The recent Court of Appeal decision in Wood v Sureterm Direct Ltd & Capita Insurance Services Ltd  EWCA Civ 839 gives further guidance on the use of business/commercial common sense as an aid to contractual construction. In reversing the decision at first instance, the Court of Appeal found that an indemnity given by a seller under a share purchase agreement did not cover the buyer's claim. The court reached this decision on the plain language used in the contract even though the effect was to make the indemnity uncommercial from the buyer's perspective.
Citing the recent Supreme Court decision in Arnold v Britton  UKSC 36, the Court of Appeal emphasised that the natural meaning of a provision should not be rejected simply because it appears uncommercial, since businessmen sometimes make bad bargains. This decision follows the recent trend of cases focusing on giving effect to the natural meaning of a contract and only using commercial common sense as an aid to construction if the words used are sufficiently ambiguous. However, whilst the legal principle is relatively settled, the frequency of appellate court involvement in the application of that principle suggests that this issue will continue to provide fertile ground for dispute.
The first respondent, Sureterm Direct Limited ("Sureterm"), was a car insurance broker. In April 2010, the second respondent, Capita Insurance Services Ltd (the "Buyer") acquired the entire issued share capital of Sureterm from the appellant, Mr Wood and other sellers (together, the "Sellers") under a share purchase agreement (the "SPA").
After the acquisition, various employees of Sureterm raised concerns to the Buyer about the company's sales processes and potential misselling of its products in the period prior to completion of the SPA. Sureterm conducted a past business review and reported its findings to the then FSA. The FSA determined that Sureterm's customers had been misled, that redress was due and the Buyer/Sureterm agreed to conduct a customer remediation exercise.
As part of the remediation, Sureterm paid £1.35 million in customer compensation, which the Buyer sought to recover from the Sellers. The Sellers relied upon the following indemnity in the SPA (the "Indemnity"):
"The Sellers undertake to pay to the Buyer an amount…to indemnify the Buyer…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 of service."
The Sellers disputed the claim on the basis that the Indemnity was not engaged in circumstances where the obligation to pay compensation arose from Sureterm self-reporting potential misselling to the FSA.
2. High Court
Agreeing with the Buyer's construction, the High Court considered that the words "following and arising out of claims or complaints registered with the FSA..." should be construed as only applying to "all fines, compensation or remedial action…" and not to "all actions, proceedings, losses, claims, damages, costs, charges, expenses and liabilities suffered or incurred". Under this interpretation, the Buyer was entitled to recover what it had paid under the remediation scheme because it constituted a loss, cost, charge, expense or liability suffered or incurred falling within the first part of the Indemnity. The court concluded that this construction was to be preferred for three main reasons: (1) the construction was supported by the language used; (2) it was also supported by the commercial context and practical consequences of the rival constructions; and (3) a number of "more minor" linguistic and syntactical points.
Mr Wood appealed.
3. Court of Appeal
The Court of Appeal unanimously reversed the High Court's decision, finding that no liability could arise under the Indemnity in the absence of any actual claim by Sureterm's customers or any complaint being registered with the FSA/FCA or other relevant authority pertaining to any misselling or suspected misselling of an insurance or insurance related product.
In the leading judgment given by Christopher Clarke LJ, the Indemnity was interpreted as creating an obligation to indemnify against two categories of loss or events giving rise to loss: (1) "all actions, proceedings, losses, claims, damages, costs, charges, expenses and liabilities suffered or incurred"; and (2) "all fines, compensation or remedial action imposed on or required to be made by [Sureterm]". The subject matters of the indemnity were then qualified by the requirement that they must be "following and arising out of claims or complaints registered with the FSA..."
The court held that it was necessary to look at the structure of the Indemnity read as whole in its original form, rather than dividing the clause into component parts. Whilst this was useful as an aid to construing the clause, the parties did not write their contract that way. However, we note that this appears inconsistent with the way in which the Court of Appeal read the clause as indemnifying against two categories of loss. The court recognised that the language used was capable of more than one meaning and in accordance with Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd  CLC 1103 it considered in detail the words used in the clause and the effect of different interpretations (consistent with the approach taken by the Supreme Court in Rainy Sky SA and others v Kookmin Bank  UKSC 50 see our blog post here).
The most striking part of the judgment is the way in which the court then dealt with commercial considerations. At first instance, Mr Justice Popplewell had regarded an exclusion from indemnity of compensation resulting from self-reporting as lacking any good commercial reason, and that this supported the conclusion he reached. The Court of Appeal took a very different approach. It considered alternative commercial factors supporting the Sellers' interpretations, such as warranties against which the Buyer could claim, meaning that its entitlement to recover in respect of mis-selling was not dependent upon bringing the case within the Indemnity. With this in mind, the court concluded:
"The fact that the deal may have been…from [the Buyer's] view, a poor one, is not, in my view, a circumstance which should dictate a different interpretation from that which, for the reasons that I have stated, I derive from the words used."
In arriving at its decision, the court was guided by the Supreme Court's approach in Arnold v Britton  UKSC 36 and the use of business/commercial common sense as a determinant of construction. Christopher Clarke LJ emphasised that businessmen sometimes make bad or poor bargains for a number of different reasons (e.g. weak negotiating position, poor negotiating or drafting skills, inadequate advice or inadvertence) and, if they do, it is not the function of the court to improve their bargain or make it more reasonable by effectively rewriting it and thereby undermining the importance of the natural language used. A balance has to be struck between the indications given by the language and the implications of rival constructions. The clearer the language, the less appropriate it will be to construe it to avoid a result which could be characterised as 'unbusinesslike'.
This decision is a reminder that contractual interpretation starts with the words used in the contract and that the court will not read in a more business-like interpretation where clear, unambiguous language has been used, save only in instances of commercial absurdity. Only where there is ambiguity in the language used will the court be permitted to conduct an exercise of determining which of the competing interpretations represents the likely commercial outcome (of course, used as an aid to identify what the reasonable bystander would have understood the parties to have meant by the words used). Accordingly, a finding that an interpretation represents a bad bargain for one of the parties (even one that lacks any good commercial reason), will not be sufficient to defeat such an interpretation. That said, this case gives another example of the High Court and Court of Appeal coming to opposite conclusions on the language used in the clause, suggesting that drawing the line between ambiguity and certainty, as well as the necessary level of commercial absurdity, is far from easy in practice. It remains to be seen whether this decision will be appealed to the Supreme Court.