In Merthyr (South Wales) Limited v Merthyr Tydfil County Borough Council (2019), the Court of Appeal considered key cases around interpretation of contracts, and in particular whether evidence of pre-contractual negotiations can be used to interpret a disputed clause.

Background

Merthyr (South Wales) Limited ("Merthyr") was a mining company which carried out mining at a site for which Merthyr Tydfil County Borough Council (the "Council") was responsible. As well as mining the site, Merthyr entered into an obligation to carry out certain restoration works, to be done after the mining was completed. A number of parent companies of Merthyr entered into a deed of guarantee in July 2007, guaranteeing that Merthyr would perform its restoration obligations.

In August 2015, when the parent companies were looking to divest themselves of their interests in coal mining, they presented the Council with a proposal to replace the deed of guarantee. The proposal, which included a cash escrow fund for the purpose of securing a proportion of the restoration costs, was accepted by the Council and the escrow agreement was executed on 21 December 2015 (the "Escrow Agreement").

The Disputed Clause

The disputed clause of the Escrow Agreement which was the subject of the legal proceedings was clause 4.2, "Funding the Account", which provided as follows:

"(a) Subject to paragraphs (b) and (c) below, on each Funding Date, the Company shall deposit an amount equal to £625,000 (as adjusted pursuant to paragraphs (c) and (d) below, the 'Quarterly Amount') into the Account.

(b) Subject to paragraphs (c) and (d) below, if on any Funding Date the Company fails to pay all or part of the Quarterly Amount into the Account (the 'Missed Funding Date'), the Quarterly Amount for the following Funding Date shall be equal to £625,000 plus the outstanding amount payable on the Missed Funding Date.

(c) Subject to paragraph (d) below, if the Company fails to pay all or part of the Quarterly Amount on two or more consecutive Funding Dates, the Quarterly Amount shall increase on each subsequent Funding Date by an amount equal to the aggregate outstanding amounts on each previous Missed Funding Date.

(d) If the Final Funding Date is a Missed Funding Date, the Company shall pay an amount equal to Total ERA Sum less the amount standing to the credit of the Account on the Final Funding [Date] by 30 June 2022 (the 'Funding Longstop Date')."

Since entering into the Escrow Agreement, Merthyr had made no payments at all into the escrow account. The Council sought an order for specific performance to compel Merthyr to make payments and was successful on its application for summary judgement. Merthyr appealed. It argued that on the proper interpretation of the Escrow Agreement it was not under an enforceable obligation to pay any money into the escrow account before the Funding Longstop Date.

Court of Appeal decision

The Court of Appeal dismissed the appeal, with Leggatt LJ giving the leading judgment and noting "The judge rejected this defence as having no real prospect of success and, in my opinion, he was plainly right to do so".

Textual analysis of clause 4.2

Merthyr sought to explain its interpretation of the disputed clause by reference to the specific words of the contract:

  • First, it relied on the "Subject to paragraphs (b) and (c) below" wording at the start of paragraph (a) and the similar wording at the start of paragraphs (c) and (d). It submitted that these words made each provision clearly conditional on the next. The only obligation which did not have a consequence was the one at (d) – i.e. payment by the Funding Longstop Date – in other words, the payment could be rolled forward until the Funding Longstop Date was reached.
  • Second, it pointed to the words "as adjusted" in clause 4.2(a), suggesting that they indicated that if Merthyr failed to pay the Quarterly Amount or any part of it on a Funding Date, then the amount payable on that date would be altered in the way required by the later paragraphs, again, with the effect that the obligation was rolled forward.
  • Third, Merthyr stressed the existence of the Funding Longstop Date – suggesting that there would have been no point including this unless it was intended to be the only enforceable payment obligation if earlier payment dates had been missed.

The Court rejected these arguments. It agreed that the words “subject to” could mean that the payment obligations in clause 4.2(a) were conditional on the provisions that followed. It also accepted that “as adjusted” indicated that if paragraphs (b) or (c) were applicable, the Quarterly Amount to be deposited into the escrow account on the Funding Date would not be the basic amount of £625,000 but an adjusted amount, reflecting the subsequent provisions. Leggatt LJ considered, however, that Merthyr's interpretation broke down thereafter because it treated the clause as potentially requiring not just one but two adjustments to be made to the amount payable on a given Funding Date – the second adjustment occurring immediately after the Funding Date had passed if the obligation to pay the money into the escrow account on that date had not been fulfilled and having the effect that once a payment on a particular Funding Date was missed, the amount due on the original Funding Date ceased to be payable – effectively reducing the required payment to zero. He concluded that this interpretation was not consistent with the language of the clause and made no commercial sense at all.

Evidence of pre-contractual negotiations

Merthyr argued that, in considering its interpretation of the clause, the Judge at first instance had failed to give appropriate regard to evidence of the genesis of the disputed clause. The relevant evidence was a section of the proposal to the Council regarding the Escrow Agreement and the Council's subsequent report which referred to payments being rolled forward to the Final Funding Date in the event that Funding Payment Dates were missed. Merthyr submitted that this evidence showed the parties intended the clause to mean that the only consequence of missing a Funding Date was that the due date would be advanced to the next quarter date, subject to the obligation to pay the full sum by 30 June 2022.

Merthyr contended that evidence of pre-contractual negotiations was admissible to show the genesis and aim of not just the transaction, but a particular provision of a contract also – here, the disputed clause. By reference to the key case law in this area, focusing in particular on the House of Lords decision in Chartbrook Ltd v Persimmon Homes (2009), the Court of Appeal rejected Merthyr's argument. Pre-contractual negotiations may be looked at to show the surrounding circumstances and, by that means, to explain the commercial or business object of a contract – but not what the contract should be understood to mean. Neither the proposal nor the Council report were therefore admissible as aids to interpretation of the disputed clause. On the proper interpretation of the Escrow Agreement, Merthyr was under a current and continuing obligation to make quarterly payments into the escrow account and the Judge at first instance had been right to enforce that obligation by an order for specific performance.

Business Common Sense and commercial purpose

The Court also objected to Merthyr's interpretation on the basis of business common sense. It reasoned that no contracting party would have intended that if a sum of money went unpaid, it ceased to be due. He described such an interpretation as "an extraordinary and improbable intention to attribute to contracting parties" – which was highly unlikely to make commercial sense. The Court further noted that Merthyr's case on interpretation was contrary to the very purpose of the escrow account. It was set up to protect the Council over the period that the mining was being carried out by building up a fund of money which would, in due course, be available to pay for restoration works once the coal extraction had ceased. No fund would be built up on Merthyr's interpretation.

Comment

Contractual interpretation can give rise to significant disputes – parties to a contract often taking differing approaches which can lead to significant differences in the operation of particular clauses. This case provides a helpful reminder of some of the key factors relevant in this area - in particular how far pre-contractual negotiations can be used as an aid to interpretation.