lord Hoffman gave his
celebrated speech in Investors Compensation Scheme v West
Bromwich Building Society 1 which has become the starting point
in all analyses of contractual interpretation. As Lord Hoffman
acknowledged, Investors Compensation was not intended to be
revolutionary, but rather to restate principles which had been
established since at least the decision in Prenn v Simmonds 2
Lord Hoffman said:
“I do not think that the fundamental change which has overtaken this branch
of the law, particularly as a result of the speeches of Lord Wilberforce in Prenn
v Simmonds, and Reardon Smith Line Ltd. v Yngvar Hansen-Tangen, is always
sufficiently appreciated. The result has been, subject to one important exception,
to assimilate the way in which such documents are interpreted by judges to the
common sense principles by which any serious utterance would be interpreted in
ordinary life. Almost all the old intellectual baggage of “legal” interpretation has
been discarded. The principles may be summarised as follows:
(1) Interpretation is the 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.
(2) The background was famously referred to by Lord Wilberforce as the “matrix
of fact,” but this phrase is, if anything, an understated description of what the
background may include. Subject to the requirement that it should have been
reasonably available to the parties and to the exception to be mentioned next, it
includes absolutely anything which would have affected the way in which the
language of the document would have been understood by a reasonable man.
2.
1. [1998] 1 WLR 896
2 .[1971] 1 WLR 1381
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(3) The law excludes from the admissible background the previous negotiations of
the parties and their declarations of subjective intent. They are admissible only in
an action for rectification. The law makes this distinction for reasons of practical
policy and, in this respect only, legal interpretation differs from the way we would
interpret utterances in ordinary life. The boundaries of this exception are in some
respects unclear. But this is not the occasion on which to explore them.
(4) The meaning which a document (or any other utterance) would convey to a
reasonable man is not the same thing as the meaning of its words. The meaning
of words is a matter of dictionaries and grammars; the meaning of the document
is what the parties using those words against the relevant background would
reasonably have been understood to mean. The background may not merely
enable the reasonable man to choose between the possible meanings of words
which are ambiguous but even (as occasionally happens in ordinary life) to
conclude that the parties must, for whatever reason, have used the wrong words
or syntax: see Mannai Investments Co. Ltd. v Eagle Star Life Assurance Co. Ltd.
(5) The “rule” that words should be given their “natural and ordinary meaning”
reflects the common sense proposition that we do not easily accept that people
have made linguistic mistakes, particularly in formal documents. On the other
hand, if one would nevertheless conclude from the background that something
must have gone wrong with the language, the law does not require judges to
attribute to the parties an intention which they plainly could not have had. Lord
Diplock made this point more vigorously when he said in Antaios Compania
Naviera S.A. v Salen Rederierna A.B.:
“...if detailed semantic and syntactical analysis of words in a commercial contract
is going to lead to a conclusion that flouts business commonsense, it must be made
to yield to business commonsense.”
3.
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Lord Hoffman was summarising established principles. As Evans LJ observed in a
later case 3 :
“The old intellectual baggage has been discarded but the courts are not travelling
light. The cabin trunks have been replaced by airline suitcases; the contents are
much the same, though they are expressed in more modern language.”
And yet, and yet. In the author’s opinion Lord Hoffman’s formulation has proved
to be revolutionary and its effects are still being seen in the steady stream of
important interpretation cases which have followed Investors’ Compensation. It is
of note that Lord Hoffman has given judgement in many of those cases: his work
has proved to be a decisive influence on the law of contractual interpretation and
in other related fields such as rectification for common mistake.
Background Knowledge
Lord Hoffman’s second principle described the background as comprising
“absolutely anything which would have affected the way in which the language
of the document would have been understood by a reasonable man”. Doubts were
very quickly expressed about the potential width of these words. In National Bank
of Sharjah v Dellborg, 4 Saville LJ questioned the value, or purpose, of introducing
evidence of the surrounding circumstances in cases where the contract is clear,
unambiguous and sensible in its outcome. He also pointed out the danger that the
introduction of background material would create for third party assignees and
others who might be affected by a contract. He powerfully argued that where a
contract is unambiguous and its meaning is not “self-evidently nonsensical” third
parties should be able to take its meaning at face value. Otherwise, their position
might be prejudiced by words which were apparently clear being given a different
construction in the light of surrounding circumstances of which the third
party would probably know nothing. Conversely, in cases where a contractual
obligation or right had passed by assignment, if the contract was construed so as
not to prejudice the assignee by reference to matters of which he knew nothing
and which he could not practically investigate, a position might arise in which a
contract had one meaning between its original parties but a different meaning
4.
3. The BOC Group v Centeon [1999] 1 All ER (Comm) 970
4. Unreported July 9th 1997
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in the hands of assignees: self evidently a recipe for disaster so far as commercial
certainty is concerned. Lord Hoffman was later to acknowledge this risk in
Chartbrook Ltd. v Persimmon Homes Ltd.5 :
“The law sometimes deals with the problem by restricting the admissible
background to that which would be available not merely to the contracting parties
but also to others to whom the document is treated as having been addressed.
Thus in Bratton Seymour Service Co Ltd. v Oxborough, the Court of Appeal decided
that in construing the articles of association of the management company of a
building divided into flats, background facts which would have been known to
all the signatories were inadmissible because the articles should be regarded as
addressed to anyone who read the register of companies, including persons who
would have known nothing of the facts in question. In Homburg Houtimport BV
v Agrosin Private Ltd. (The Starsin) the House of Lords construed words which
identified the carrier on the front of a bill of lading without reference to what
it said on the back, on the ground that the bankers to whom the bill would be
tendered could not be expected to read the small print. Ordinarily, however, a
contract is treated as addressed to the parties alone and an assignee must either
inquire as to any relevant background or take his chance on how that might
affect the meaning a court will give to the document. The law has sometimes to
compromise between protecting the interests of the contracting parties and those
of third parties. But an extension of the admissible background will, at any rate
in theory, increase the risk that a third party will find that the contract does not
mean what he thought. How often this is likely to be a practical problem is hard
to say.”
In BCCI v Ali 6, Lord Hoffman reconsidered his second principle and, ironically,
demonstrated the ambiguity of apparently clear language by pointing out that
when in Investors Compensation he had said “absolutely anything”, he did not by
that mean “absolutely anything”.
5.
5. [2009] 1 AC 1101
6. [2002] 1 AC 251
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He said:
“The background is however very important. I should in passing say that when,
in Investors Compensation Scheme Ltd. v West Bromwich Building Society, I said
that the admissible background included “absolutely anything which would
have affected the way in which the language of the document would have been
understood by a reasonable man”, I did not think it necessary to emphasise that
I meant anything which a reasonable man would have regarded as relevant .
I was merely saying that there is no conceptual limit to what can be regarded
as background. It is not, for example, confined to the factual background but
can include the state of the law (as in cases in which one takes into account that
the parties are unlikely to have intended to agree to something unlawful or
legally ineffective) or proved common assumptions which were in fact quite
mistaken. But the primary source for understanding what the parties meant is
their language interpreted in accordance with conventional usage: “we do not
easily accept that people have made linguistic mistakes, particularly in formal
documents.” I was certainly not encouraging a trawl through “background”
which could not have made a reasonable person think that the parties must
have departed from conventional usage.”
Despite this qualification, judges continued to be concerned about whether
extrinsic evidence of the surrounding circumstances was either relevant or
cogent enough to assist in determining the parties’ intention from the words
which they had used. The sheer volume of material, often of doubtful relevance,
which the courts were asked to consider by way of background also caused
concern: “palpably inadmissible” as Coulson J put it in Persimmon Homes (South
Coast) Limited v Hall Aggregates (South Coast) Limited 7. A particular problem
was the attempt to introduce evidence of pre-contractual negotiations ostensibly
as background material (for which purpose it was admissible) but in reality so
that the court heard evidence of what the parties intended (for which purpose
it was not admissible). The need to ascertain why such evidence was being
adduced and then to make highly artificial distinctions between what was
legitimate background material and what was evidence of the parties’ intention
6.
7. [2008] EWHC 2379
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led some to question whether the exclusionary rule should continue to apply at
all. In a summary judgement application in Proforce Recruitment Limited v The
Rugby Group Limited 8 the Court of Appeal ruled that it was arguable that pre
contractual negotiations were admissible as part of the relevant background to the
interpretation of a contract as well as to prove that the parties had negotiated on
the basis of an agreed meaning of particular words (which had long been said to
be an exception to the general exclusionary rule).
So, the stage was set for a no holds barred challenge to the exclusionary rule. That
challenge came in the case of Chartbrook Limited v Persimmon Homes Limited. The
claimant developers wanted to rely upon pre contractual negotiations by way of
interpretation, in order to support their contention that Persimmon had agreed to
pay “super overage” in a land contract. The House of Lords rejected the invitation.
Lord Hoffman said:
“The conclusion I would reach is that there is no clearly established case for
departing from the exclusionary rule. The rule may well mean, as Lord Nicholls
has argued, that parties are sometimes held bound by a contract in terms which,
upon a full investigation of the course of negotiations, a reasonable observer
would not have taken them to have intended. But a system which sometimes
allows this to happen may be justified in the more general interest of economy and
predictability in obtaining advice and adjudicating disputes. It is, after all, usually
possible to avoid surprises by carefully reading the documents before signing
them and there are the safety nets of rectification and estoppel by convention.
...
The rule excludes evidence of what was said or done during the course of
negotiating the agreement for the purpose of drawing inferences about what the
contract meant. It does not exclude the use of such evidence for other purposes: for
example, to establish that a fact which may be relevant as background was known
to the parties, or to support a claim for rectification or estoppel. These are not
exceptions to the rule. They operate outside it.”
7.
8. [2006] EWCA Civ 69
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Thus, the Court recognised that in some circumstances the exclusionary rule may
result in parties being held to a contract in terms which, after a full examination
of the negotiations, a reasonable observer would not have taken them to have
intended. Nevertheless this is an acceptable price to pay for a system which
protects the wider public interest in economy and predictability in dispute
resolution.
So, post Chartbrook, what are the circumstances in which evidence of pre
contractual negotiations is admissible and what use can be made of such
evidence? The exceptions are:
a) To establish that a fact was known to the parties. In an interesting gloss
on this exception, the Supreme Court in Oceanbulk Shipping and Trading SA v
TMT Asia Limited 9 decided that evidence of the communication of the fact will
still be admissible even if it was made in a without prejudice negotiation. The
circumstances were unusual. A dispute about payments under freight forward
agreements had been settled by a compromise agreement. Subsequently an action
was brought alleging breach of the compromise agreement. Delicately steering
a course through the post Chartbrook distinction between admitting evidence of
pre contractual negotiations for the improper purpose of interpretation and doing
so for the legitimate purpose of establishing that a fact was known to the parties,
Lord Clarke said:
“As Lord Hoffmann himself put it in para 14 of his speech in Chartbrook Ltd. v
Persimmon Homes Ltd., in every case in which the interpretation of the language
used in the contract is in issue, the question is what a reasonable person having
all the background knowledge which would have been available to the parties
would have understood them to be using the language in the contract to mean. In
the Chartbrook case the House of Lords considered and rejected the submission
that what at para 42 Lord Hoffmann called the exclusionary rule, which excludes
evidence of what was said or done in the course of negotiating an agreement for
the purpose of drawing inferences about what the contract means, should now be
abolished. It accordingly remains part of English law. The exclusionary rule does
not exclude such evidence for all purposes. Lord Hoffmann put it thus in para 42:
8.
9. [2011] 1 AC 662
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“It does not exclude the use of such evidence for other purposes: for example, to
establish that a fact which may be relevant was known to the parties, or to support
a claim for rectification or estoppel. These are not exceptions to the rule. They
operate outside it.”
It is not in dispute that, where negotiations which culminate in an agreement are
not without prejudice, the exclusionary rule applies to the correct approach to
the construction of the agreement. Nor is it in dispute that in those circumstances
evidence of the factual matrix is admissible as an aid to interpretation even where
the evidence formed part of the negotiations. The distinction between objective
facts and other statements made in the course of negotiations was clearly stated by
Lord Hoffmann in para 38 of the Chartbrook case:
“Whereas the surrounding circumstances are, by definition, objective facts,
which will usually be uncontroversial, statements in the course of pre-contractual
negotiations will be drenched in subjectivity and may, if oral, be very much in
dispute.”
Trial judges frequently have to distinguish between material which forms part of
the pre-contractual negotiations which is part of the factual matrix and therefore
admissible as an aid to interpretation and material which forms part of the precontractual negotiations but which is not part of the factual matrix and is not
therefore admissible. This is often a straightforward task but sometimes it is
not. In my opinion this problem is not relevant to the question whether, where
the pre-contractual negotiations that form part of the factual matrix are without
prejudice, evidence of those negotiations is admissible as an aid to construction of
the settlement agreement. The two questions are, as I see it, entirely distinct.
In these circumstances, I see no reason why the ordinary principles governing
the interpretation of a settlement agreement should be any different regardless
of whether the negotiations which led to it were without prejudice. The
language should be construed in the same way and the question posed by Lord
Hoffmann should be the same, namely what a reasonable person having all the
background knowledge which would have been available to the parties would
have understood them to be using the language in the contract to mean. That
9.
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background knowledge may well include objective facts communicated by one
party to the other in the course of the negotiations. As I see it, the process of
interpretation should in principle be the same, whether the negotiations were
without prejudice or not. In both cases the evidence is admitted in order to enable
the court to make an objective assessment of the parties' intentions”.
b) In support of a claim for rectification or estoppel by convention. These
applications of course do not represent departures from, or even exceptions to,
the general rule: a party seeking to set up either of these claims is not seeking to
interpret the written contract, but on the contrary to establish that the written
contract does not accurately state the parties’ true bargain;
c) To establish the general object of the contract. The thinking here is that if
the court is made aware of the general object which the parties were trying to
achieve, that knowledge will inform the court’s interpretation of the contract. It
is unclear to what extent this exception has survived the decision in Chartbrook,
and it is suggested by the author that if it still exists at all, it should be used only
with the utmost caution. Flaux J elegantly set out the dangers in Excelsior Group
Productions Limited v Yorkshire Television Ltd. 10 :
“It seems to me that there is a very fine line between looking at the negotiations
to see if the parties have agreed on the general objective of a provision as part of
the task of interpreting the provision and looking at the negotiations to draw an
inference about what the contract meant (which is not permissible), a line so fine it
almost vanishes.”
Wise advocates will be astute to ensure that their opponents do not use this
supposed exception as a stalking horse to introduce evidence of intention by
another route. It is suggested that in most cases the object of the contract will
be ascertainable from verifiable facts known to the parties, rather than from
recollections of what happened in negotiation.
d) In consumer contracts, to establish whether a term was individually negotiated
for the purpose of applying regulation 5 of the Unfair Terms in Consumer
Contracts Regulations 1999 (by which a term which was not individually
10.
10. [2009] EWHC 1751 (Comm)
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negotiated shall be regarded as unfair if it operates to the detriment of the
consumer contrary to the requirement of good faith). This, of course, is not an
exception to the rule, because the question is not one of interpretation, but of
whether a term is enforceable.
e) To decide whether there is a commercial justification for a term which is said
to be a penalty. As in the previous category, the evidence is admitted in relation to
the question of enforceability rather than interpretation.
The death of the private dictionary principle
It used to be thought that another exception to the exclusionary rule was that
evidence of pre contractual negotiations was admissible to establish that the
parties had contracted on the basis of an agreed meaning of words. As noted in
paragraph 6 above, this was one of the grounds on which the Court of Appeal in
Proforce ruled that such evidence was arguably admissible. In Partenreederei M. S.
Karen Oltmann v Sausdale Shipping Co Ltd. 11 Kerr J held that where the words used
are capable of bearing more than one meaning, the court would admit evidence
showing that the parties had negotiated on the basis that one of those meanings
was to be adopted. Thus, the parties could in effect create a private dictionary of
their contractual expressions. In Chartbrook, Lord Hoffman roundly rejected this
notion, saying:
“On its facts, The Karen Oltmann was in my opinion an illegitimate extension of the
“private dictionary” principle which, taken to its logical conclusion, would destroy
the exclusionary rule and any practical advantages which it may have. There are
two legitimate safety devices which will in most cases prevent the exclusionary
rule from causing injustice. But they have to be specifically pleaded and clearly
established. One is rectification. The other is estoppel by convention, which
has been developed since the decision in The Karen Oltmann : see Amalgamated
Investment & Property Co Ltd v Texas Commerce International Bank Ltd. If the
parties have negotiated an agreement upon some common assumption, which
may include an assumption that certain words will bear a certain meaning, they
may be estopped from contending that the words should be given a different
11.
11. [1976] 2 Lloyds Rep 98
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meaning. Both of these remedies lie outside the exclusionary rule, since they
start from the premise that, as a matter of construction, the agreement does not
have the meaning for which the party seeking rectification or raising an estoppel
contends.”
It is submitted that the private dictionary principle in the Karen Oltmann sense has
not survived Chartbrook, a view expressed provisionally by Flaux J in Excelsior:
“In the light of these observations, it must be debatable to what extent the
decisions to which [counsel for Yorkshire television] drew my attention in his
opening submissions, can still be regarded as good law. These were decisions to
the effect that pre-contractual negotiations are admissible to show that the parties
have negotiated on an agreed basis as regards the meaning of certain words in
their contract.”
A party wishing to contend that an agreed meaning was adopted must now rely
upon one or both of Lord Hoffman’s safety nets of rectification and estoppel, and
be willing to plead and prove them. The point was made forcefully in the New
Zealand case of Vector Gas Ltd. v Bay of Plenty Energy Ltd. 12 :
“Although an estoppel will usually arise from the adoption of a special meaning,
it is in cases where words are capable of bearing more than one meaning that
estoppel is likely to have its primary application. A party may be estopped from
denying that one of two possible meanings was the meaning the parties intended
their words to bear. This, or an agreement as to meaning is the best analysis of the
controversial decision in The Karen Oltmann.
...
The Karen Oltmann is sometimes referred to as a special (private dictionary)
meaning case because of Kerr J’s reference to the parties’ “own dictionary
meaning”. But I agree with the House of Lords in Chartbrook that this is not its
true basis. The case was one where the word “after” was, on its face, capable of two
12.
12. [2010] NZSC 5
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meanings. If the parties agreed or represented to each other in the telexes that the
word “after” meant “on the expiry of” and the agreement or representation was
relied on when they entered into the time charter, the parties were each estopped
by that agreement or representation from contending that the word “after” bore
the alternative meaning 13. Indeed, on the basis discussed earlier, they were bound
by any such definitional agreement. Of course, the court must be satisfied that an
agreement or representation as to meaning, reached or made during negotiations,
was still operating at the time the contract was formed and represented a
linguistic premise on which it had been formed. The Karen Oltmann was correctly
decided; but on the basis of agreement or estoppel as to meaning, not on the basis
of special meaning. There was nothing special about the meaning of the word
“after”. It was, however, capable of two meanings. The parties had consensually
resolved which meaning was to apply, or an estoppel had been created, and
evidence to that effect was admissible.”
This decision is cited in the 2012 edition of Chitty on Contracts at 12-121, where
the text nevertheless assumes without discussion that the private dictionary
principle in the sense explained in the Karen Oltmann decision survives. The
author suggests that this is not correct. The Proforce litigation demonstrates why
its demise is not to be lamented. At trial, the judge (Cresswell J), whilst deprecating
in principle the use of the private dictionary exception to circumvent the
exclusionary rule, found that on the facts there was no agreed meaning anyway.
Much time and cost had been spent taking the case to the Court of Appeal in order
to establish that the point was arguable, only for it not to arise on the facts. The
question at what point in litigation objection should be taken to the admissibility
of evidence of pre-contractual negotiations is beyond the scope of this article 14, but
surely Arden LJ was correct to observe in Anglo Continental Educational Group (GB)
Ltd v Capital Homes (Southern) Ltd. 15 that:
“At all events, the court should not allow the focus of a case about interpretation to
be distorted by a detailed enquiry about material that plays a minor role, if any, in
resolving the case.”
13.
14. Enthusiasts of satellite litigation about procedure should read Beazer Homes
Ltd v Stroude [2005] EWCA Civ 265, Standard Life Assurance Ltd v Oak Dedicated
Ltd [2008] 1 CLC 59 and the Anglo Continental decision cited at note 15 below.
15. [2009] EWCA Civ 218.
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Rectification for mtual mistake
Chartbrook, as well as clarifying the application of the exclusionary rule, will have
important implications for the relationship between contractual interpretation
and rectification for mutual mistake. Grasping the concepts with which the
House of Lords was grappling is not for the faint hearted. It will be recalled that
in Chartbrook, the primary question was whether as a matter of construction, the
contract called for “super-overage” to be paid by Persimmon. The court concluded
that, properly construed, the contract did not call for “super-overage”, so it follows
that everything which the case said about rectification is, strictly speaking, obiter.
Nevertheless it is likely to be followed and developed, as is already becoming clear.
The Court of Appeal expressly endorsed the Chartbrook view of rectification in the
Daventry case, discussed later in this article.
Where a contract contains obvious clerical or drafting errors, these may be
corrected by construction without recourse to rectification, provided that
the mistake is obvious and it is clear what was meant. This much has been
uncontroversial since at least the decision in East v Pantiles Plant Hire Limited 16,
which was approved in Chartbrook subject to the qualification that in deciding
whether there is a clear mistake, the court may consider the background and
context and not merely the words used.
However, in Chartbrook the court went much further in considering what the
position would have been if it had been concluded that properly construed the
contract did call for “super-overage”. Lord Hoffman began by adopting the
summary of Peter Gibson LJ in Swainland Builders Ltd. v Freehold Properties
Ltd. 17 that:
“The party seeking rectification must show that:
(1) the parties had a common continuing intention, whether or not amounting to
an agreement, in respect of a particular matter in the instrument to be rectified;
(2) there was an outward expression of accord;
14.
16. [1982] 2 EGLR 111
17. [2002] 2 EGLR 71
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(3) the intention continued at the time of the execution of the instrument
sought to be rectified;
(4) by mistake the instrument did not reflect that common intention.”
Lord Hoffman concentrated on the requirement that the parties had a common
continuing intention. The requirement is not that the parties were subjectively
(ie in fact) in agreement about the disputed term or terms: rather that there must
have been an outward expression of a common intention such that the parties
objectively appeared to be in agreement. In deciding whether there was such
an outward expression, the court applies the same principles as it would to the
construction of any other contract: it does not seek to look inside the parties’
minds. If the final document differs from the parties’ objective intention, then
rectification is available. Thus, on the facts in Chartbrook, Chartbrook had always
intended that super-overage would be payable. A person reading the documents
leading up to the contract would, objectively, have concluded that super-overage
was not to be payable. Therefore, if the contract had, properly construed, called for
it to be payable, rectification would have been available to Persimmon.
This has curious consequences. Chartbrook had throughout intended that
Persimmon should pay super-overage. If the contract had in fact provided for
that to happen, it would have coincided with Chartbrook’s intention. Granting
rectification would thus have held Chartbrook to a contract which it had not
intended to make and about which it had never misled Persimmon. Further, it
seems odd that in cases where the parties were in fact in agreement subjectively,
the objective test might hold them to a contract which neither intended to make.
In cases where there was no subjective agreement, a better test might be to ask
how the party claiming rectification (“B”) understood the other words of the other
party (“A”) at the stage of the prior agreement and whether that understanding
was reasonable. If B understood A’s words in their normal meaning and had no
reason to know that A meant something different, then B should be able to take
those words at face value. On that basis, if the contract in Chartbrook, properly
construed, had called for super-overage, then adopting Lord Hoffman’s approach
15.
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would have entitled party B (Persimmon) to rectification. If, however, Persimmon
had known of Chartbrook’s real intention, it would not have been permitted to
hold Chartbrook to the normal meaning of the prior agreement and if the written
agreement had reflected Chartbrook’s intention, rectification would have been
denied. In that result, Persimmon would have been bound by a contract which
it did not intend to make but on the hypothesis that Persimmon know that
Chartbrook intended super overage to be payable and did not point out that it
disagreed, few would see any injustice in that outcome.
It is overstating matters to suggest that the Chartbrook decision has upset the apple
cart so far as rectification is concerned, but it undoubtedly has raised questions
which future cases will have to resolve, as is demonstrated by the division of
judicial opinion in the Court of appeal arising out of the convoluted facts of
Daventry District Council v Daventry and District Housing Limited 18.
In that case, the local authority was selling its housing stock to the defendant
social landlord. One of the matters for negotiation was which of the two would
bear the deficit of £2.4m in the employees’ pension fund when the employees
were transferred. The local authority suggested that the defendant should do
so, but should pay a reduced price to reflect that obligation. At a meeting of the
defendant’s board, its negotiator said that the proposal meant that the local
authority would bear the deficit and urged the board to accept. In the following
weeks, therefore, each party believed that the other would bear the deficit. The
contract as executed contained a clause requiring the local authority to pay the
amount of the deficit to the defendant. When the local authority realised this, it
claimed rectification of the contract to reflect its prior understanding. At trial it
was common ground that the matter was to be assessed objectively by reference to
what a reasonable observer would have concluded was the parties’ intention. The
trial judge found that when the parties had signed a draft non-binding version of
the contract three weeks after the local authority had made its proposal, there was
proof on an objective view that the defendant was to bear the deficit. However,
five days before completion, when there was an exchange of e mails and telephone
calls, and the new clause was inserted and the local authority’s solicitor approved
16.
18. [2012] 1 WLR 1333
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the clause’s insertion. That being so, the only objective conclusion was that the
local authority would be paying. Therefore the original common intention had not
endured until the contract was made, and rectification was refused.
On appeal, rectification was ordered. The judgements are notable for the
divergence of opinion between the judges about the theory of rectification, in a
process described by Lord Neuberger MR as “a dialogue through the exchange and
consequent refining of successive drafts of our respective judgements”. Etherton
LJ dissented, effectively for the same reasons as the trial judge, saying:
“As the judge forcefully observed, it was Daventry District Council's (“DDC”)
oversight, rather than any equity arising from mutual mistake, which was the
cause of its misfortune. True it may be, as [counsel for DDC] submitted, that there
were objectively good commercial reasons why DDC would never have agreed to
clause 14.10.3. It was sufficient, however, to defeat DDC's claim for rectification for
mutual mistake, that Daventry District Housing (“DDH”) was outwardly clearly
indicating its own interpretation and intention, which were at variance with those
of DDC, but DDC did not challenge the clause, and indeed, expressly assented to it.
Had DDC raised an objection or even an inquiry, the disagreement between the
parties would have become clear, and DDH would not have entered into a contract
on the terms of the earlier non-binding agreement because it did not have the
funding to do so. I cannot see any unconscionability in those circumstances in
holding DDC to the contract, rather than changing its terms so as to give effect
to the uncommunicated subjective intention of DDC to adhere to the original
objective provision for DDH to pay the £2·4m notwithstanding the clear terms of
the draft clause 14.10.3 to the contrary.”
However, Etherton LJ carried out an extensive analysis of the reasoning in
Chartbrook. He said:
“By way of reinforcement of those points, it may be helpful to consider the policy
considerations justifying the intervention of equity by rectification for mutual
mistake of a contract binding on the parties at common law.
17.
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There are primarily four factual situations to consider. The first one is where
the parties subjectively and objectively (that is to say in their communications
passing between them—or “crossing the line”) are in agreement but the formal
documentation as executed fails to give effect to that prior agreement. The
documentation should be rectified to bring it into line (retrospectively) with their
prior accord. Subject to such matters as delay and prejudice to any third party
interests, there is no good reason not to do so.
The second scenario is where the parties never subjectively had the same
intention, but the communications crossing the line show that objectively there
was a common continuing intention at all relevant times prior to the execution
of the final documentation, and the formal documentation reflected those prior
communications. In that situation, whether or not rectified, one or other of the
parties will be bound by a contract which they did not subjectively intend to enter
into. It is right that the claimant should not be entitled to rectification to bring
the documentation into line with a subjective intention and belief that was never
communicated to the defendant and to which the defendant never agreed.
The third scenario is where there was objectively a prior accord, but one of
the parties then subjectively changed their mind, but objectively did not bring
that change of mind to the attention of the other party. It is right that, if the
documentation gives effect to the objective prior accord, the formal documentation
should not be rectified to reflect the changed but uncommunicated subjective
intention; and if the documentation as executed reflects the changed but
uncommunicated subjective intention, it should be rectified to give effect to the
objective prior accord. To do otherwise would be to force on one of the parties a
contract which they never intended to make on the basis of an uncommunicated
intention and belief.
The fourth scenario is where there was objectively a prior accord (whether
or not a subjective common intention), and one of the parties then objectively
changed their mind, that is to say objectively made apparent to the other party
that they intended to enter into the transaction on different terms. Leaving
18.
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aside rectification for unilateral mistake (the requirements for which are quite
different), it is right that, if the documentation as executed gives effect to the
objectively indicated change of mind, a claim for rectification to give effect to
the earlier prior accord should be refused. Once again, to do otherwise would
force on the defendant a contract which they never intended to make on the basis
of the claimant's uncommunicated subjective intention to enter into a contract
on the basis of the original accord notwithstanding the defendant's objectively
communicated change of mind.
That analysis shows why it is good policy to favour objective accord or objective
change of accord over subjective belief and intention in cases of rectification for
mutual mistake.”
On its facts, said Etherton LJ, this was a category four case.
Toulson LJ, whilst applying the Chartbrook reasoning, because it achieved justice
in the circumstances of the case, nevertheless seriously questioned whether it
was correct and whether it would achieve justice in all circumstances, preying
academic criticism in support. He said:
“There has been much recent academic writing about rectification and the rules
of construction. On the issues in the present case I have found particular help
from two articles by Professor David McLauchlan—“The ‘Drastic’ Remedy of
Rectification for Unilateral Mistake” (2008) and “Commonsense Principles of
Interpretation and Rectification?” (2010). In the first article, written after the
decision of the Court of Appeal in the Chartbrook case, Professor McLaughlan
suggested a basis on which the developer's rectification claim should succeed,
but it was different from the basis adopted by the House of Lords. In his second
article, written after the decision of the House of Lords, Professor McLauchlan
commented:
“This ruling [the ruling on rectification] is also likely to prove contentious. It is
important to remember that rectification had been denied in the lower courts
19.
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on the basis of two main findings of fact that the House refused to disturb. First,
Chartbrook's intention was exactly what, we must assume for the purposes of this
issue, the contract provided for. This meant that rectification was not available
on the usual ground of common mistake in recording the terms of the contract.
Secondly, Chartbrook did not know of, and had not in bad faith sought to take
advantage of, Persimmon's mistake. Consequently, the latter could not satisfy what
were thought to be the requirements for ordering rectification where there is
mere unilateral mistake. In view of these undisturbed findings of fact it is difficult
to accept that Chartbrook was mistaken, at least in any usual sense of that word.
The company intended the contract to provide the benefits that (we assume) it
did provide for. The only principled basis for allowing rectification is the one I
suggested earlier in this Review. Chartbrook ought to have been aware from the
offers that preceded the drafting of the written contract that Persimmon did not
intend to offer the pricing formula Chartbrook intended, and, as a result of the
various communications between the parties, including Chartbrook's agreement
in principle to the offers made by Persimmon, the latter were led reasonably to
believe that the price they intended to offer was assented to.”
With the utmost respect, I see much force in this criticism. The factual context
of the decision in the Chartbrook case was that the “syntactical arrangement”
of the words of schedule 6, if literally applied, would produce results which
Lord Hoffmann described at para 20 as “arbitrary and irrational”. Professor
McLauchlan argued that although the judge found that the owner was not
dishonest, and genuinely understood the contract to mean what it claimed, it
should have been aware that the developer did not intend to offer “super overage”
and that through the course of negotiations, the owner was led reasonably to
believe that its version of the price formula was accepted. In support of this
approach Professor McLauchlan cited the classical statement of Blackburn J in
Smith v Hughes on the formation and construction of a contract:
“If, whatever a man's real intention may be, he so conducts himself that a
reasonable man would believe that he was assenting to the terms proposed by
the other party, and that other party upon that belief enters into the contract
20.
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with him, the man thus conducting himself would be equally bound as if he had
intended to agree to the other party's terms.”
Professor McLauchlan argues that the same principle should apply when
considering rectification of a written contract. He is critical of the courts for
having developed the law in a formulaic way instead of concentrating on what he
sees as a broader underlying principle.
Notwithstanding the immense respect due to Lord Hoffmann and other members
of the House of Lords, I have difficulty in accepting it as a general principle that
a mistake by both parties as to whether a written contract conformed with a
prior non-binding agreement, objectively construed, gives rise to a claim for
rectification. Take a simple example. A and B reach what they understand to be an
agreement in principle. They confirm it by an exchange of letters. A believes that
the correspondence means x. B believes that it means y. Neither is aware that the
other's understanding is different and there is no question of either behaving in
such a way as to mislead the other. They then enter into a written contract which
both believe gives effect to the agreement. They are both wrong. Objectively
construed, the non-binding agreement meant x but the written contract means y.
On the Chartbrook principle, A is entitled to have the contract rectified to conform
with the correspondence. I share Professor McLauchlan's difficulty in seeing why
it should be right to hold B to a contract which he never intended to make and
never misled A into believing that he intended to make.
In such a case it is hard to see why the written contract should not prevail.
Rectification complements the rules of construction of contracts and serves a
similar purpose. In general terms, the purpose is that the contract should give
effect to what the parties intended should be the contractual bargain or, in some
cases, what the party claiming rectification was led or encouraged by the other
party to believe was to be the contractual bargain. Rectification in the example
given above would not achieve that purpose. Rather, it would bind a blameless
party to a re-formed contract which he did not intend”.
21.
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Lord Neuberger MR was more circumspect in his consideration, but nevertheless
clearly left the door open for the point to be reconsidered in an appropriate case.
He said:
“These conflicting and complicating factors serve to emphasise the importance of
adhering to the fundamental principles applicable to a rectification claim when
considering the competing arguments in this case. Rectification is an equitable
remedy, which means that its origins lie in conscience and fair dealing, but
those origins cannot be invoked to justify an unprincipled approach: far from
it. Particularly as rectification is normally invoked in a contractual context, it
seems to me that its principles should reflect the approach of the law to contracts,
in particular to the formation and interpretation of contracts. Similarly, as
rectification most commonly arises in a commercial context, it is plainly right that
the applicable principles should be as clear and predictable in their application as
possible.
At any rate in relation to rectification claims based on common mistake, those
principles have been recently analysed in Lord Hoffmann's characteristically
elegant and perceptive speech in Chartbrook Ltd v Persimmon Homes Ltd which
has been discussed and quoted from by both Etherton and Toulson LJJ. As Toulson
LJ points out, this analysis was technically obiter and, as he goes on to explain, the
analysis is not without its difficulties and has not met with universal approval in
learned articles, and may have to be reconsidered or at least refined.
However, like both Toulson and Etherton LJJ, I think that it is right to proceed on
the basis of Lord Hoffmann's analysis on this appeal, even if it could otherwise
be appropriate for this court to depart from that analysis (as to which I express
no view). It would be wrong to depart from the analysis on this appeal for two
reasons. First, any qualification of, or variation to, that analysis which has been
raised in any article to which we have been referred would not affect the outcome
of this appeal; secondly, the appeal was argued, and the case below was argued
and decided, on the basis of Lord Hoffmann's analysis.
22.
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Lord Hoffmann’s analysis, in summary terms, proceeds as follows. When it comes
to deciding whether there is a contractual relationship between two parties,
and, if there is, what the terms of the contract are, such questions are normally
to be assessed by what a hypothetical reasonable objective observer, aware of
all the relevant facts known to both parties, and what has been communicated
between the parties, would have concluded to be their intention. Exceptions to
that general principle exist, such as (i) the exclusion of the antecedent negotiation
when it comes to the interpretation of a written contract, and (ii) the subjective
intention or understanding of the parties, which is inadmissible in relation to
the interpretation of written contracts, although it is admissible when it comes
to oral, or partly oral, contracts. Accordingly, where rectification of the terms of
a contract is sought on the basis of alleged common mistake, while there will be
some exceptions, the general rule is that the court should judge the question by
reference to what a hypothetical reasonable objective observer, aware of all the
relevant facts known to both parties, would conclude.
However, the court will inevitably not adopt precisely the same approach to
a rectification claim as it adopts to an interpretation issue. Three differences
are relevant for present purposes. First, in a rectification claim the antecedent
negotiations are admissible: indeed they are normally of central relevance.
Secondly, even in relation to written contracts, some subjective evidence of
intention or understanding is not merely admissible, but is normally required in a
rectification claim: the party seeking rectification must show that he indeed made
the relevant mistake when he entered into the contract. Thirdly, as Etherton LJ
points out above, rectification is an equitable remedy and therefore is subject to
somewhat different rules from interpretation”.
Lord Neuberger MR, like Toulson LJ, considered that the case fell in to category
three of Etherton LJ’s analysis rather than category four. However, he considered
that their disagreement in the result reflected a different view of the application
of the laws to the unusual facts, rather than any disagreement of legal principle.
Nevertheless, the author suggests that Lord Hoffman’s meticulous examination of
the theoretical basis of rectification for common mistake has uncovered areas in
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which slavish adherence to the concept of the outward expression of prior accord
might lead to injustice: equitable retains its flexibility and further refinement is to
be expected.
Commercial Common Sense and the limits of Construction
Lord Diplock’s characteristically incisive observation in The Antaios that:
“If detailed and syntactical analysis of words in a commercial contract is going to
lead to a conclusion that flouts business common sense it must yield to business
common sense.”
Continues to be cited in almost all cases in which one construction of the
contract is said to lead to an absurd or at least commercially unlikely outcome.
This question arose in Rainy Sky SA v Kookmin Bank 19. The case concerned
performance bonds issued by a bank in relation to ship building contracts. The
buyers claimed to be entitled to call upon the bonds in the event of the ship
builder’s insolvency. The bank contended that the bonds, properly construed, did
not extend to that eventuality. Both constructions were arguable and neither could
be said to lead to a result which was commercially absurd. The Supreme Court
confirmed that where the parties had used unambiguous language, the court had
to apply it. However, where the language was ambiguous, the court could prefer
the construction which was consistent with business common sense in the light of
the surrounding circumstances. In order to do so it was not necessary to conclude
that one construction led to an absurd or irrational result before looking to the
commercial purpose of the agreement. The matter was summarised by Lord
Clarke thus:
“The language used by the parties will often have more than one potential
meaning. I would accept the submission made on behalf of the appellants that
the exercise of construction is essentially one unitary exercise in which the court
must consider the language used and ascertain what a reasonable person, that is
a person who has 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
24.
19. [2011] 1 WLR 2900
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contract, would have understood the parties to have meant. In doing so, the court
must have regard to all the relevant surrounding circumstances. If there are two
possible constructions, the court is entitled to prefer the construction which is
consistent with business common sense and to reject the other.”
The Supreme Court drew significant support from the Court of Appeal decision
in Co-operative Wholesale Society Ltd v National Westminster Bank plc 20 as an
illustration of the imperative to apply unambiguous language where it appears,
but to have regard to business common sense in cases of ambiguity. In the
Co-operative case, a series of rent review clauses was in dispute. The landlord
contended that the clauses deemed the market rent to be the headline rent
obtainable after a hypothetical rent free period, even though such rent free
periods were, in the prevailing market conditions, granted to disguise the fall in
the rental value of the property 21. This was regarded by the Court of Appeal as a
most improbable commercial result. Nevertheless, where the words of the review
clause admitted of no other construction, the landlords succeeded. Where there
was ambiguity, the court was able to reach a result which accorded with business
common sense. In Rainy Sky the Co-operative decision was helpfully summarised
and approved:
“Where the parties have used unambiguous language, the court must apply
it. This can be seen from the decision of the Court of Appeal in Co-operative
Wholesale Society Ltd v National Westminster Bank plc. The court was considering
the true construction of rent review clauses in a number of different cases. The
underlying result which the landlords sought in each case was the same. The court
regarded it as a most improbable commercial result. Where the result, though
improbable, flowed from the unambiguous language of the clause, the landlords
succeeded, whereas where it did not, they failed. The court held that ordinary
principles of construction applied to rent review clauses and applied the principles
in Antaios Cia Naviera SA v Salen Rederierna AB (The Antaios).
25.
20. [1995] 1 EGLR 97
21. This may seem peculiar. What was happening in the London office market at the time is explained in the
opening paragraphs of the judgement. Rather than accepting a reduction in the asking rent, landlords operating
in a tenants’ market would offer long rent free periods at the beginning of the term, unrelated to any requirement
for fitting out etc. The question in the case was how to construe clauses by which such rent free periods were to
be disregarded in fixing the reviewed rent of a sitting tenant. Applying a literal construction would result in the
tenant post review paying more over the reviewed period than the property would command in the real market.
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After quoting the passage from the speech of Lord Diplock cited above,
Hoffmann LJ said:
“This robust declaration does not, however, mean that one can rewrite the
language which the parties have used in order to make the contract conform to
business common sense. But language is a very flexible instrument and, if it is
capable of more than one construction, one chooses that which seems most likely
to give effect to the commercial purpose of the agreement.”
The court also comprised Leggatt and Simon Brown LJJ. Simon Brown LJ said
that, having regard to the improbable result for which the landlords contended,
only the most unambiguous of such clauses could properly be found to bear
the landlords' construction and that in the case of only one of the leases did the
clause “unambiguously ...achieve the improbable result for which the landlords
contend”. The case is of interest because Simon Brown LJ considered that, of the
other three cases, one unambiguously failed to achieve the result sought by the
landlords, whereas, of the other two, he said this:
“For my part, I would accept that the more obvious reading of both favours the
landlord's construction. I am persuaded, however, that they are capable of being,
and therefore, for the reasons already given, should be, construed differently.”
Implied Terms
It is probably unnecessary to review the decision of Attorney General of Belize
v Belize Telecom 22 in any detail. It has become the standard authority on implied
terms. There was perhaps a certain inevitability that it was Lord Hoffman who
summarised the law relating to implied terms, reformulating what historically
have been regarded as tests more as guidelines or expressions of the idea that the
proposed implied term must spell out what the contract actually means. He said:
“It follows that in every case in which it is said that some provision ought to be
implied in an instrument, the question for the court is whether such a provision
would spell out in express words what the instrument, read against the relevant
22. [2009] 1 WLR 1988
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background, would reasonably be understood to mean. It will be noticed ...that
this question can be reformulated in various ways which a court may find helpful
in providing an answer—the implied term must “go without saying”, it must be
“necessary to give business efficacy to the contract” and so on—but these are not
in the Board's opinion to be treated as different or additional tests. There is only
one question: is that what the instrument, read as a whole against the relevant
background, would reasonably be understood to mean?
There are dangers in treating these alternative formulations of the question as if
they had a life of their own. Take, for example, the question of whether the implied
term is “necessary to give business efficacy” to the contract. That formulation
serves to underline two important points. The first, conveyed by the use of the
word “business”, is that in considering what the instrument would have meant
to a reasonable person who had knowledge of the relevant background, one
assumes the notional reader will take into account the practical consequences
of deciding that it means one thing or the other. In the case of an instrument
such as a commercial contract, he will consider whether a different construction
would frustrate the apparent business purpose of the parties. That was the basis
upon which Equitable Life Assurance Society v Hyman was decided. The second,
conveyed by the use of the word “necessary”, is that it is not enough for a court
to consider that the implied term expresses what it would have been reasonable
for the parties to agree to. It must be satisfied that it is what the contract actually
means.
The danger lies, however, in detaching the phrase “necessary to give business
efficacy” from the basic process of construction of the instrument. It is frequently
the case that a contract may work perfectly well in the sense that both parties can
perform their express obligations, but the consequences would contradict what a
reasonable person would understand the contract to mean. Lord Steyn made this
point in the Equitable Life case, when he said that in that case an implication was
necessary “to give effect to the reasonable expectations of the parties”.
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The same point had been made many years earlier by Bowen LJ in his well known
formulation in The Moorcock:
“In business transactions such as this, what the law desires to effect by the
implication is to give such business efficacy to the transaction as must have been
intended at all events by both parties who are business men... ”
Likewise, the requirement that the implied term must “go without saying” is no
more than another way of saying that, although the instrument does not expressly
say so, that is what a reasonable person would understand it to mean. Any attempt
to make more of this requirement runs the risk of diverting attention from the
objectivity which informs the whole process of construction into speculation about
what the actual parties to the contract or authors (or supposed authors) of the
instrument would have thought about the proposed implication. The imaginary
conversation with an officious bystander in Shirlaw v Southern Foundries (1926)
Ltd is celebrated throughout the common law world. Like the phrase “necessary to
give business efficacy”, it vividly emphasises the need for the court to be satisfied
that the proposed implication spells out what the contact would reasonably be
understood to mean. But it carries the danger of barren argument over how
the actual parties would have reacted to the proposed amendment. That, in the
Board's opinion, is irrelevant. Likewise, it is not necessary that the need for the
implied term should be obvious in the sense of being immediately apparent, even
upon a superficial consideration of the terms of the contract and the relevant
background. The need for an implied term not infrequently arises when the
draftsman of a complicated instrument has omitted to make express provision
for some event because he has not fully thought through the contingencies which
might arise, even though it is obvious after a careful consideration of the express
terms and the background that only one answer would be consistent with the rest
of the instrument. In such circumstances, the fact that the actual parties might
have said to the officious bystander “Could you please explain that again?” does
not matter.
28.
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In BP Refinery (Westernport) Pty Ltd v Shire of Hastings Lord Simon of Glaisdale,
giving the advice of the majority of the Board, said that it was “[not] necessary to
review exhaustively the authorities on the implication of a term in a contract” but
that the following conditions (“which may overlap”) must be satisfied:
“(1) it must be reasonable and equitable; (2) it must be necessary to give business
efficacy to the contract, so that no term will be implied if the contract is effective
without it; (3) it must be so obvious that ‘it goes without saying’ (4) it must be
capable of clear expression; (5) it must not contradict any express term of the
contract.”
The Board considers that this list is best regarded, not as series of independent
tests which must each be surmounted, but rather as a collection of different ways
in which judges have tried to express the central idea that the proposed implied
term must spell out what the contract actually means, or in which they have
explained why they did not think that it did so. The Board has already discussed
the significance of “necessary to give business efficacy” and “goes without saying”.
As for the other formulations, the fact that the proposed implied term would be
inequitable or unreasonable, or contradict what the parties have expressly said, or
is incapable of clear expression, are all good reasons for saying that a reasonable
man would not have understood that to be what the instrument meant”.
It follows from this that it is not the function of the court to improve upon the
parties’ contract, still less to write the contract which it thinks that they should
have made. Lord Hoffman again:
“Before discussing in greater detail the reasoning of the Court of Appeal, the Board
will make some general observations about the process of implication. The court
has no power to improve upon the instrument which it is called upon to construe,
whether it be a contract, a statute or articles of association. It cannot introduce
terms to make it fairer or more reasonable. It is concerned only to discover what
the instrument means. However, that meaning is not necessarily or always what
the authors or parties to the document would have intended. It is the meaning
29.
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which the instrument would convey to a reasonable person having all the
background knowledge which would reasonably be available to the audience to
whom the instrument is addressed: see Investors Compensation Scheme Ltd v West
Bromwich Building Society. It is this objective meaning which is conventionally
called the intention of the parties, or the intention of Parliament, or the intention
of whatever person or body was or is deemed to have been the author of the
instrument.
The 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. Otherwise, the express provisions of
the instrument are to continue to operate undisturbed. If the event has caused loss
to one or other of the parties, the loss lies where it falls.
In some cases, however, the reasonable addressee would understand the
instrument to mean something else. He would consider that the only meaning
consistent with the other provisions of the instrument, read against the relevant
background, is that something is to happen. The event in question is to affect the
rights of the parties. The instrument may not have expressly said so, but this is
what it must mean. In such a case, it is said that the court implies a term as to what
will happen if the event in question occurs. But the implication of the term is not
an addition to the instrument. It only spells out what the instrument means”.
It is fair to say that the Belize decision has excited widespread interest, perhaps
because it is seen as liberating the implication of terms from the straightjacket of
strict tests. It is also, open to the abuse of using the test of what the contract must
mean to circumvent the requirement of necessity. It is perhaps because of this
that in the author’s opinion, it is possible to detect some rowing back from the
guideline approach of Belize and a renewed emphasis on not retrospectively rewriting the parties’ contract for them.
30.
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In Mediterranean Salvage and Towage Limited v Seamar Trading and Commerce
Inc 23 the Court of Appeal emphasised that the test for the implication of a term
remains one of necessity:
“Moreover, as I read Lord Hoffmann’s analysis, although he is emphasising that
the process of implication is part of the process of construction of the contract,
he is not in any way resiling from the often stated proposition that it must be
necessary to imply the proposed term. It is never sufficient that it should be
reasonable. This point is clear, for example, from the well-known speech of
Lord Wilberforce in Liverpool City Council v Irwin where he rejected the approach
of Lord Denning, which was to permit the implication of reasonable terms. He
identified two classes of implied term in the case (as here) of a complete, bilateral
contract. He said that in a case of established usage the courts are spelling out
what both parties know and would, if asked, unhesitatingly agree to be part of the
bargain. That is not, in my opinion, this case. Lord Wilberforce added:
‘In other cases, where there is an apparently complete bargain, the courts are
willing to add a term on the ground that without it, the contract will not work–this
is the case, if not of The Moorcock ...itself on its facts, at least of the doctrine of The
Moorcock as usually applied.’
Lord Wilberforce stressed that the test is one of necessity. Is it necessary to make
the contract work?”
The court in Mediterranean Salvage drew support from an earlier, but previously
little noticed, formulation of the same principle in the judgement of the Court of
appeal given by Sir Thomas Bingham MR in Philips Electronique Grand Public SA v
British Sky Broadcasting Ltd 24:
“The courts’ usual role in contractual interpretation is, by resolving ambiguities
or reconciling apparent inconsistencies, to attribute the true meaning to the
language in which the parties themselves have expressed their contract. The
implication of contract terms involves a different and altogether more ambitious
23. [2009] EWCA Civ 531
24. [1995] EMLR 472
31.
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undertaking: the interpolation of terms to deal with matters for which, ex
hypothesi, the parties themselves have made no provision. It is because the
implication of terms is so potentially intrusive that the law imposes strict
constraints on the exercise of this extraordinary power.
There are of course contracts into which terms are routinely and unquestioningly
implied. If a surgeon undertakes to operate on a patient a term will be implied
into the contract that he exercise reasonable care and skill in doing so. It is
inconceivable that any patient would in any imaginable circumstance commit his
bodily well-being to the ministrations of a surgeon who did not undertake that
obligation, or that a surgeon could hope to remain in practice without professing
to discharge it. Again, quite apart from statute, the courts would not ordinarily
hesitate to imply into a contract for the sale of unseen goods that they should be of
merchantable quality and answer to their description and conform with sample.
It is hard to imagine trade conducted, in the absence of express agreement, on any
other terms.
But the difficulties increase the further one moves away from these paradigm
examples. In the first case, it is probably unlikely that any terms will have been
expressly agreed, except perhaps the nature of the operation, the fee, and the time
and the place of operation. In the second case, the need for implication usually
arises where the contract terms have not been spelled out in detail or by reference
to written conditions. It is much more difficult to infer with confidence what the
parties must have intended when they have entered into a lengthy and carefullydrafted contract but have omitted to make provision for the matter in issue.
Given the rules which restrict evidence of the parties' intention when negotiating
a contract, it may well be doubtful whether the omission was the result of the
parties' oversight or of their deliberate decision; if the parties appreciate that they
are unlikely to agree on what is to happen in a certain not impossible eventuality,
they may well choose to leave the matter uncovered in their contract in the hope
that the eventuality will not occur.
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Developments in the
Interpretation of Contracts
The question of whether a term should be implied, and if so what, almost
inevitably arises after a crisis has been reached in the performance of the
contract. So the court comes to the task of implication with the benefit of
hindsight, and it is tempting for the court then to fashion a term which will reflect
the merits of the situation as they then appear. Tempting, but wrong”.
The author suggests that those words: “Tempting, but wrong”, should be foremost
in the mind of any judge or advocate confronted by the alluring prospect of
implying a term to remedy a perceived defect in a contract after a crisis has arisen.
The question is what the contract must mean: not what it would be convenient for
it to mean after the event. If, properly applying the requirement of necessity, a
term cannot be implied, the loss must lie where it falls.
An illustration
In the context of real property litigation an interesting illustration of some of
the principles which are discussed in this article was the Court of Appeal case of
Fitzhugh v Fitzhugh 25 in which the author appeared for the successful appellant.
The case concerned a licence to occupy land. The licensor was defined as two
named individuals. The licensee was one of those individuals and another person:
so one of the individuals was both a licensor and a licensee. The licence provided
that if the licensee was in serious breach of the licence then the licensor could
serve a notice and was required to do so if the licensor wished to terminate the
licence. The question was whether a valid notice could be served by one only of the
licensors: his co licensor (who in his capacity of licensee was allegedly in breach)
would not of course co-operate in the exercise. It was argued for the claimant
licensor that the termination clause could be construed so that the word “licensor”
meant either of them or, alternatively, that a term should be implied to the
effect that one only of the licensors could serve a breach notice. Both arguments
failed. As to the first, following Rainy Sky, the court concluded that there was no
ambiguity such as would entitle the court to have regard to business common
sense.
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25. [2012] EWCA Civ 694, [2012] 2 P & CR 14
clear | compelling | approachable
Developments in the
Interpretation of Contracts
“[Counsel for the respondent] felt compelled to accept that “the Licensor” in [the
definitions clause] of the licence necessarily included Anthony but maintained
that it did not do so in [the termination clause]. In his submission this was a case
where the meaning of “the Licensor” in [the termination clause] had two possible
constructions, it was therefore ambiguous, and accordingly the judge was right to
prefer the construction that was consistent with business common sense and to
reject the other. By way of support for that approach, Mr Clarke referred us to the
decision of the Supreme Court in Rainy Sky SA v Kookmin Bank per Lord Clarke
of Stone-cum-Ebony. [Counsel for the appellant’s] response to that in his reply was
that there was no such ambiguity as Mr Clarke suggested.
I prefer and accept [counsel for the appellant’s] submissions. Anthony is expressly
described as one of the individuals making up “the Licensor” in the opening
words of the licence. The phrase “the Licensor” in [the definitions clause] plainly
includes him. So must it in [the termination clause]”.
As to the second argument, since even if no term was implied the contract was still
workable (though clumsy), the test of necessity was not satisfied and so no term
was implied:
“The reasonable man would therefore be likely to conclude that although an
interpretation of “the Licensor” in [the termination clause] as including any
licensor who was also a licensee might perhaps give rise to practical difficulties,
and perhaps unwanted expense, in the future, there was no basis for a conclusion
that it would render the machinery of [the termination clause] unworkable. He
might well consider that [the termination clause] could instead have been drafted
in a way that would avoid any such difficulties arising in the future—for example,
by providing for the relevant notice to be given by “the Licensors other than any
who is for the time being a Licensee”. But even if he were to be of that view, it is
no part of the function of a court of construction to improve the document it is
called upon to construe, nor does it have any power to do so (see again the Belize
Telecom case at [16], per Lord Hoffmann). Moreover, as [the termination clause]
remains workable even if its working out may, in the event of obstruction from
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Developments in the
Interpretation of Contracts
Anthony, prove cumbersome or expensive, there is no necessity to imply the sort
of term that the judge was prepared to imply. There was therefore no justification
for implying it”.
Conclusion
There, for the time being, matters rest. We can be confident that they will not do so
for long. The inherent ambiguity of language and the desire of parties to avoid the
consequences of their bargains when the unforeseen happens (or, less honourably,
to wriggle out of what they know they had agreed) mean that legal ingenuity
will always be brought to bear to try to find another construction. Lord Hoffman
has, with elegant and lucid prose, reinforced the intellectual rigour which judges
from Lord Diplock onwards have brought to bear on the question of contractual
interpretation. The continuance of that process is essential to the development
of a coherent, fair and predictable jurisprudence which regulates how citizens
deal with their commercial and property affairs. We look forward to 2013 with
interest.
James Howlett
35.