The Court of Appeal has once again confirmed that commercial common sense and background should not be used to erode the importance of the express language used when interpreting a contract.

In the case of Kason Kek-Gardner Limited v Process Components Limited [2017] EWCA Civ 2132, the court also considered the interpretation of related contracts.

Facts of the case

Following the administration of Kemutuc Powder Technologies Ltd (KPTL), the administrators entered into a sale contract with Process Components Ltd (PCL), a new company formed by former directors of KPTL, for the sale of the assets of two divisions of KPTL on 30th June 2009. A further sale agreement was then entered into by the administrators on 10th July 2009 with Kason Kek-Gardner Ltd (KGL), another new company formed by different directors, in relation to the remaining divisions of KPTL.

PCL and KGL subsequently entered into a licence agreement under which PCL licenced the use of intellectual property rights formerly owned by KPTL. However, when a competitor of PCL purchased KGL, PCL terminated the licence agreement on the basis of a purported breach of confidentiality. A dispute subsequently arose about what intellectual property rights KGL had actually acquired from the administrators and whether those rights had already been sold to PCL. KGL argued that the parties had acquired the intellectual property for the divisions they had each acquired.

The High Court judge decided that all the parties had acted on the assumption that PCL had acquired the whole of KPTL's intellectual property, but that, construed as a whole, the sale agreement with PCL only transferred the intellectual property rights in the divisions it had acquired. The judge also held that KGL was permanently estopped from denying that PCL owned the relevant intellectual property. The judgement was contradictory in places and so KGL appealed to the Court of Appeal.

Court of Appeal decision

The Appeal was dismissed. Although the judge had erred in some respects in relation to the construction of the sale agreements, KGL's overall challenge failed. In reaching this conclusion, the judge considered the following issues:

Contractual interpretation

KGL argued that the sale agreements should be read together, since they were part of the same administration, with the effect that both parties acquired the intellectual property rights they needed for their respective businesses. The Court of Appeal stated that the general rule is that the subsequent conduct of the parties to an agreement cannot affect the true interpretation of the agreement; still less can the subsequent conduct of strangers to the agreement. The second agreement was concluded ten days after the first with a different purchaser, and could not therefore be used to interpret the first agreement.

KGL also argued that, since the factual background (namely, the administration) was known to both parties, it would be surprising if a reasonable reader of the sale agreement with PCL would have understood it to transfer all IP rights beyond those necessary for the divisions which PCL was buying. It therefore argued that the agreement should be interpreted as limiting the transfer of the intellectual property rights to PCL. The Court of Appeal confirmed that the correct approach to the interpretation of contracts was set out in Wood v Capita Insurance Services Ltd [2017], namely that the court's task is to determine the objective meaning of the language which the parties have included in the agreement when read in the context of the factual background. The court clarified that admissible background was limited to facts that were known or reasonably available to both/all of the parties. The High Court judge had mistakenly taken into account a series of offers made to the administrators without considering whether those offers were known to all parties.

In relation to KGL's arguments based on commercial common sense and background, the Court of Appeal referred to Arnold v Britton [2015] confirming that reliance on commercial common sense and background should not be used to devalue the importance of the language of the provisions to be interpreted. In this case, there was nothing in the admissible background, or in the language of the sale agreement with PCL, that supported the proposition that the intellectual property rights were divided according to purpose.

Termination of the licence agreement

In relation to the alleged breach of the licence agreement, KGL argued that there was an implied term that it could disclose the licence agreement for reasonable business purposes and that included disclosure to a potential purchaser. It therefore contended that it had not breached the confidentiality provisions in the licence agreement by disclosing the agreement to a competitor during the due diligence process.

The Court of Appeal confirmed that a term will not be implied into a detailed commercial contract unless it is necessary to give the contract business efficacy or if it is so obvious it goes without saying. The necessity required by the test is necessity for the business efficacy of the contract; not some wider business purpose of a contracting party. In this case, the sale of KGL was not a necessary purpose of the licence agreement and disclosure of the agreement was therefore in breach of its terms. PCL was therefore entitled to terminate the licence.

This case confirms the current approach of the courts to contract interpretation, as set out in Wood v Capita,reflecting the ongoing shift away from reliance on common sense and business context, and instead focussing on the precise language. In practice, this is a reminder to ensure that contracts are sufficiently clear and certain at the time of execution. Subsequent conduct cannot affect the interpretation of the contract, nor can contracts which are signed subsequently which do not form part of a composite transaction.

If the parties would like to refer to additional documents or factual background that may be relevant to the interpretation of the contract, this should be added into the agreement itself, for example in the recitals provisions.

The decision also clarifies that when considering whether a term should be implied to give business efficacy to a contract, it is the contract that matters not the wider purpose of the contracting party.