Supreme Court’s judgment regarding the construction of ambiguous clauses

Rainy Sky S.A. and others v Kookmin Bank [2011] UKSC 50

This is the first Judgment of the Supreme Court in this area since Lord Hoffman’s Judgment in Chartbrook v Persimmon Homes. This Judgment  further continues the trend of the Courts emphasising the importance of being commercial when interpreting ambiguous clauses in agreements.

Whilst this decision is therefore of importance to those who negotiate and draft contracts as well as to those who resolve disputes, clearly it is far preferable to avoid ambiguity in agreements by ensuring that the language used is as certain as possible. Aside from reviewing documents carefully before agreeing them, a useful way of clarifying the commercial intent of parties is by using the recitals of an agreement to set out what the parties’ commercial intentions are and what the context of the agreement is. Ensuring a record is kept of all negotiations and points of interpretation of an agreement may also help to establish the meaning of an ambiguous clause.

In brief, this Judgment builds on that of Chartbrook v Persimmon Homes where it was established that the Courts are prepared to intervene and correct mistakes made in contractual drafting where it is clear that an error has occurred and where it is equally clear what the parties’ actual intention was. When the Court does intervene it will interpret the clause from the view of the “reasonable person”.

Rainy Sky S.A. and others v Kookmin Bank establishes that if there are two possible constructions, as in this case, it is generally appropriate to adopt the interpretation that is most consistent with business common sense and to reject the other. It is not necessary to conclude that a particular construction would produce an absurd or irrational result before proceeding to have regard to the commercial purpose of the agreement. This Judgment shows the commercial approach of the Courts which we view as being sensible.

Issue in Dispute

In May 2007 Rainy Sky S.A. and others (“Rainy Sky”) entered into shipbuilding contracts (“the Contracts”) with Jinse Shipbuilding Co Ltd (“the Builder”). Under the Contracts Rainy Sky were to pay the Builder in instalments for each vessel ordered. Article 8 of the Contracts stated that the payment of the first instalment was conditional upon the Builder providing the Buyer with a satisfactory refund guarantee (“the Bonds”). In particular Article 12.3 of the Contracts stated that if the Builder became subject to certain insolvency proceedings “[Rainy Sky] may ... require the Builder to refund immediately to [Rainy Sky] the full amount of all sums paid by [Rainy Sky] to the Builder”.

In August 2007 the Builder issued the Bonds to Rainy Sky. The Bonds stated that the Builder promised to pay Rainy Sky “all such sums due to [Rainy Sky] under the Contract”. It was explained in the Bonds that this promise was given “in consideration of [Rainy Sky’s] agreement to make the pre-delivery instalments under the Contract”. It was further stated in the Bonds that the Builder’s liability would not be affected by “any insolvency, re-organisation or dissolution of the Builder”.

In 2008 the Builder experienced financial difficulties and later became subject to a formal debt work out procedure. Rainy Sky then wrote to the Builder demanding repayment of the instalments already made under the Contracts. Though it was common ground that the Contracts were relevant to the true construction of the Bonds, the Builder rejected Rainy Sky’s demands on the basis that the Builder had not undertaken to guarantee payments of refunds arising under Article 12.3 of the Contracts. Therefore, at the heart of the dispute was the question of whether, under a true construction of the Bonds, Rainy Sky were entitled to payment from the Builder in accordance with Article 12.3 of the Contracts.

Procedural History

In the High Court the judge ruled in favour of Rainy Sky’s construction of the Bonds. On appeal the majority of the Court of Appeal (Thorpe and Lord Patten) overturned this decision. Lord Patten’s conclusion in the Court of Appeal was as follows:

“In this case (as in most others) the Court is not privy to the negotiations between the parties or to the commercial and other pressures which may have dictated the balance of interests which the contract strikes. Unless the most natural meaning of the words produces a result which is so extreme as to suggest that it was unintended, the Court has no alternative but to give effect to its terms. To do otherwise would be to risk imposing obligations on one or other party which they were never willing to assume and in circumstances which amount to no more than guesswork on the part of the Court.”

Supreme Court’s Judgment

The Supreme Court unanimously overturned the Court of Appeal’s decision.

Lord Clarke, giving the Judgment, stated that unlike Patten LJ he did not consider it 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 Lord Clarke suggested that a balance ought to be struck and that “a Court when construing any document should always have an eye to the consequences of a particular construction”. Lord Clarke stated that he agreed with the sentiment that “speaking generally, commercially minded judges would regard the commercial purpose of the contract as more important than niceties of language”.

Lord Clarke concluded that the case law in this area (notably Lord Hoffman’s Judgment in Chartbrook v Persimmon Homes) show 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. This process involves ascertaining what a reasonable person would have understood the parties to have meant. A reasonable person, for these purposes, is one who has all the background knowledge that would reasonably have been available to the parties at the time of the contract.

Regarding the role to be played by the consideration of business common sense in determining what the parties meant, Lord Clarke held that where the parties have used unambiguous language, the Courts must apply it. However, if there are two possible constructions, as in this case, it is generally appropriate to adopt the interpretation that is most consistent with business common sense and to reject the other. It is not necessary to conclude that a particular construction would produce an absurd or irrational result before proceeding to have regard to the commercial purpose of the agreement.

Applying this to the facts of the dispute, Lord Clarke found that a construction of the Bonds which excluded the Builder’s insolvency from situations that trigger the Builder’s repayment obligations made no commercial sense.