In Rainy Sky S.A and six others v Kookmin Bank  UKSC 50, the Supreme Court provided useful guidance on the role of business common sense in construing a clause in a commercial contract, particularly in circumstances where there are competing plausible constructions, neither of which is clearly preferable on the language used alone.
On 11 May 2007, the first to sixth appellants (the Buyers) entered into separate contracts (the “Contracts”) with Jinse Shipbuilding Co Ltd (the Builder) under which the Builder agreed to build and sell a vessel to each of the Buyers. The price of each vessel was $33.3m, payable in five equal instalments of $6.66m, with the final instalment payable on delivery. It was a condition precedent to payment of the first instalment that the Builder deliver a refund guarantee to each Buyer in a form acceptable to the Buyers’ financiers. On 22 August 2007, the respondent (the Bank) issued an advance payment bond (the Bonds) to each of the Buyers. The seventh appellant was the assignee of the benefit of the Bonds (the Assignee).
The Buyers had each paid the first instalment (one Buyer had also paid the second) when, in late January 2009, the Builder became insolvent. The Buyers notified the Builder that this triggered an obligation under Article XII.3 of the Contracts (which dealt with the insolvency of the Builder) to repay the instalments received. The Builder refused and the dispute was submitted for arbitration. The Buyers then demanded repayment of the instalments paid from the Bank under the Bonds. The Bank refused on the grounds that: first, it was not obliged to pay until the dispute between the Buyers and the Builder was resolved; and, second, in any event, the Bonds did not cover refunds in the event of insolvency under Article XII.3 of the Contracts.
Both arguments were rejected in the High Court, and summary judgment was given for the appellants. The Bank appealed on the second ground only, and the Court of Appeal allowed this appeal by a majority of two to one. The appellants appealed to the Supreme Court. The only question for determination was whether, on a true construction of the Bonds, the Buyers were entitled to payment under the Bonds of refunds to which they were entitled under Article XII.3 of the Contracts.
The relevant terms of the Bonds
The Bonds, which took the form of a letter from the Bank to the Buyers, provided insofar as is relevant:
“ Pursuant to the terms of the Contract, you are entitled, upon your rejection of the Vessel in accordance with the terms of the Contract, your termination, cancellation or rescission of the Contract or upon a Total Loss of the Vessel, to repayment of the pre-delivery instalments of the Contract Price paid by you prior to such termination or a Total Loss of the Vessel…”
“ In consideration of your agreement to make the pre-delivery instalments under the Contract and for other good and valuable consideration … we hereby, as primary obligor, irrevocably and unconditionally undertake to pay you, your successors and assigns, on your first written demand, all such sums due to you under the Contract…” (emphasis added)
The question of construction was simply whether “all such sums” in final line of paragraph  referred to the pre-delivery instalments in the first line of that paragraph, or to the sums referred to in paragraph . If the former, then the Bank would be obliged to repay the pre-delivery instalments however they became due under the Contracts, including in the event of the Builder’s insolvency; if the latter, the obligation only arose in the narrower circumstances of termination of the Contract or total loss of the Vessel, stipulated in paragraph , and not in the event of the Builder’s insolvency.
Business common sense
The parties accepted that both constructions were plausible. The key issue between the parties therefore became the extent to which it was permissible to rely on considerations of business common sense to select between the two plausible constructions. The appellants argued that, given that it flew in the face of business common sense that the Buyers would have accepted Bonds that did not protect against the Builder’s insolvency – the most likely trigger of default – their construction should be preferred.
The majority of the Court of Appeal considered that, on the natural meaning of the words used and absent considerations of business common sense, the Bank’s construction was preferable. It then refused to rely on business common sense to displace this construction. As the Court of Appeal summarised:
“Unless the most natural meaning of the words produces a result which is so extreme as to suggest that it was unintended, the Court has no alternative but to give effect to its terms. To do otherwise would be to risk imposing obligations on one or other party which they were never willing to assume and in circumstances which amount to no more than guesswork on the part of the Court”.
The Supreme Court unanimously rejected this proposition, restating the correct approach to construction and the role of business common sense as follows:
- The exercise of construing a contract is a unitary one in which the court considers the language used to ascertain what a reasonable person would have understood the parties to have meant;
- The relevant reasonable person is one 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 contract;
- Where the parties have used unambiguous language, the court must apply it even if the effect of this language is at odds with business common sense;
- However, if there are competing plausible constructions, the court can prefer the construction which is consistent with business common sense even if, focussing only on the language used, this is the less natural meaning.
The correct construction
The Supreme Court agreed with the parties that both constructions of the Bonds were plausible. The problem with the Buyers’ construction was that it was not easy to discern a purpose for paragraph  if the words “all such sums” in paragraph  referred back the first line of that paragraph. Its strength was that it was more straightforward, reducing the Bank’s promise to that of repaying the predelivery instalments as they became due under the Contracts, whereas the scope of paragraph , and the circumstances in which liability would be triggered under the Bonds on the Bank’s construction, was far less clear.
Following a careful analysis of the Bonds and some of the relevant terms of the Contracts themselves, the Supreme Court concluded that, looking at the agreements as a whole, and focussing only on the natural meaning of the words used, the Buyers’ construction was to be preferred. However, had the Bank’s construction been preferable on the language (as the Court of Appeal found), it would have been appropriate to displace this given the commercially surprising result, namely that the insolvency of the Builder – the situation for which the security of an advance payment bond was most likely to be needed – would not be covered by it. If such a result were intended, the Bonds should have spelt it out clearly. The appeal was therefore allowed.
Given that the Supreme Court preferred the Buyers’ construction on the language used alone, the comments on business common sense were not necessary for the decision reached. However, it is clear that the Supreme Court was anxious to correct what it considered to be an inaccurate statement of the principles of contractual construction by a majority of the Court of Appeal and to restate the effect of previous authorities on the point. Considerations of business common sense are an important tool to be used when determining what a reasonable person would have understood the parties to have meant by a contractual clause and, as such, form part of the normal principles of construction.