Background

A written contract will not always refl ect the parties’ actual agreement. Although the courts will not readily accept that contracting parties have made mistakes in formal documents, sometimes it is clear that something must have gone wrong. The question of how to put it right has recently received considerable judicial attention. This Bulletin looks at the principles involved and at two recent decisions in which they have been applied.

In interpreting contracts, English law focuses on the presumed objective intention of the contracting parties. Courts look at the ordinary meaning of the words used and determine what a reasonable person with knowledge of the full factual matrix - that is, all the background information available to the parties - would have understood the words to mean. In order to uphold the objectivity of the test and the benefi ts that it is deemed to bring (above all, certainty and predictability), evidence as to pre-contractual intentions and negotiations is generally inadmissible.  

However, where something has plainly gone wrong with the language of the contract, an overly narrow focus on the words can thwart the aim of giving effect to the parties’ objective intentions and would elevate certainty over commerciality. Therefore, the courts sometimes give effect to what the contract should have meant. This is mainly done in two ways. First, the court may deem the words to mean what they should mean (ie, correction by construction). Second, it may rewrite the words to mean what they should mean (ie, rectifi cation). There is a fi ne line between these remedies. Broadly speaking, the former is a way of repairing minor mistakes in drafting, whereas the latter is used where a more fundamental error has occurred in committing the agreement to paper. However, neither approach is an exception to objective orthodoxy; rather, correction and rectifi cation are simply alternative vehicles through which to give effect to the parties’ objective intentions when the written words of the contract fail to do so.

Correction by construction

In the leading case, Lord Hoffmann stated that for a court to correct an error by construction, it is suffi cient for it to be “clear that something has gone wrong with the language” and “clear what a reasonable person would have understood the parties to have meant”.1 If this is so, there is no limit “to the amount of red ink or verbal rearrangement or correction which the court is allowed” to ensure that the contract refl ects what the parties must objectively have intended.

Where the English courts embrace this approach to construction - and they appear increasingly willing to do so - the result is more likely to accord with the parties’ actual commercial intentions, rather than those which were erroneously recorded. It also removes the need to meet the higher test for rectifi cation.

State Street Bank and Trust Company v Sompo Japan Insurance Inc

Facts

In this case2 Cheyne CLO Investments Ltd issued fl oating-rate notes in six tranches with varying priorities, due in 2018. The notes were constituted by a trust deed between the trustee, the issuer and Sompo Japan Insurance Inc, the guarantor. The conditions of the notes were set out in a schedule to the trust deed. The notes were secured by total return swaps between the issuer and a swap counterparty.

An event of default arose. The swap counterparty claimed against the guarantor. The guarantor paid the sum claimed and sought reimbursement from the issuer under the terms of a reimbursement agreement.

An issue arose as to whether the guarantor was entitled to the reimbursement. This turned on the defi nition of the term ‘fi nancial guarantee fl oating amount’, which appeared in the conditions, the master defi nitions and the offering circular. The defi nition in the conditions and master defi nitions (ie, the contractual documents) did not refer to amounts payable under the swaps. However, a defi nition in the offering circular, which did not have contractual effect, included that reference.

Decision

The court found that it was clear from a consideration of all relevant documents that an obvious mistake had been made in the contractual defi nition. Without correction, the arrangement would make no commercial sense in the context of the transaction as a whole. The court found that a rectifying construction of the contractual documentation was equally clear: the contractual defi nition could and should be read as if it included a reference to the amounts payable under the swaps. The question of rectifi cation, which had been advanced in the alternative, did not therefore arise.

The case is a clear illustration of how mistakes in writing can be corrected - whatever the extent of the necessary correction - when what the parties meant is clear to a reasonable person looking at all the documents and the factual matrix.

Rectification

Rectifi cation goes further than correction by construction. Rather than looking at the written agreement and trying to make it good though interpretation, the court rectifi es the contract on the basis that, as written, it is fundamentally mistaken. Thus, the focus shifts from an interpretation of the existing language to a more fundamental rewriting of the text.

A party seeking rectifi cation based on a common mistake must show that:

the parties had a common continuing intention, whether or not this amounted to an agreement, in respect of a particular matter in the agreement to be rectifi ed  

there was an outward expression of accord  

the intention continued at the time of the execution of the instrument for which rectifi cation is sought through error  

the instrument did not refl ect the common intention.3  

Pre-contractual negotiations are admissible in rectifi cation claims, as such evidence is fundamental to ascertaining the parties’ intentions that were not committed to the fi nal written agreement. However, the continuing common intention must have been objectively manifest. What matters is the “the words and acts of the parties demonstrating their intention, not [their] inward thoughts”.4

The following recent decision demonstrates both the court’s approach to rectifi cation generally and the impact of ‘entire agreement’ clauses in these circumstances.

Surgicraft Ltd v Paradigm Biovices Inc

Facts

In this case5 Surgicraft validly terminated its exclusive distribution agreement with Paradigm on the grounds of Surgicraft’s change of control. The contractual documentation did not provide for compensation in the event of such termination.

The contract also contained: (i) an ‘entire agreement’ clause, which provided that the written terms constituted the “entire understanding between the parties with respect to the subject matter and supersede[d] all prior agreements, negotiations and discussions between the parties relating to it”; and (ii) a clause which provided that the “signing of this agreement implies acceptance of all clauses stated herein”.

Paradigm claimed that there was a mistake in the documentation and that the parties’ continuing common intention had been that termination for a change of control would give rise to compensation. Surgicraft argued that there had been no such intention; even if there had been, rectifi cation was unavailable because the ‘entire agreement’ provision prevented a party from asserting an understanding that was contrary to the terms of the written agreement.

Decision

The High Court found on the evidence that the parties’ continuing common intention was that Paradigm should receive compensation in the event of termination for change of control. Accordingly, it ordered rectifi cation of the written terms to refl ect that intention.

The court found that the ‘entire agreement’ clause was not a bar to this. Its purpose was to “preclude a party … from threshing through the undergrowth and fi nding in the course of negotiations some (chance) remark or statement… on which to found a claim.”6 A claim for rectifi cation, by contrast:

proceeds on the basis that the parties have made a mistake in expressing their true agreement, a mistake which infects [an entire agreement clause] as much as any other aspect of the agreement.”

Nevertheless, the court acknowledged that an entire agreement clause was relevant in ascertaining the parties’ common intention. Where the contract contained an entire agreement provision as a boilerplate clause, this could not be taken (without more) to indicate the parties’ common intention. However, if there was evidence that the parties had considered the clause as part of their negotiations and had turned their minds to its meaning and effect, it could lead to the conclusion that their objective common intention was to restrict the scope of their contract to the terms of the written agreement, however mistaken such terms might be.

Comment

The overarching endeavour in cases of contractual interpretation is to get as close as possible to the parties’ actual agreement as objectively construed. The construction or rectifi cation of written agreements are simply ways for courts to do this. Together with estoppel by convention, they are safety nets which save agreements from being distorted by errors in committing them to paper.

The recent, more liberal approach to these issues is to be welcomed. As documents that underpin complex deals come under greater scrutiny, it is encouraging to see that the English courts are prepared to take a modern commercial approach to the issues that inevitably arise. Getting as close as possible to actual intentions and agreements, as opposed to applying an overly formulaic and prescriptive focus on the form in which those agreements have come to be recorded, should promote more commercial outcomes in litigation.

However, the courts will not be readily persuaded that parties have made linguistic mistakes and there is an inherent unpredictability in judges’ responses to such claims.

As the House of Lords acknowledged in Chartbrook, the subtleties of language are such that no judicial guidelines or statements of principle can prevent a divergence of opinion as to whether something has gone wrong with the language. Even where such a problem can be established, it is a diffi cult task to prove that, in the face of confl icting written evidence, the agreement was as the challenging party claims that it was.

Parties should be as clear and precise as possible in the drafting of written agreements. However, mistakes will occur. The documentation in the State Street Bank, for example, included over 500 defi ned terms.

It is advisable to keep records, notes and superseded drafts from negotiations. If a dispute arises, parties should think carefully about how best to establish what they say was the actual agreement. In the event that the contractual wording does not assist them in this, the factual matrix and (in rectifi cation claims) evidence of precontractual negotiations may be available to support an alternative, more favourable, reading of the contract. For this reason, parties will often seek both remedies in the alternative. Not only is the threshold for correcting a contract by construction less onerous, but combining it with a claim for rectifi cation will provide the opportunity to put evidence of pre-contractual negotiations before the court, even though it is not technically admissible on the construction argument.