In a case reported in the last month, Fairstate Ltd v General Enterprise & Management Ltd and another  EWHC 3072 (QB), the High Court considered whether the established principles of construction and rectification could be applied to remedy defective drafting in a guarantee. It was held that because the guarantee was so fundamentally flawed and unsuitable for the transaction and the defects too extensive, neither construction nor rectification could be used by the Court to remedy it.
The Court decided that to apply legal principles so as to correct the document in this case, the Court would be writing a new contract for the parties - and this would go against the statutory defence available to a guarantor under Section 4 of the Statute of Frauds Act 1677. Section 4 provides that a guarantee must be in writing and signed by the guarantor or person authorised by it.
Although this case was decided on its facts, it serves as a useful reminder of the importance of fully and accurately recording the terms of commercial arrangements in a form appropriate for the underlying transaction.
Rectification and the correction of errors by construction are the two main areas of law under which the Court has the power to correct documents.
Rectification is a remedy used to correct mistakes made in a document in order to reflect the true bargain intended between the parties. The subjective intention of the parties is considered, rather than looking at the document cold and interpreting it purely based on the language used.
Rectification is only available in the following very limited circumstances:
- Unilateral mistake.
This applies where it can be shown that:
- Party A was mistaken as to whether the document did or did not contain a particular term;
- Party B was aware of the omission or inclusion and that it was due to a mistake by Party A;
- Party B allowed Party A to enter into the agreement but omitted to draw the mistake to Party A's notice; and
- The error must have been calculated for the benefit of Party B.
This ground is often relevant where a party accuses the other of "sharp practice". There is, however, no right to claim rectification of a contract where Party A was mistaken as to the terms of the document but Party B was not aware that Party A had made a mistake.
- Mutual mistake.
This is where, before entering into a document, both Party A and Party B have reached a firm accord as to what it would contain. That accord must continue until the document is executed. Contrary to both parties' expectations, the document must fail to reflect their common intention. At that point, either party (or both of them) can apply to have the document rectified to reflect the intended terms of agreement.
In a claim for rectification, the Court seeks to establish the subjective intention of the parties. So, evidence of the parties' pre-contractual negotiations is admissible. For rectification to work, whether there is either unilateral or mutual mistake, there needs to be clear evidence of a continuing accord between the parties which the final completed document does not reflect. Crucially, there needs to be convincing proof of the parties' common intention, in substance and in detail. If this can be ascertained, the exact form in which the common intention is to be expressed is immaterial. The Court will not invoke rectification as a remedy, if there is any doubt as to what the parties' real intention was.
The burden of proof is on the party seeking the remedy of rectification. It can be particularly difficult for a party to prove that the document does not reflect the common intention of the parties if there is a lack of written records or correspondence reflecting the terms that had been agreed between the parties up to entering into the contract. There have been cases where the remedy of rectification has not been available to a party because the evidence as to what had been agreed came from witnesses attempting to recall events that had taken place decades before and accordingly such evidence was not sufficiently clear. In the context of Real Estate, this can be particularly problematic because some contracts (i.e. leases) run for decades, and the current parties may not even be the original ones – for example where there have been assignments of landlord and/or tenant interests.
In certain circumstances, rectification may not be necessary and an error in a document can be corrected by the Court by construction. The conditions for the correction of errors in a document by construction are that:
- there must be a clear error on the face of the document; and
- the correction needed to cure the error must be clear.
Where parties disagree as to the meaning of an express term, a Court will interpret a term of a written document in accordance with what a reasonable person would have understood the parties to have meant by the words used, taking into account the relevant background knowledge which would reasonably have been available to the parties at the time of the contract.
The words used are construed in their ordinary and natural meaning unless the context requires otherwise and in construing the words used, the whole of the document may be taken into consideration.
The construction of a document is an objective process and so (unlike the position for rectification) the actual intention of the parties is irrelevant. When construing a document, evidence of pre-contractual negotiations between the parties is generally inadmissible – but there is an exception to this rule: where a term of a document may have more than one meaning, and it is alleged that the parties agreed that the word or phrase had a particular meaning, then the Court may examine evidence in order to determine whether the parties, by their common intention, gave their own meaning to the term.
The Court may also take into account background facts in order to decide whether there has been an error and what correction is required to be made. In the case of The Starsin , words had been mistakenly omitted from a clause in a contract. The House of Lords was able to determine what those words should have been by looking at a standard form of the clause. The House of Lords held that as long as the gist of the missing words was clear, the contract could be corrected accordingly. It was not necessary for the missing wording to be known exactly.
Rectification is a limited remedy and before the Court will invoke it, there needs to be clear evidence of both parties' intentions up to the point when they entered into the contract.
The following practical tips may assist in a claim to remedy an error, or indeed to ensure that another party does not attempt (e.g. unfairly) to use these remedies to change the terms of a contract to which you are a party: -
- Ensure at the time when the agreement is being negotiated that the initial Heads of Terms are as clear as possible so to show the commercial arrangement agreed between the parties;
- Ensure that any changes to the Heads of Terms are clearly recorded in correspondence, so as to prevent a party suggesting that an earlier accord stayed in place until the agreement was completed;
- Question in writing any communication from another party in negotiations that suggests that the intention or purpose of the eventual agreement will be different from what you consider it to be;
- Set up checklists of all the points that should be covered in the Heads of Terms for particular transactions (thus ensuring knowledge gained from the experience of previous transactions is applied going forward and Heads of Terms are full);
- If a mechanism is to be implemented in the future under the contract, consider carefully, and agree with the other party, how it will operate and record such agreement clearly in Heads of Terms or in correspondence - with worked examples if necessary - e.g. are any unusual conditions to a break option clearly agreed between the parties? On rent review, is the break option in the lease to be incorporated in to the hypothetical lease? Have the calculations for overage been tested and, if suitable, examples agreed?
- Avoid informal agreements that are nevertheless intended to be legally binding, or ones that are meant to vary or qualify agreements already in place;
- Whilst you are negotiating, mark your correspondence as "subject to contract" so that there can be no doubt that the deal is still only prospective until a formal agreement is documented.