Thus far in the contract basics series, we have considered how an unwritten contract can be created and interpreted, the risks posed by inadvertently creating a legally binding contract , how to formally execute contracts and deeds and the difference between conditions and warranties. This month, we will look at the importance of ensuring that the terms of a contract are sufficiently precise and detailed in order to accurately reflect the intentions of the contracting parties. We will also briefly consider the approach that courts adopt when interpreting ambiguous and vague terms of a contract and why this can be a risk to contracting parties.
Why do contract terms need to be specific?
Let us use the example of a customer purchasing services from a supplier. Following successful negotiations concerning the price and the terms of the deal, the parties should ensure that all terms are accurately and comprehensively recorded in a written agreement. From the customer's perspective, this might include a specification detailing the performance obligations required of the supplier and rights attaching if required standards are not met.
In many situations, the contracting parties may be blissfully unaware that the contract between them isn't very clear and often this may not have a material consequence, particularly if the supplier performs the services on time and to the required standard and the customer duly pays the supplier in full and on time. However, if for instance, the services provided by the supplier do not meet the customer's requirements and the dissatisfied customer goes back to the original contract to identify whether a term may have been breached or to seek to compel the supplier to perform better, then certainty of those contractual terms will suddenly become very pertinent to both parties, with both parties wanting to know exactly what their respective obligations and rights are.
In order to show that the supplier is in breach of contract, the customer would ideally be able to cite an express provision within the contract, such as in the specification, which the supplier has breached and cite the consequences provided by the contract attaching to such breach. This would support the customer's complaint, enabling it to seek to compel the supplier to remedy a defect or improve performance or face certain contractual consequences, such as termination or paying compensation to the customer.
But what if the contract was simply not sufficiently detailed and it was not clear from the drafting of the specification what the nature or extent of the obligations imposed on the supplier actually were or what the consequences attaching to such sub-standard performance were? This situation often leads to disputes about what the agreement was and what terms of the contract mean.
It is often not possible to rely on statements made by the other party during contract negotiations if these are not expressly set out in the contract. Entire agreement clauses, which are included in most written contracts, effectively mean that written or oral statements, representations, assurances etc. given during negotiations are not capable of forming additional terms of the contract (this is subject to certain exceptions, such as when a statement is given fraudulently).
So if the parties do not reach a resolution then the matter can quickly escalate, with lawyers becoming involved.
The risks of taking action under an ambiguous contract without legal advice
If, for example, the customer wishes to terminate the contract with the supplier, the customer must ensure that the contract terms actually entitle it to do so. For instance, customers often have to show that there has been a material breach by the supplier and that the customer has followed the stipulated contractual procedure attaching to such breaches (which often requires the customer to give the supplier the opportunity to remedy these over a certain timescale). Only if the supplier has failed to remedy a material breach may the customer potentially be entitled to terminate. The danger of uncertainty of terms in this context is that the customer may not actually be entitled to terminate and if it purports to do so, may itself become subject to a claim or counter claim for wrongful termination by the supplier. Therefore, legal advice is recommended before considering what options are available. However, if the contract is still unclear then a court may be called upon to rule on its interpretation. As we will see, though, relying on a court's interpretation may give rise to an outcome which was not what the contracting parties had originally intended.
The Court's approach when analysing ambiguity in a contract
When presented with a contract which is unclear, the courts will look at the contract as a whole and seek to interpret terms in the contract, based on the starting point of what a reasonable person would consider the meaning to be and what the intentions of the parties were, when assessed objectively.
Increasingly, courts prefer to adopt a pragmatic approach when interpreting ambiguity in contracts, seeking to give effect to and uphold the commercial value in a contract wherever possible. This involves the court looking into the apparent objective intentions of the parties and attempting to construct the contract in a manner which seeks to give business efficacy to the arrangement.
However, there is only so far that a court will go in interpreting the terms of an ambiguous contract and, in extreme circumstances; a court may declare a contract unenforceable owing to uncertainty. There are a number of different approaches and tools which are adopted by a court; some of these are briefly summarised below:
Interpretation or rectification - For simple errors and mistakes (e.g. a drafting error), a court can apply a test which either interprets the term from the perspective of a reasonable person or rectifies the mistake as an equitable remedy, to reflect the parties' intentions, with uncertain terms or words being given their natural and ordinary meaning. However, a court would only apply these tools for simple errors for discrete clauses, not going so far as interpreting or rectifying an entire contract.
Implying a term into the contract - In the absence of a specific express term, the customer may have to argue that the supplier had breached an implied term of the contract. However, this is subject to the customer successfully arguing that an implied term can be included in the contract and often the drafting attempts to exclude implied terms. Terms can be implied by usage or custom, the parties' previous course of dealings, the intention of the parties, common law and statute.
Relying on an implied term is therefore weaker than relying on an express term and even an implied term may not assist if the whole agreement is uncertain. For instance, if a customer is seeking to argue that a specific obligation has not been performed, a more general standard implied by statute (such as section 13 of the Supply of Goods and Services Act 1982, which implies a term that any services provided, will be carried out with reasonable care and skill) may not be sufficiently precise to enable the customer to succeed in showing that the supplier is in breach of a certain obligation.
Specific Rules of Interpretation – one particular tool of interpretation used by the courts is the contra preferentum rule, which means that a court may interpret a particular contract or clause against the party who is seeking to solely rely on it, particularly if that party has drafted the clause in question and it only benefits that party. Clearly, this could backfire against one party in particular.
What is admissible as background evidence? - The courts will consider the contract from the perspective of a reasonable business person possessing the relevant background knowledge from when the contract was formed. As well as the surrounding circumstances, a court will consider whether there is common practice in the particular market and to an extent, what was said during negotiations between the parties.
Litigating over uncertain contracts is costly and the outcome of a court's decision not always predictable. Often, a customer is left in a position whereby it will not receive adequate compensation or be able to terminate the contract and may be faced with less attractive alternatives such as accepting an inadequate offer of compensation, having to negotiate and buy its way out of a contract or even be forced to continue with the term of the contract, working with and paying a supplier with whom it is likely to have a strained relationship.