In March this year, the Supreme Court handed down a judgment that has quickly become the final piece of a triumvirate of statements on the common law principles of contract interpretation.

Following on from Rainy Sky SA v Kookmin Bank [2011] UKSC 50 and Arnold v Britton [2015] UKSC 36 came Wood v Capita Insurance Services Ltd [2017] UKSC 24, ostensibly all saying the same thing in different ways.

This article revisits the trio of Supreme Court cases and the new status quo they have created.

Rainy Sky SA v Kookmin Bank [2011] UKSC 50

It all began with some boats. The clients paid instalments in advance and the shipbuilder issued refund guarantee bonds. Before completing the boats the shipbuilder got into financial difficulty and then refused to refund the instalments paid by the clients. Cue legal proceedings and a debate over the proper construction of the drafting in the bonds.

The debate revolved around two possible interpretations with wildly different consequences – the guarantor bank was either liable to pay full refunds for all the clients, or nothing at all.

Lord Clarke reviewed the case law and summarised that “the ultimate aim of interpreting a provision in a contract, especially a commercial contract, is to determine what the parties meant by the language used, which involves ascertaining what a reasonable person would have understood the parties to have meant.” This reasonable person is “one who has all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.”

Given that the two interpretations were both possible constructions, the answer hinged on the role of business common sense. Lord Clarke said “[i]t is not in my judgment necessary to conclude that, unless the most natural meaning of the words produces a result so extreme as to suggest that it was unintended, the Court must give effect to that meaning.” Instead, “if there are two possible constructions, the Court is entitled to prefer the construction which is consistent with business common sense and to reject the other.” Only “[w]here the parties have used unambiguous language, the Court must apply it.”

Ultimately, Lord Clarke held that

the buyers’ construction is to be preferred because it is consistent with the commercial purpose of the bonds in a way in which the bank’s construction is not.

Arnold v Britton [2015] UKSC 36

This case concerned leases for chalets in a caravan park in south Wales. The contested wording had two possible meanings: the landlord contended that the leases provided for a service charge of £90 with 10% compound interest, which would lead to a service charge in 2072 of £1,025,004! There is a quote, attributed to Einstein but not verified, that says compound interest is “the most powerful force in the universe”. The tenants contended that the clause simply required them to pay a fair proportion of the landlord’s costs.

Lord Neuberger reiterated the point from Rainy Sky that the Court must identify intentions by referring to “what a reasonable person having all the background knowledge which would have been available to the parties would have understood them to be using the language in the contract to mean”. He set out his own framework for analysing meaning, stating that one must focus on “the meaning of the relevant words... in their documentary, factual and commercial context. That meaning has to be assessed in the light of (i) the natural and ordinary meaning of the clause, (ii) any other relevant provisions of the lease, (iii) the overall purpose of the clause and the lease, (iv) the facts and circumstances known or assumed by the parties at the time that the document was executed, and (v) commercial common sense, but (vi) disregarding subjective evidence of any party’s intentions.”

Lord Neuberger gave his thoughts on the use of commercial common sense when interpreting a contract. It should not be used to undervalue the importance of the language of the provision, nor invoked retrospectively. “The mere fact that a contractual arrangement, if interpreted according to its natural language, has worked out badly, or even disastrously, for one of the parties is not a reason for departing from the natural language.”

The Supreme Court held that the landlord’s interpretation was correct, and this judgment was seen by some as a shift away from the purposive approach to contract interpretation employed in Rainy Sky and towards a more literal approach. This was to be denied by the Supreme Court two years later in Wood v Capita.

Wood v Capita Insurance Services Ltd [2017] UKSC 24

This case involved the sale and purchase of an insurance brokerage company. Following the sale, it was discovered that the company had been mis-selling products in the period prior to completion. The parties contested the meaning of an indemnity clause in the sale and purchase agreement.

Lord Hodge took time to explain that Arnold did not involve a recalibration of the principles in Rainy Sky. He confirmed Lord Clarke’s assertion in Rainy Sky that interpretation is a unitary exercise, and “where there are rival meanings, the Court can give weight to the implications of rival constructions by reaching a view as to which construction is more consistent with business common sense.” The quality of the drafting should also be considered. Lord Hodge also confirmed the balancing considerations put forward by Lord Neuberger in Arnold regarding the “possibility that one side may have agreed to something which with hindsight did not serve his interest” and “the possibility that a provision may be a negotiated compromise or that the negotiators were not able to agree more precise terms”. Ultimately, “[t]his unitary exercise involves an iterative process by which each suggested interpretation is checked against the provisions of the contract and its commercial consequences are investigated”.

The common law approach to contract interpretation is often said to be like a pendulum, but Lord Hodge elegantly rejected this, saying “[t]extualism and contextualism are not conflicting paradigms in a battle for exclusive occupation of the field of contractual interpretation”, and “[t]he extent to which each tool will assist the Court in its task will vary according to the circumstances of the particular agreement or agreements.”

Basically: it depends, on a case by case basis.

Turning to the indemnity clause, Lord Hodge said that, on its own, it may appear anomalous, but in the context of the rest of the agreement, it made more sense. With that in mind, the restrictive nature of the indemnity clause was not contrary to business common sense. The Court held that the indemnity clause was not triggered.

Comment

As Lord Hodge said in Wood, “[t]he recent history of the common law of contractual interpretation is one of continuity rather than change.” These judgments provide clear guidance on long-standing principles. Although at a glance these three cases may appear to be affording different weights to these principles, this is in fact justified by the particular facts of each case, and the overall approach is consistent across them all.