• In Wood (Respondent) v Capita Insurance Services Limited (Appellant) [2017] UKSC 24, the Supreme Court has unanimously dismissed an appeal brought by Capita Insurance Services Limited (“Capita”) on the construction of an indemnity clause.
  • The Supreme Court emphasised that it did not seek, once again, to reformulate the guidance to the legal profession, noting that its judgments in Arnold v Britton [2015] AC 1619 and Rainy Sky SA v Kookmin Bank [2011] 1 WLR 2900 provide sufficient statements of this nature.

  • Rainy Sky and Arnold are often seen as pulling in opposite directions, with the former having given a greater role to commercial common sense in interpreting contracts, while the latter re-emphasised the importance of the natural meaning of the words used.

  • The present judgment, however, emphasises the common ground, commenting that they were in fact saying the same thing – namely that interpretation is a unitary exercise, in which a balance must be struck between the indications given by the language used (in both the clause under scrutiny and the remainder of the contract) and the implications of rival constructions (which is usually thought of as the business common sense approach).

  • Interestingly, Lord Hodge said that in striking a balance between these two tools to construction it does not matter which way round they are used, so long as the court balances the indications given by each.

  • The decision does however emphasise that the weight to be given to each tool will depend on the circumstances. Some agreements may be successfully interpreted by textual analysis, eg because they have been professionally drafted and their meaning is clear. Others may require a greater emphasis on the commercial background and implications to interpret a disputed provision.

  • It also emphasises, in line with Arnold, that business common sense can only be taken so far, remembering that one side may have agreed to something which with hindsight did not serve his interest. It is not the role of the court to save the parties from a bad bargain.

Background to the appeal

The appeal concerns an indemnity clause in a share purchase agreement ("the SPA"), for the sale and purchase of the entire issued share capital of Sureterm Direct Limited ("the Company"), a car insurance broker. The sellers of the Company were its managing director Mr Wood (together with other minor shareholders) (the "Sellers"). The buyers of the Company were Capita Insurance Services Ltd (the "Buyer").

After the acquisition, the Company conducted a past business review in response to concerns that had been raised by its employees in relation to its sales processes and potential misselling of its products in the period prior to completion of the SPA. In accordance with its regulatory obligations, the Company then reported these findings to the FSA. This ultimately led to the FSA determining that the Company's customers had been misled and that it should conduct a customer remediation exercise, which it did, resulting in the payment of £1.35 million in customer compensation.

The Buyer then brought a claim against the Sellers for losses they had suffered as a result of the misselling, relying 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 [the Company] following and arising out of claims or complaints registered with the FSA, the Financial Services Ombudsman or any other Authority against [the Company], 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 claimed that this loss was outside the scope of the Indemnity given that the requirement to remediate customers had not arisen as a result of a claim by the customers or a complaint by those customers to the FSA (but rather arose from the Company self-reporting the misselling).

At first instance, Popplewell J held that the Indemnity required the Sellers to indemnify the Buyer even if there had been no claim or complaint by a customer, primarily on the basis that it did not make business common sense for the clause to operate to exclude those claims. The Court of Appeal disagreed and found that liability under the Indemnity could not arise in the absence of any actual claim or complaint by a customer. (For a summary of the Court of Appeal's decision ([2015] EWCA Civ 839), see our blog post on that decision here).

The Buyers appealed to the Supreme Court.

Judgment

The Supreme Court unanimously upheld the Court of Appeal's decision, finding that the Sellers were not liable under the Indemnity given there had been no actual claim by customers or any complaint registered with the FSA in relation to the misselling.

In the lead judgment given by Lord Hodge (with whom the other Justices agreed) the court held that its primary task in contractual interpretation is to ascertain the objective meaning of the language in the contract.

Citing the Supreme Court's decision in Arnold v Britton [2015] AC 1619 (which confirmed the approach in Rainy Sky SA v Kookmin Bank [2011] 1 WLR 2900), the court noted that where there are rival constructions, the court may have regard to business common sense as an aid to deciding between them. However, in striking a balance between indications given by the language used and the implications of the rival constructions based on business common sense, the court must consider the quality of drafting of the clause and must also be alive to the possibility that one party has struck a bad bargain.

Striking this balance involves an iterative process of considering each suggested interpretation against the provisions of the contract and its commercial consequences (Arnold citing In re Sigma Finance Corpn [2010] 1 All ER 571). Lord Hodge said, interestingly, that to his mind it did not matter whether this analysis begins with an examination of the plain language or with the factual background and implications given by rival constructions, so long as the court balances the indications given by each.

Lord Hodge emphasised that both the language and the commercial implications should be used as tools to ascertain the objective meaning of the agreement, and their use will vary according to the circumstances of the particular agreement. Some contracts can be successfully interpreted principally by textual analysis (because of their sophistication, or because they have been negotiated and prepared by skilled professionals), whereas others will require a greater emphasis on the factual matrix (because of their informality, brevity or the absence of skilled professional assistance).

The Indemnity

In applying these principles to the Indemnity, the court took the view that it was poorly drafted and its meaning was therefore "avoidably opaque". It was therefore necessary to adopt the iterative process in order to examine the clause both through a textual analysis of the words in the context of the contract as a whole, and to consider whether the wider relevant factual matrix could provide guidance as to its meaning in light of the commercial effect of rival interpretations.

The court gave considerable emphasis to the contractual context in this case. In particular, the court appears to have been influenced by the existence of warranties which, subject to a two year limitation, would have provided for compensation for losses which arose from the FSA redress scheme. The court observed that two years after completion was not an unreasonably short period of time in which to conduct an internal review for any relevant misselling/regulatory breaches in order to bring a claim under the warranties. The court considered that it is not contrary to business common sense for parties to agree wide-ranging warranties, which are subject to a time limit, and in addition to agree a further indemnity, which is not subject to any such limit but is triggered only in limited circumstances.

In this context, the court made interesting observations about the utility of business common sense to aid the construction of a contract which has plainly been the subject of negotiation by sophisticated parties:

"Business common sense is useful to ascertain the purpose of a provision and how it might operate in practice. But in the tug o’ war of commercial negotiation, business common sense can rarely assist the court in ascertaining on which side of the line the centre line marking on the tug o’ war rope lay, when the negotiations ended."

While the agreement may have become a bad bargain for the Buyer, given their failure to bring a claim in time under the warranties, it is not the court's role to construe the Indemnity in a way that improves their bargain.

Accordingly, the result may have been different had the Indemnity stood on its own (ie if the contract did not contain the warranties). In that event, it may have been anomalous to exclude loss caused by regulatory action that was prompted otherwise than by a customer claim or complaint (ie from the Company self-reporting). This reinforces the importance of construing the contract as a whole, within its wider context.

Comment

While the Supreme Court has sought to emphasise that it was not intending to restate the recent key authorities underpinning the common law position in relation to contractual interpretation, the court's application of those principles in this case suggests a more balanced consideration of both the textual approach (focusing on the plain language of the contract) and the purposive approach of looking at the factual context to consider the commercial implications of the rival meanings. Perhaps the possible shift in emphasis is explained by the fact that, unlike in Arnold, the Supreme Court concluded very clearly that the clause was poorly drafted, which created difficulties both in the interpretation of the meaning of the plain language as well as the rival interpretations and their practical consequences. However, the fact that yet another case of contractual construction has reached the highest appellate courts highlights the difficulty in applying to individual clauses what the courts treat as the settled principles.