Background
Facts
Decision
Comment


While the courts are increasingly willing to give effect to broader notions of business common sense in construing commercial agreements, a recent Court of Appeal decision highlights the limits of this approach.(1) Despite the thrust of recent decisions, it provides an instance of the written word trumping an arguably more intuitively commercial construction.

Background

In seeking to ascertain the true meaning of commercial agreements the courts have become increasingly willing to weigh the factual matrix in the mix with the written word. It is no longer the case that the court can take account of the factual background only if the words used are ambiguous or otherwise produce an absurd result. Textual ambiguity is no longer a prerequisite for consideration of the broader context of a commercial deal.

The court's task is to ascertain the intention of the parties (objectively speaking) from the words used in the commercial document, in the relevant context and against the factual background in which the document was created. The Supreme Court has emphasised the importance of business common sense when considering competing constructions of an agreement, such that the courts are not obliged to favour the natural meaning of words, but are entitled to prefer the construction that is consistent with business common sense.(2)

Facts

This latest appeal in a long line of recent decisions on points of construction required the court to construe a pre-payment provision within a loan facility agreement.

The facility was concluded in February 2011 with repayment to commence in April 2012. The facility provided for a pre-payment fee of 6% in the event that the loan was voluntarily repaid within the first year.

Within the first year, the borrower pre-paid the loan in full following a refinancing of the facility through a third-party bank. The lenders sought to enforce the pre-payment provision. They argued that because the pre-payment arose as a result of a voluntary refinancing, the pre-payment itself was voluntary and the borrower's liability for the 6% fee was therefore triggered.

The borrower relied on a provision requiring it to pre-pay the loan in an amount equal to any 'finance proceeds' received by it or any member of its group – under which definition fell the proceeds of refinancing. The borrower maintained that as the receipt of the proceeds of the refinancing had given rise to an obligation to pre-pay under the facility, the pre-payment itself was not voluntary and the pre-payment fee was therefore not payable.

The lenders argued that this could not possibly have been the intended consequence and would amount to an uncommercial construction. The pre-payment fee – which was to compensate the lenders for the high rate of return on interest payments that would be lost if the loan were voluntarily pre-paid – could, on this analysis, be avoided by a refinancing of the loan, rather than a straightforward pre-payment from the borrower's own funds.

Decision

The Court of Appeal found in favour of the borrower. It held that the decision to obtain the refinancing facility and the requirement to use the proceeds from that to repay the loan in full were two separate matters. It did not follow from the fact that the first decision was voluntary that the pre-payment was also voluntary.

Once the acts of refinancing and pre-payment were separated, the court found the construction of the clause "much easier". Once the borrower had obtained the finance proceeds from the refinancing facility, it was contractually obliged to use that sum to pre-pay the loan. To characterise pre-payment in those circumstances as voluntary would, the court held, be "an abuse of language".

The court was mindful that the lenders' submissions on commercial common sense risked confusing that notion with what was, as properly construed, a reference to good business sense on their part – a wholly different concept.

The court also had regard to the fact that the facility, which ran to 146 pages, had taken three months to negotiate and had involved six different sets of lawyers for the original lenders, who had incurred legal fees of almost $2 million in the process.

Against that background, the court was unwilling to find that the facility lacked commercial common sense. The court found the limited provision for a pre-payment fee to be the embodiment of commercial common sense. Lord Justice Aikens noted that:

"Doubtless the Borrower would not have wanted to pay such a fee (which would be US$30 million if the Facility had been fully drawn down) at all. Doubtless the Lenders would have wanted a fee to be paid for prepayment in as many circumstances as possible. Doubtless they settled on a compromise: a fee was payable if there was prepayment under clause 8.5. That ultimate position is the essence of 'commercial common sense'."

In reaching this conclusion, the court was keen to establish that:

  • commercial common sense is not to be elevated to an overriding criterion of construction;
  • the parties should not be subjected to an individual judge's own notion of what might have been the sensible solution to the parties' commercial conundrum; and
  • the issue of construction should not be determined by what seems like commercial common sense from the point of view of one of the parties to the contract.

Comment

It has been said that the 'perfect' commercial agreement will be not only sufficiently clear for a person reading in good faith to understand, but also sufficiently precise that a person reading in bad faith cannot misunderstand.(3)

However, few commercial agreements are perfect. The meaning of a sentence will often be more than that of the separate words. The increasing focus on the wider factual matrix and commercial common sense renders the court better placed to construe as accurately as possible the parties' actual (albeit deemed) agreement.

This decision provides a reminder of the dangers of commercial common sense being used (or, rather, misused) to rewrite agreements so as to produce an outcome that is consistent not with the parties' written agreement, but rather with subsequent views as to the intuitive and commercially 'correct' result.

This case shows that the court is capable of respecting that tipping point. A contract as heavily negotiated as the facility in question – in the absence of clear evidence of something having gone wrong with the language – was plainly an improper agreement over which to spill judicial red ink.(4)

For further information on this topic please contact Matthew Dando at RPC by telephone (+44 20 3060 6000), fax (+44 20 3060 7000) or email (matthew.dando@rpc.co.uk).

Endnotes

(1) BMA Special Opportunity Hub Fund Ltd v African Minerals Finance Ltd [2013] EWCA Civ 416.

(2) Rainy Sky SA v Kookmin Bank [2011] UKSC 50.

(3) Re: Castioni (1891) 1 QB 149.

(4) The decision can be contrasted with the Court of Appeal decision earlier this year in Kudos Catering (UK) Limited v Manchester Central Convention Complex Limited [2013] EWCA Civ 38 (for further details please see "Excluding liability (and avoiding judicial red ink)"). In that case, a seemingly wide exclusion of claims for loss of profit was held to have been restricted to claims in respect of poor performance (as opposed to non-performance) of the agreement. To have held otherwise, in that instance, would have left one party without a remedy in the event of the counterparty's non-performance, rendering the contract effectively devoid of contractual content.

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