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Contractual interpretation: Through the looking glass... once again?

20 April 2017


In this article, which first appeared in Commercial Litigation Journal under the title "Contract: Nohow or contrariwise", Paul Brehony and William Gow of Stewarts Law consider the pendulum of case law in contractual interpretation.

The five principles of contractual interpretation


In Investors Compensation Scheme v West Bromwich Building Society [1998] AC 896, Lord Justice Leggatt cited Alice Through the Looking Glass when rejecting the interpretation adopted by the first instance court. He said that its interpretation was "not an available meaning of the words" and was "unimpressed by the alleged commercial nonsense of the alternative construction".

Lord Hoffman took a different view in the House of Lords. "I will say at once that I prefer the approach of the learned judge," he said, in support of the first instance analysis. He asserted that "almost all the old intellectual baggage of 'legal' interpretation has been discarded" and set out the following five principles of contractual interpretation:

  • The intention of the parties is an objective question of what a 'reasonable person' would understand the contract to mean.

  • The 'matrix of fact' allows for intention within context; what is reasonably available to the parties and affects the reasonable understanding of the language.

  • Previous negotiations of the parties and declarations of subjective intent are excluded.

  • Words in a contract do not need to be taken literally, as what is meant by the document is the parties' intention.

  • Where the 'natural and ordinary meaning' does not reflect the parties' intentions then something must have gone wrong in the language and the law is not required to attribute an intention which the parties' did not have.

There have been a number of recent decisions in which this apparent orthodoxy has shifted to some extent. To continue Lord Justice Leggatt's metaphor, the Court has asked itself "Mirror, mirror on the wall, what is the fairest interpretation of them all?"

Natural and ordinary meaning

 
In Arnold v Britton [2015] UKSC, Lord Neuberger warned: "The clearer the natural meaning, the more difficult it is to justify departing from it." An emphasis on literal interpretation emerged using natural and ordinary meaning, irrespective of commercial common sense and justified on the grounds that these are the terms the parties intended to include. The more unclear the provision is, the greater the scope for ambiguity so very clear language is imperative.

In Idemitsu Kosan Co Limited v Sumitomo Corporation [2016], the court decided that in the absence of clear drafting it would not import the intention of the parties as the agreement should have been drafted to make such intention clear on a natural and ordinary reading. Parties should draft express provisions to clarify intention and not rely on pre-contractual representations or negotiations. It would be artificial and wrong to read a part of the agreement in isolation of its function when ascertaining intention (following Sycamore Bidco Ltd v Breslin [2012]).

Perceived commercial intention

 
Despite Arnold v Britton, there has been a move from literal to perceived commercial intention. Nobahar-Cookson v The Hut Group Ltd [2016] applied the narrowest possible interpretation to resolve ambiguity because the term (an exclusion clause for warranty claims) involved important contractual obligations that should not be withdrawn from lightly. Lord Justice Briggs noted the court's regard for "commercial common sense" based on the functionality of the clause and purposive construction.

Where the contractual words are ambiguous, it will be construed against the party seeking to rely on them (contra proferentem rule). This would only apply if linguistic, contextual and purposive analysis did not adequately resolve the ambiguity.

Commercial common sense

 
Where there is ambiguity, a clause should be construed in a way that is commercially sensible over what would be an absurdity (Rush Hair Ltd v Gibson-Forbes [2016], following Prophet Plc v Huggett [2014]). All the circumstances of the transaction or business should be considered. It is necessary to ascertain the meaning conveyed to a reasonable person having all the background knowledge reasonably available at the time of the contract. This covers what the parties contemplated at the time of the contract, recognising that parties understand that commercial situations change (Karen Denise Millen v Karen Millen Fashions Limited and Mosaic Fashions [2016]).

What the parties knew or should have known is considered, as it would be artificial to only rely on the current state of business when entering into a contract. Clauses should be examined in context to identify intentions. The court recognised that a clause does not necessarily have the same effect in every context and the law may account for different commercial contexts when ambiguities arise.

Context

 
The term "close of business" in Lehman Brothers International (Europe) (in admin.) v ExxonMobil Financial Services BV [2016] was not defined in the agreement, yet it is a common expression in business. One party argued that it meant 5pm and the other that it was the typical 7pm closing time for commercial banks. The court appreciated that commercial sense is context specific. It found that the term "close of business" may be used in many different contexts, but in this instance the relevant context was an agreement between an international investment bank and a large corporation. A "reasonable person" would not consider 5pm as the end of a working day, especially when the business did not actually close at 5pm. The agreement could have included an express provision defining a cut-off time, but instead it used the vague term "close of business". This was interpreted as having been intended by the parties to create flexibility and prevent arguments based on precise time, which would not make commercial sense. If there is a requirement for certainty this should be specified in the contract, even if it is in relation to a commonly used expression.

Linguistic consistency versus substantive inconsistency

 
Courts may imply terms into a contract to fill a gap in the drafting, giving effect to what the parties' intended. The Court of Appeal in Irish Bank Resolution Corp Ltd (In Special Liquidation) v Camden Market Holdings Corp [2017] highlighted that when considering an implied term it is first necessary to look at the express terms.

Lord Justice Beatson cited Lord Neuberger's statement in Marks & Spencer plc v BNP Paribas Securities Services Trust Company (Jersey) Ltd [2015] that it is a "cardinal rule" that an implied term must not contradict an express term. It is an objective test based on what a reasonable person would view as the parties' intentions underpinned by the background knowledge reasonably available at the time of the contract.

Lord Hoffmann in Attorney General of Belize and others v Belize Telecom Ltd [2009] stated that the rules on implied terms had been relaxed. The Supreme Court in Marks & Spencer plc v BNP Paribas Securities [2015] held that Belize is no longer authoritative and that the approach established prior to Belize should be applied. The agreements did not contain express wording to exclude or delimit the implied terms, but the express provisions were still the starting point for interpretation.

In Irish Bank, the court differentiated between two ways in which an implied term may be inconsistent with an express term. The first is through direct linguistic inconsistency. There was no linguistic inconsistency between the express term (that the bank could market the loan by disclosing information to potential purchasers) and the implied term (that there should be no marketing of the loan by the bank in competition with Camden's marketing of the property). There were scenarios where the bank could market the loan without being in competition and the information could be disclosed without prejudicing Camden.

The second is through substantive inconsistency: where the implied term is substantively inconsistent with the express wording. The implied term would amount to a significant restriction on the bank's power to deal with the loan and to its entitlement to disclose information to prospective assignees/transferees. An express and unrestricted power cannot be restricted by an implied qualification (following Reda v Flag Ltd [2002]). Lord Justice Beatson accepted that where there is substantive inconsistency an express term may be supplemented with an implied term for the purpose of clarification.

However, where a contract is lengthy and carefully drafted but is silent on a particular issue it is difficult to infer with confidence what the parties intended (Philips Electronique Grand Public SA v British Sky Broadcasting Ltd [1995]). If the agreement works without the implied term, this indicates that it would be a significant impediment to imply a term that already deals with the subject matter expressly. Whilst an implied term may be linguistically consistent with an express term, it may nonetheless be substantively inconsistent.

Where does this leave us?

 
Judgments on contractual interpretation presently offer little certainty for litigants, which is immensely undesirable. It did seem with Arnold v Britton that we were seeing a revival of literal interpretation, but the tables turned once again with purposive interpretation gaining momentum.

Nobahar-Cookson highlighted a layered approach: a purposive view from the outset followed by a narrow literal reading within that context.

Irish Bank distinguishes linguistic consistency from substantive consistency when exploring the relationship between implied and express terms.

These two cases touch upon how natural and ordinary meaning could factor in commercial common sense, which in time may offer a way forward beyond the Looking Glass. We shall see.

One thing that is certain is that a new consensus on interpretive methodology needs to emerge.

 


Paul BrehonyPaul Brehony is a Partner in our Commercial Litigation team. Paul specialises in complex international and domestic commercial litigation, arbitration and alternative dispute resolution often in a multi-jurisdictional context. Paul advises corporates and individuals from a wide range of industry sectors, with a particular emphasis on fraud and professional negligence.

He was formerly leader of the UK Commercial Litigation team at PwC Legal and his experience includes five years within SJ Berwin's Dispute Resolution Department and over five years in the Commercial Litigation Department at Simmons & Simmons.

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