The Supreme Court gives helpful guidance on the approach the courts should take when interpreting contractual terms.

What’s the issue?

There has been tension in recent court decisions as to the extent to which business good sense should be used as a tool for interpreting contracts. Different approaches appeared to have been outlined in Rainy Sky v Kookmin Bank which relied heavily on an interpretation of commercial good sense, and Arnold v Britton which placed an emphasis on textual interpretation.

What’s the development?

In Wood v Capita Insurance Services Limited, the Supreme Court has gone some way to clarifying the approach it believes should be taken and reconciling the different interpretation tools, emphasising that textual analysis and looking at commercial good sense are not mutually exclusive. The Supreme Court says that interpretation will depend on a range of factors: the words used in the contract, the context in which the words are used and business commercial sense. It is not the role of the court to remedy a bad bargain. Which tool to interpretation is most used will depend on the facts of the case. For example, where engagement letters are heavily negotiated between experienced parties, textual analysis is more likely to be useful whereas the factual matrix may be more relevant in short or oral agreements. However, where professional engagement letters have been poorly drafted, the factual matrix may be useful in conjunction with the purpose of similar provisions in contracts of the same type.

What does this mean for you?

The interest of the case lies mainly in its discussion of how the courts should approach issues of contractual interpretation which will be relevant in assessing the likelihood of winning a contractual dispute.

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The case revolved around an indemnity given by a seller to a purchaser in relation to mis-selling of insurance claims. The disagreement was over the wording of the indemnity and whether it covered only claims made as a result of actions registered with the FSA or whether, as the buyer argued, it also covered fines imposed as a result of the seller self-reporting. The contract also contained warranties covering mis-selling claims which were limited to two years after sale of the company. The Supreme Court upheld the Court of Appeal’s decision which had overturned that of the High Court and ruled that costs arising out of self-reported issues were not covered by the indemnity.

The Supreme Court held that the court’s primary task is to ascertain the objective meaning of the language in the contract. The court can have regard to the business common sense approach when considering rival constructions but in doing so, it must strike a balance between the language used and the commercial context. It does not matter whether the analysis begins with an examination of the plain language or factual matrix and implications of commercial business sense as long as an appropriate balance is struck between them. The process is iterative so each interpretation should be considered against the provisions of the contract and its commercial consequences.

In this instance, the factual matrix was useful when looking at the rival interpretations because it was significant that the contract included time-limited warranties which also covered costs arising from mis-selling of insurance prior to the sale. This meant it was more likely that the indemnity should be narrowly interpreted. The fact that the buyer had, with hindsight, made a bad bargain, was not relevant.