Advisory
Global Sourcing
Global Sourcing
Real Estate
Litigation
September 3, 2008
Court Decision Reinforces the Importance
of Clear Contract Drafting
by Tim Wright and Dominic Hodgkinson
An English Court of Appeal decision has re-affirmed the principle that precontractual negotiations are not admissible in English court proceedings
as evidence to help the court interpret any disputed provision of the contract,
except where the court is being asked to correct a clear mistake (rectification)
or where the parties have used an undefined term in a specific and unusual
way (the private dictionary principle). This principle has cost the claimant,
Persimmon, £3.5 million.
The judgment is a useful reminder for lawyers to ensure that they have fully understood their clients’ intentions and that the drafting reflects those intentions. It should be required reading for any lawyer who has
ever reviewed the defined terms schedule of an agreement.
Background
Chartbrook was the owner of a building site. Persimmon was a construction company. Chartbrook sold
the site to Persimmon for a residential development. Persimmon agreed to pay Chartbrook a base sum
of £4,683,565 and a ‘balancing payment’.
The balancing payment was defined as 23.4% of the net residential sales in excess of the base sum.
Chartbrook’s interpretation of this, which the court agreed was the common-sense interpretation, was that
Persimmon was agreeing to pay Chartbrook a base sum and a percentage of all profits made in excess
of that sum.
Persimmon’s interpretation of this, which the pre-contractual negotiations bore out, was that Persimmon
was agreeing to pay Chartbrook a base sum and an additional sum comprising 23.4% of the net residential
sales minus the base sum.
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To illustrate this in simple mathematical notation where the base sum is £100, the percentage 20% and the
net residential sales £500 (proportionately approximately correct), then:
„
under Chartbrook’s interpretation it was owed £100 + (20% of £400) = £180;
„
under Persimmon’s interpretation Chartbrook was owed £100 + ((20% of £500) - £100) = £100.
This difference added up to a £3.5 million difference in Chartbrook’s favour.
Inadmissibility of Pre-Contractual Negotiations in Contract Interpretation
The principle of contract interpretation is set out in Investors Compensation Scheme Ltd v West Bromwich
Building Society1. When a court is interpreting a disputed provision of a contract it may be necessary to
consult evidence outside the contract in order to establish the background to the disputed provision.
However, pre-contractual negotiations are not admissible as such outside evidence. They are specifically
excluded on the practical policy ground that in trying to establish an objective interpretation of a disputed
provision it is unhelpful to admit subjective evidence regarding what each party thought the disputed provision meant at various stages before the contract was finally signed.
Although the conduct of the pre-contractual negotiations supported Persimmon’s interpretation of how the
balancing payment should be calculated, the ICS principle meant that it could not introduce any of this evidence.
Exceptions to the Principle Excluding Pre-Contractual Negotiations
Rectification
Rectification is an equitable remedy where a court corrects a mistake made in a written contract. The
applicant must show that the provision does not reflect the intentions of the parties but that correcting the
provision will reflect their intentions. In order to demonstrate this, the applicant can rely on pre-contractual
negotiations. The burden of proof is on the applicant.
Application of this principle was possibly the most appropriate resolution of the interpretation issue in this
case. However, although the pre-contractual negotiations supported Persimmon’s interpretation, Chartbrook successfully maintained that it had genuinely misinterpreted Persimmon’s pre-contractual correspondence which discussed payment, and that it sincerely believed that its own interpretation of ‘balancing
payment’ reflected the parties’ intentions at the time of signature. Collins LJ commented that there were
two alternative explanations for this:
The first was that two apparently upright and experienced businessmen made an extraordinary mistake when reading Persimmon's letters of offer in February (and again in May), for reasons which
they cannot now remember, despite their best honest endeavours. The second was that they were
cool risk takers, secretive from their own lawyers, dishonourable to their business counterparties for
their own financial gain, and skilled and sophisticated liars on oath. In short, thoroughgoing rogues.
Briggs J, who heard the case at first instance, decided that Chartbrook’s evidence was realistic and credible. Accordingly, Persimmon was held not to have satisfied the burden of proof and it was not possible to
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apply the principle of rectification to the contract. As the Court of Appeal cannot ordinarily retry evidence,
this finding was upheld.
Private Dictionary Principle
The Private Dictionary Principle says that where a particular phrase does not have a natural and ordinary
meaning and where it is argued that the phrase was used by the parties in a specific way, evidence from
the parties’ pre-contractual negotiations is admissible in order to decide what the phrase does actually
mean.
However, Briggs J held that as ‘balancing payment’ was specifically defined in the contract, this principle
could not apply to such a term. The Court of Appeal agreed with him.
Conclusion
If ever there was a case for clear and precise drafting this is it. The definition in the contract of ‘balancing
payment’ was circular and tortuous. However, the message of the judgment is clear and simple: make
sure that a contract reflects the parties’ intentions and does so in clear, certain and unambiguous language
because if a mistake is made the courts will not necessarily step in to correct a contract just because
a party feels that it has got a ‘bad bargain’.
Collins LJ argued that where the bargain was so bad as to flout business common sense, then a court
could correct the disputed clause. However, Rimer LJ and Tucker LJ were not attracted by this idea, which
would have seen the courts moving toward an equitable principle of ‘contractual fairness’ and away from
the traditional principle of contract law that the courts should uphold a contract and not seek, except
in extraordinary circumstances, to interfere, in a business situation2, in the terms agreed to between the
contracting parties.
Persimmon was therefore stuck with the common-sense interpretation of ‘balancing payment’, resulting
in a loss of £3.5 million. This loss has not come at a good time for Persimmon: in July, it announced that
it had cut 2,000 jobs because of the credit crunch impact on the housing industry, and in August it reported
a 64% decrease in pre-tax profits for the first half of 2008 compared to 2007. Overall then, a lesson not just
for Persimmon but for all business lawyers: make sure the contract is drafted in a clear and unambiguous
manner.
For further information, please contact:
Tim Wright (bio)
London
+44.20.7847.9505
[email protected]
Dominic Hodgkinson (bio)
London
+44.20.7847.9563
[email protected]
J
1
[1998] 1 All ER 98
2
As opposed to Business-to-Consumer contracts where legislation such as the Unfair Contract Terms Act 1977 or the Unfair
Terms in Consumer Contracts Regulations 1999 gives consumers a raft of rights they can enforce even after they have
accepted the contract, and where the courts are not slow to step in and assist consumers enforce those rights.
This publication is issued periodically to keep Pillsbury Winthrop Shaw Pittman LLP clients and other interested parties
informed of current legal developments that may affect or otherwise be of interest to them. The comments contained herein
do not constitute legal opinion and should not be regarded as a substitute for legal advice.
© 2008 Pillsbury Winthrop Shaw Pittman LLP. All Rights Reserved.
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