Contract preparation is key!

Contract preparation is key!

30 January, 2019 by Gilson Gray in Blog

Disputes are an unfortunate reality of life.  Businesses often try to avoid them by agreeing long and detailed contractual terms at the start of their relationship.  But here’s the rub – sometimes those very terms become the source of a dispute.  This blog looks at what happens when the parties to a written contract cannot agree the meaning of a written term.

Extra-judicial settlement

Usually parties will instruct lawyers to advise them on what a particular term in a contract means.  Good legal advice taken early can lead to speedy resolution or at least limit the extent (and therefore cost) of a dispute by giving a client realistic expectations of how a contract might be interpreted by the courts.  Equally they can provide alternative interpretations of a term which the client might not have been aware of.  In other words they can arm a client for a dispute and prevent them incurring unnecessary costs where an argument is not as strong as they hoped.

Negotiation between parties, often through lawyers, frequently results in a compromise resolution where the outcome will usually reflect the strength of parties’ arguments.

Litigation

Sometimes, however, even the best legal advice won’t resolve a dispute through negotiation.  There can be many reasons for this including an intransigent opponent or, more commonly, both parties being convinced of the arguments in their favour.  More often than not, it then falls to the court to decide what the disputed term means.

How does the Judge approach that job?

Essentially the judge takes into account the ordinary meaning of the words actually used in the contract, the commercial context of the agreement and the commercial sense of the competing interpretations and will carry out a balancing act to come to his or her view of the correct meaning.

Textualism v Contextualism in contractual interpretation 

There have been some key decisions in the UK courts over the last few years dealing with contractual interpretation and the balance to be struck between textualism (interpreting the clause based on the natural/ordinary meaning of the particular language used) v contextualism (interpretation taking into account the commercial context in which the clause was drafted).

In particular Rainy Sky SA v Kookmin Bank [2011] UKSC 50, Arnold v Britton [2015] UKSC 36 and Wood v Capita Insurance Services Ltd [2017] UKSC 24

Rainy Sky SA v Kookmin Bank [2011] UKSC 50

A shipbuilder company entered into a contract with Rainy Sky SA to build a ship. The price was $33,300,000 payable in 5 equal instalments. The ship builder provided Rainy Sky SA with a guarantee from Kookmin Bank so that the bank would guarantee repayment of any instalments that had already been paid upon the happening of certain events. The dispute centred on the wording of the guarantee and whether the bank was required to make payment to Rainy Sky SA in the event of the ship builder’s insolvency as well as in the event of rejection of the ship. Rainy Sky SA argued that it did and raised the action against Kookin Bank when the shipbuilder experienced financial difficulties. The bank’s argument was that repayment was only required if the contract was terminated or if there was a total loss of the ship and not in the event of insolvency.

The Supreme Court held that the ultimate aim of interpretation is to determine what the parties meant by the language they used and that this involves ascertaining what a reasonable person would have understood the parties to have meant. If there are two possible constructions, the court is entitled to prefer the construction which is more consistent with business common sense. The court held that the bank’s construction would have the “surprising and uncommercial” result in that it would not be available to meet the builder’s repayment obligation in the event of the ship builder’s insolvency and found in favour of Rainy Sky SA.

Arnold v Britton [2015] UKSC 36

Arnold v Britton concerned the interpretation of a service charge provision in a contract governing the long leases of holiday chalets in Wales. As a result of the landlord’s interpretation of the provision the service charges had risen from £282 to over £2700.  The landlord argued that the provision allowed them to render a charge for a specified sum (increasing every 3 years) while the tenants argued that the landlord’s interpretation produced such an absurdly high charge that it could not be correct and that the specified sum was a cap only with a variable sum being payable based on a fair proportion of the actual expenditure. The tenant was initially successful in the county court but lost every appeal thereafter. In the Supreme Court Lord Neuberger seems to move away from the commercial, purposive approach in Rainy Sky to a more literal approach to interpretation essentially saying that courts should not invoke the idea of “commercial common sense” to deter from the wording actually used by the parties themselves and that courts should not re write contracts so that they have a more commercial outcome (from the court’s point of view). He further opined that the court should not search for “drafting infelicities” to depart from the natural meaning of the words and that commercial common sense should not be applied retrospectively, i.e. just because a bargain has ended up working out badly for one of the parties this is not a reason for departing from the natural language used. The court held that the purpose of interpretation is to identify what the parties agreed not what the court thinks they should have agreed and it is not the function of the court to “relieve a party from the consequences of his imprudence or poor advice”.

In both of the above cases the Supreme Court has sought to give guidance on the way contracts should be interpreted. Following Rainy Sky SA there was a shift towards the starting point in interpreting contracts to be commercial common sense and to almost ignore the ordinary, natural meaning of the words used. As a result of Arnold v Britton there was a swing the other way and the focus shifted towards the natural meaning of the words used and less importance was placed on commercial common sense. To clarify matters and provide further guidance the Supreme Court then issued its decision in Wood v Capita Insurance Services Ltd [2017] UKSC 24 to clarify and essentially revisit the balance to be struck between commercial common sense and the specific language used.

The current position

While commercial common sense remains relevant the court will consider what makes commercial common sense by taking into account the agreement as a whole, not just looking at the particular clause in isolation. The court’s task is to ascertain the objective meaning of the language the parties have chosen to express their agreement which requires consideration of the contract as whole and, depending on the nature, formality and quality of its drafting more or less weight to be given to elements of the wider context. Where there are rival meanings the court will give weight to rival contractions by reaching a view in respect of what is more consistent with business common sense. Interestingly the court also opined that it was necessary to be alive to the possibility that a party might have agreed to something that did not serve his best interest and that a provision might be a negotiated compromise so that while on the face of it a bad bargain this might not, in fact, be the case.

The decision in Wood v Capita emphasises the importance of precise and careful drafting to ensure the contract works as a whole taking into account how each provision works alongside the others.  With this in mind the best safeguard against misinterpretation down the line is to instruct solicitors to draft your contract at the outset to ensure, as best you can, that your requirements and intentions are properly documented and potential interpretation disputes minimised.


For More Information Contact:

Lorna Davidson
Mobile: 07975 593 476
Direct Dial: 0141 433 7743
Email: ldavidson@gilsongray.co.uk

Rosie Walker
Mobile: 07841 921 684
Direct Dial: 0131 516 5374
Email: rwalker@gilsongray.co.uk

The information and opinions contained in this blog are for information only. They are not intended to constitute advice and should not be relied upon or considered as a replacement for advice. Before acting on any of the information contained in this blog, please seek specific advice from Gilson Gray.