In Kowloon Development Finance Limited v Pendex Industries Limited & Ors  HKEC 704 Lord Hoffmann NPJ took the opportunity to clarify the requirements that need to be met to rectify a document recording an agreement between the parties. He also pointed out the differences between the concepts of mutual and unilateral mistake. The judgment provides helpful guidance to anyone involved in negotiating and drafting contracts or seeking to argue that a signed agreement does not reflect the true agreement reached between the parties.
The facts of the case
The case involved two consent orders that had been drafted to reflect settlement agreements between the parties. The Plaintiff had loaned considerable amounts of money to the Defendant. The Defendant fell behind with its repayments and the Plaintiff brought proceedings against the Defendant for repayment of the outstanding amount plus interest. The parties entered into two consecutive consent orders providing for payment of certain instalments, in 2004 and 2005 respectively. The Defendant argued that the second consent order was in full and final settlement, whereas the Plaintiff asserted that both consent orders only documented agreements as to payments to be made by the Defendant in 2004 and 2005, with the outstanding balance to remain payable in accordance with arrangements to be reached between the parties thereafter. The second consent order had not been drafted very well and did not contain a statement that the outstanding balance (after payment of the 2005 instalments) was to remain payable. One of the arguments advanced by the Plaintiff was that the consent order should be rectified for either a mutual or unilateral mistake to make it clear that it did not completely discharge the outstanding debt.
Lord Hoffmann NPJ (with whom the other judges agreed) pointed out that it was possible to construe the consent order to arrive at the meaning asserted by the Plaintiff, ie that the consent order was not in full and final settlement. However, as the original judgment was based on the rectification argument and there appeared to be some confusion as to the application of rectification based upon either mutual or unilateral mistake, he took the opportunity to set out the relevant principles in this regard.
Mutual or common mistake
A mutual or common mistake exists where the parties have agreed one thing, but have mistakenly recorded something else. For the purpose of establishing what the actual agreement between the parties is, the common law applies an objective test. This means that the proper question to ask is what a reasonable observer would have understood the parties to have agreed taking into account all relevant background facts known to the parties at the time. The subjective intentions of the parties are irrelevant. As part of the relevant background facts (also known as the “factual matrix”) the court may take account of pre-contractual negotiations or draft heads of agreement. In this respect, rectification differs from the construction of a contract, where pre-contractual negotiations and previous drafts of the contract may not generally be taken into account when construing a contract. In short, the concept of rectification for mutual mistake means that the court carries into effect what the parties objectively appear to have agreed by bringing the document in line with that agreement.
In contrast to the objective approach taken in the case of mutual mistake, a unilateral mistake is concerned with the subjective states of mind of the parties. Rectification for unilateral mistake is available where one party is mistaken about the meaning of a contract and the other party is aware of that party’s mistake. Although, unlike in civil law jurisdictions, common law does not generally recognise an obligation to negotiate a contract in good faith, rectification for unilateral mistake provides a remedy for a specific form of bad faith, ie cases in which one party tries to take advantage of a counterparty’s mistake rather than drawing the mistake to that party’s attention.
Lord Hoffmann NPJ found that on the facts the second consent order could be rectified based both on mutual and unilateral mistake and that the two bases for rectification were not necessarily mutually exclusive. In other words, it was possible to argue that the parties had made an agreement that included a term that they had mistakenly left out when drafting the agreement, but in case no objective agreement could be proven on the facts, it was also possible to argue that one party knew both that the crucial term had been left out and that the other party was labouring under a mistaken belief that it had been included in the contract.
- When drafting a contract it is important to ensure that the contract reflects the actual agreement reached between the parties and does not contain any ambiguities to avoid unnecessary and costly disputes and to achieve certainty.
- Where a party wishes to argue that the agreement reached between the parties is different from what it appears to be from the wording of the contract it may base its case on the principles of construction, or implication of a term (to give efficacy to the contract), or rectification based on (unilateral or mutual) mistake.
- In a claim for rectification, it may be possible to seek rectification based on both mutual and unilateral mistake (rather than one or the other) if the facts support such a claim.
- Pre-contractual negotiations may be taken into account in a claim of mistake, but are generally inadmissible when construing the agreed terms of a contract.