The courts are often faced with disputes regarding the correct interpretation of language used in commercial agreements. This topic has generated a number of Supreme Court decisions, which address the weight to be given to the parties’ background knowledge and the relevant documentary, factual and commercial context when determining the meaning of the words on the page. The modern approach was helpfully summarised by Lord Neuberger in Arnold v Britton1 .
In the recent case of Kitcatt and others v MMS UK Holdings Ltd and others2 , the High Court was faced with the argument that a warranty in a share sale and purchase agreement (“SPA”) was meaningless and unenforceable. The Court held that the warranty was enforceable and, in doing so, provided a useful reminder of the importance of reading the wording in the context in which it appears.
On 1 March 2011, the shareholders of advertising agency, Kitcatt Nohr Alexander Shaw Ltd (“Kitcatt”) sold their shares to MMS UK Holdings Limited (“MMS”).
The SPA included an “earn out” provision under which the deferred consideration payable for the shares was tied to the performance of Kitcatt following the acquisition, which would largely be dependent on the performance of a new merged agency to be formed from the merger of Kitcatt and Digitas. MMS gave a warranty stipulating that neither it nor certain named senior employees were aware:
“of any facts or circumstances that could reasonably be expected to have a material adverse impact upon the Operating Income and/or Revenue in 2012 or 2013 (being a reduction of at least 20% in the case of Operating Income and 10% in the case of Revenue) including, without limitation...(i) the resignation or expected loss of any client of Digitas...”
The agency’s performance of the business postacquisition was such that no deferred consideration became payable. The sellers alleged that MMS had been aware that Digitas was about to lose a significant amount of work from its main client and claimed damages for breach of the above warranty.
The High Court’s analysis of the warranty
The buyers challenged the enforceability of the warranty on the following grounds:
(a) the warranty provided no baseline against which 2012 or 2013 performance could be measured; and
(b) the terms “Operating Income” and “Revenue” should be given their defined meaning (the actual operating income and revenue in any given year), with the effect that the warranty did not make sense because it was impossible to say at the date of the SPA whether it had been breached.
Baseline for comparison
The sellers argued that the relevant comparison was between the Operating Income and Revenue on the basis of the information which had been provided to them and what would reasonably have been expected if the expected loss of business had been disclosed.
The Judge emphasised that the answer was “a question of construction”, namely whether, properly construed, the clause provided a baseline which enabled a comparison to be made.
In assessing this, he followed the modern approach to contract interpretation summarised by the Supreme Court in Arnold v Britton, namely that the court must ascertain the meaning of the document by focusing on the meaning of the relevant words in their documentary, factual and commercial context, including the background knowledge available to the parties and the overall purpose of the clause in question. He held that the relevant background knowledge and overall purpose of the clause included the fact that:
(a) the deferred consideration payable to the sellers would be dependent on the future performance of Digitas, about which they had been given little information;
(b) by contrast, the buyers had carried out due diligence on Kitcatt;
(c) the protection provided by the warranty was an important part of the overall deal, without which the balance between the original consideration and the deferred consideration might be distorted; and
(d) the success of the Kitcatt/Digitas merger was to be for the benefit of both parties to the SPA.
With this context in mind, the Judge noted that the clause was directly concerned with the reasonable expectations of the parties. He concluded that, on its natural meaning, it provided for a comparison between what would reasonably be expected:
(a) on the basis of the information provided; and
(b) if the facts and circumstances in question had been disclosed.
As such, a comparison could be made and the warranty was enforceable. The buyers’ approach was based on what the Judge described as an over literal reading of the warranty.
With regard to the buyers’ argument that the definitions were inconsistent with the warranty, the Judge held that if incorporating those definitions into the terms of the warranty rendered the clause unenforceable and unworkable, that in itself was a strong indication that the parties did not intend this to be done. He stated that “a definition should be the servant of clarity, not a dictator of absurdity”.
He also noted that the list of defined terms in the SPA was introduced by the words:
“In this agreement the following words and expressions have the following meanings unless the context requires otherwise...”
He held that the context did clearly require otherwise. Although this justified the Judge’s conclusion that Operating Revenue and Income were not intended to be used in the warranty in their defined sense, it seems likely that he would have reached the same conclusion in the absence of those introductory words.
The Judge accepted that there may be instances where a clause is meaningless, but this would be a last resort – here it would mean that a clause which was obviously intended to provide important protection to one party and underpin the whole deal would be unenforceable. There was no need to do that here – on the proper interpretation of the warranty it was perfectly workable.
While the Kitcatt case turns on its specific facts, the decision is a useful illustration of the approach taken by the English courts to interpreting contractual provisions and the preference for reaching an interpretation that gives effect to what the parties must have intended rather than frustrating that intention.
The Judge’s comments on the defined terms in the warranty are also of interest. Although definitions are of course useful in facilitating more concise drafting of contracts, they will not be “the dictator of absurdity”. Where defined terms are used in a clause, it is still necessary to ask whether the parties intended those terms to be used in their defined sense – if this leads to a meaningless or unworkable conclusion, that will be a strong indicator that they did not.