Enter to open, tab to navigate, enter to select
Contract interpretation: the end of the more liberal trend?
Practical Law UK Articles 7-618-8691 (Approx. 6 pages)
Contract interpretation: the end of the more liberal trend?
by Zoe Schluter, PLC Magazine
| Published on 24 Sep 2015 • United Kingdom |
In a further warning to commercial practitioners that the courts will not use commercial common sense to rewrite a party's bad bargain, the Court of Appeal has held that an indemnity given by the sellers under a share purchase agreement did not cover the buyer's claim. The court focused on the natural meaning of the language used in the provision and cautioned against using commercial common sense to determine how a contract should be interpreted.
In a further warning to commercial practitioners that the courts will not use commercial common sense to rewrite a party's bad bargain, the Court of Appeal has held that an indemnity given by the sellers under a share purchase agreement (SPA) did not cover the buyer's claim (Wood v Sureterm Direct Ltd & Capita Insurance Services Ltd [2015] EWCA Civ 839).
In what could be seen as a weakening of the trend towards a more liberal, or purposive, approach to contract interpretation, the court focused on the natural meaning of the language used in the provision and cautioned against using commercial common sense to determine how a contract should be interpreted.
The dispute
Capita Insurance Services Ltd bought Sureterm Direct Limited, an insurance broker, from three individuals, including Mr Wood who held 94% of the shares in Sureterm. An indemnity in the SPA covered claims and complaints registered with the then-regulator, the Financial Services Authority (FSA), relating to mis-selling (see box "The indemnity").
Following a review of its past sales activities, Sureterm reported findings of potential mis-selling to the FSA, which concluded that Sureterm's customers had been misled and that redress was due. Sureterm and Capita agreed to a customer remediation exercise, which involved paying around £1.35 million in compensation. Capita sought to recover this money, along with other costs and expenses, from Mr Wood under the indemnity.
Mr Wood argued that the indemnity was not engaged as there was never any actual claim by Sureterm's customers or any complaint registered with the FSA or other authority. By contrast, Capita's construction of the indemnity was that the words "following and arising out of claims or complaints registered with the FSA" only related to the second part of the indemnity concerning fines, compensation or remedial action and not to the first part, which dealt with, among other things, losses, costs, charges, expenses and liabilities. Therefore, according to Capita, it should be indemnified for the events listed in the first part of the provision without the need for any claim or complaint to be registered with the FSA.
The High Court agreed with Capita's construction of the indemnity ([2014] EWHC 3240). Mr Wood appealed.
Court of Appeal decision
The Court of Appeal undertook a detailed consideration of the language of the indemnity and, preferring Mr Wood's construction, upheld Mr Wood's appeal.
In contrast to the High Court, the court found that the indemnity should not be read as though it were divided into parts, but as a composite whole, as this was how the parties had drafted it. The court found Capita's construction incoherent as, among other things, it did not specify any entity against which an action that was commenced without FSA involvement should be brought. Looking at Mr Wood's construction of the indemnity, while the language was somewhat tautologous, the court observed that this is not unknown in commercial contracts. The court also did not ascribe any real meaning to the drafter's "erratic" use of commas.
In addition, the court pointed out that while the High Court had been persuaded by the argument that there was no good commercial reason to exclude self-referrals to the FSA or action taken of the FSA's own accord, Capita also had the benefit of warranties in the SPA that addressed Sureterm's business conduct before the acquisition, and any mis-selling would be likely to have breached those warranties. The fact that the deal might have been a poor one for Capita did not justify a different interpretation of the indemnity from the one that the court derived from the words used.
Approaches to contract interpretation
While the broad principles of contract interpretation are useful starting points for the court, its task of applying them to the specific facts of a case is less straightforward. This is clearly demonstrated by the fact that the High Court and the Court of Appeal in Wood, both having undertaken a thorough and lengthy analysis of the indemnity provision, came to different conclusions as to its meaning.
The court must conduct a difficult balancing exercise between the literal and liberal approaches to contract interpretation. A purely literal approach looks at the plain meaning of the language without considering the underlying purpose of the provision, even if this results in an unfavourable outcome for one of the parties. The liberal approach focuses on the commercial purpose of the contract and, where more than one construction is possible, allows the court to choose the construction that is most likely to give effect to the parties' commercial intentions.
Over the years, the courts have moved towards favouring a markedly more liberal approach. For example, in Chartbrook Limited v Persimmon, Lord Hoffman said that there is no limit to the amount of linguistic correction that the court is permitted to do; all that is required is that it is clear that something has gone wrong with the language, and it is clear what a reasonable person would have understood the parties to have meant ([2009] UKHL 38; see News brief "The exclusionary rule: Hoffmann's last word").
Another example is the Supreme Court's rejection in Rainy Sky SA v Kookmin Bank of the Court of Appeal's approach that the court must give effect to the most natural meaning of the disputed words unless this produces a result which is so extreme as to suggest that it was unintended ([2011] UKSC 50; see News brief "Contractual interpretation: let commercial common sense prevail"). Instead, the Supreme Court held that where the court is asked to construe a provision in a contract that can have more than one possible meaning, the meaning which is consistent with commercial common sense is to be preferred.
However, the Court of Appeal in Wood cautioned that care must be taken in using commercial common sense to determine a provision's meaning. What is common sense in commercial terms will necessarily depend on the context; for example, a provision may have been heavily negotiated and be the product of a compromise. It is not the court's role to make a party's bad bargain more commercially reasonable by rewriting it.
The court also said that it must strike a balance between the language used and the practical implications of different constructions, so that where language is clear it may be less appropriate to construe it in a certain way to avoid an uncommercial result. However, where the natural reading of the provision produces a wholly uncommercial result, the court is entitled to favour an alternative, less obvious, reading of the language.
Lessons to be learned
The approach taken by the Court of Appeal in Wood, in conjunction with the recent decision in Arnold v Britton and others, might suggest a movement away from the more liberal approach to contractual interpretation ([2015] UKSC 36; www.practicallaw.com/9-616-5783). The Supreme Court in Arnold stressed that the language of a provision should not be diminished by placing reliance on commercial common sense and that it is not the court's function to relieve a party from the consequences of imprudence or poor advice.
While decisions on contract interpretation are necessarily fact-specific, if Arnold and Wood do suggest that the courts are becoming reluctant to tip the balance towards the liberal approach, it makes it even more essential for practitioners to focus on clarity in drafting and ensuring that there is as little room as possible for different interpretations.
Practitioners should consider the contract as a whole and how each provision fits in with the others, including any boilerplate provisions (see feature article "Drafting commercial contracts: pitfalls for the unwary"). This is particularly important if one provision is heavily negotiated, as it can be easy in a pressurised environment to focus on what is contentious and fail to ensure that the contract is internally consistent. In some cases, it may be helpful to ask an experienced litigator to review the contract in order to highlight any potential areas of dispute, especially if they have not been involved in the drafting or negotiation and can perhaps look at the contract more objectively.
It is also important to consider the structure of the contract as well as the language used. It is often better to break down provisions into subsections rather than attempt to cover every conceivable event in one long, convoluted sentence. If the indemnity provision in Wood had been separated into subsections, it is highly unlikely that the parties would have found themselves involved in a time-consuming and costly dispute.
Zoe Schluter, PLC Magazine.
The indemnity
"The Sellers undertake to pay to [Capita] an amount equal to the amount which would be required to indemnify [Capita] and each member of [Capita's] Group against all actions, proceedings, losses, claims, damages, costs, charges, expenses and liabilities suffered or incurred, and all fines, compensation or remedial action or payments imposed on or required to be made by [Sureterm] following and arising out of claims or complaints registered with the FSA, the Financial Services Ombudsman or any other Authority against [Sureterm], the Sellers or any Relevant Person and which relate to the period prior to the Completion Date pertaining to any mis-selling or suspected mis-selling of any insurance or insurance related product or service."