In a judgment that has surprised many commentators and caused some concern amongst credit providers, a High Court decision has interpreted ambiguous provisions in a finance agreement so as to conclude that a borrower’s prepayment of a loan facility following a voluntary refinancing did not trigger a prepayment fee provision in the agreement.

Aston Hills Financial Inc & ors v African Minerals Finance Ltd [2012] EWHC 2173 (Comm).

Background – the role of ‘business common sense’ in contractual interpretation

The last few years have seen considerable judicial attention to the issue of when courts can and should take into account considerations of ‘business common sense’ in interpreting commercial contracts. This issue of course forms part of the wider debate as to when a court should go beyond a purely literal interpretation of contractual wording and take a ‘purposive’ approach to construction – that is, taking into account the purpose behind the contractual provision in its surrounding context.

A basic rule of contractual construction is, of course, that words must be given their natural, ordinary meaning. However, another clearly established principle is that the parties’ contractual intentions are to be assessed by reference to what a reasonable observer with all the relevant background knowledge available to the parties would have understood the parties to have agreed by the words they used.

The ‘literal versus purposive’ issue therefore reflects the tension between:

(i)  the basic principle that courts should enforce only what the parties are found to have in fact agreed and not re-write their bargain into something that the court thinks would have been commercially more sensible or fairer; and

(ii)  the argument that the commercial purpose of a contractual provision is useful and relevant information in discerning what the parties meant by the words they used  –  and that to ignore that context is to risk misinterpreting the parties’ intentions.

When considering developments in this area, it is worthwhile bearing in mind a distinction that can be drawn – at least in theory – between two categories of case:

  • Non-ambiguous provisions: Where there is only one clear literal meaning of the language used but one party asserts that the parties did not in fact intend it to have that meaning and, in support of that assertion, seeks to rely on the non-commerciality of the literal meaning. That is, the court is effectively being asked to correct a drafting mistake; and
  • Ambiguous provisions: Where the words used are, on their natural and ordinary meaning, reasonably capable of bearing more than one interpretation. The most common example is where the meaning of a provision depends on how it is read alongside other provisions of the contract. The question in these cases is whether, in order to choose between the two interpretations, the court should limit itself to assessing the linguistic arguments (that is, which of the two available meanings is the more natural meaning) or whether it can also consider which of the two would make the most sense from a commercial perspective.

(The Aston Hills decision discussed below falls into this second category).

In respect of non-ambiguous clauses, where a court is being asked to depart from the clear literal meaning of the language, the most useful starting point in understanding the modern approach remains that of Lord Hoffman in Investors Compensation Scheme Ltd v West Bromwich Building Society (No.1) [1998] 1 WLR 896 (at 913B-E):

‘..The “rule” that words should be given their “natural and ordinary meaning” reflects the common sense proposition that we do not easily accept that people have made linguistic mistakes, particularly in formal documents. On the other hand, if one would nevertheless conclude from the background that something must have gone wrong with the language, the law does not require judges to attribute to the parties an intention which they plainly could not have had.’

Consistent with that approach, subsequent authorities suggest that, while a court may in some cases rely on considerations of business common sense to depart from the literal meaning of contractual language, that will only be justified in cases where the result of the literal interpretation would be so absurd and commercially nonsensical that it could not be what the parties agreed.

However, in the case of ambiguous provisions, where there is more than one available construction of the language, the position has been definitively settled only more recently, by the Supreme Court’s decision in Rainy Sky SA and others v Kookmin Bank [2011] UKSC 50.

In Rainy Sky, the Court of Appeal had delivered a judgment that was widely perceived as a departure from the previously understood position, by holding that where contractual language produced competing interpretations, a court was not entitled to base its decision on the ‘commerciality’ of the competing constructions ‘unless the most natural meaning of the words produces a result which is so extreme as to suggest that it was unintended’. By finding so, the Court of Appeal was effectively restricting the role of business common sense in interpreting ambiguous provisions to the same limited categories of case as apply to non-ambiguous provisions.

Happily, the Supreme Court unanimously rejected that approach and clearly reaffirmed the purposive approach in cases where there are multiple available interpretations, holding:

‘It is not…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…

If there are two possible constructions, the Court is entitled to prefer the construction which is consistent with business common sense and to reject the other’ (at 21).

It is interesting to note that, in Rainy Sky, it was clear that only one of the two competing interpretations made any sense from a commercial perspective. The defendant did not even seek to put forward any commercially-based explanation of its preferred interpretation but merely argued that such commercial factors were irrelevant. The judgment of Mr Justice Eder in the Aston Hills case considered below illustrates the difficulties that can arise when the business common sense arguments are regarded by the court as less clear cut.

Facts

The dispute in Aston Hills concerned whether a lender was entitled to a fee in respect of a borrower’s early prepayment of a loan under a facility agreement for an iron ore project.

In simplified terms, the facility agreement contained:

  • a relatively standard voluntary prepayment provision allowing the borrower to prepay the whole or part of the loan before the full term (subject to notice and a minimum prepayment amount) (‘the voluntary prepayment provision‘);
  • a provision imposing a prepayment fee of 6% upon any prepayment made ‘pursuant to [the voluntary prepayment provision]’ (‘the fee provision’); and
  • a mandatory prepayment provision obliging the borrower to prepay the loans in an amount equal to any finance proceeds it obtained (‘the finance proceeds provision’).

The borrower obtained refinancing from another source (as expressly permitted under the contract) and, as it was required to by the finance proceeds provision, prepaid the loans in the amount of the finance proceeds obtained.

The lender claimed a prepayment fee on the amounts prepaid, asserting that the prepayment triggered the fee provision because it was voluntary (given that the obligation to prepay arose only because of the borrower’s voluntary decision to refinance).

The borrower resisted on the basis that the fee provision was, on its wording, expressly limited to payments made under the voluntary prepayment provision. The payment in question was not purported to be made under that provision (for example, it did not comply with the relevant notice provision) and therefore did not trigger the fee obligation.

Decision

Both parties and the Court accepted at the outset that the principles of construction to be applied by the Court were as set down by the Supreme Court in Rainy Sky. That is, as there were two arguable constructions of how the disputed provisions operated, the Court was entitled to undertake a weighing exercise comparing which of the two made more sense from a commercial perspective (and was therefore more likely to be what a reasonable observer would have understood the parties to have agreed).

Accordingly, a large portion of the argument before the Court consisted of the parties’ submissions as to why their preferred interpretation was the more commercially sensible. However, after considering those submissions at some length, Eder J concluded that the arguments were evenly balanced and did not point clearly in favour of one construction or the other: “The arguments fly in different directions – or at least are not clear cut’“.

That conclusion might seem somewhat surprising to those dealing regularly with loan facility agreements and familiar with the role played by voluntary prepayment fees in such transactions. In particular, the commercial factors cited in favour of the bank’s interpretation that were considered by the Judge, but ultimately not regarded as sufficiently persuasive, included:

  • Given that a clear purpose of voluntary prepayment fees is to compensate a lender for the cost of funds and the loss of future payments, Eder J did observe that ‘… it seems to me somewhat odd that the lender’s entitlement should depend on the circumstances in which the borrower makes the payment‘. He noted that, while it might be considered commercially ‘unfair’ for a borrower to have to pay such a fee in the case of a mandatoryprepayment, ‘there is no such “unfairness” where a borrower decides for its own commercial interests to refinance “voluntarily” and to pay off the existing facility from such refinancing’. However, Eder J appears to have concluded that this factor was not determinative because ‘it begs a number of questions as to what is meant by “voluntarily“‘ and ‘it is arguably inconsistent with the language employed by the parties‘;
  • Eder J accepted that the borrower’s construction would permit it deliberately to adopt a course of action that would allow it to evade payment of the prepayment fee;
  • If the prepayment fee was not payable in these circumstances of a refinancing, it was difficult to see when it would ever have been payable, as the borrower was allegedly known to be not in a position to prepay the loan (in the minimum $100m amount) from its own cash resources. In those circumstances, the fee provision would be redundant. Eder J stated that he was ‘impressed with that argument’ and would have been prepared to accept it as an aid to construction, but that the borrower’s inability to fund a prepayment itself had not in this case been factually substantiated.

Having concluded that the commercial arguments were not clear cut, the Judge stated that there would be ‘potential danger’ in relying on such arguments to reach a decision. He therefore returned to examining the wording of the various clauses and, as a matter of literal construction, concluded that no prepayment fee was payable. While accepting that the refinancing had been voluntary, he refused to conclude that the consequent prepayment itself could therefore also be characterised as voluntary and be regarded as falling within the voluntary prepayment provision. As the fee provision was, on its wording, expressly limited to payment under that voluntary prepayment provision, no fee was payable.

Having reached that conclusion based exclusively on a literal interpretation of the provisions, Eder J, perhaps anticipating the reception his decision would receive, acknowledged:

I should emphasise that I remain very uncertain whether this conclusion accords with business common sense. As noted above, it was [the lender’s] submission that it did not. However, I found the arguments in relation to what was supposedly business common sense difficult to apply and whatever such arguments may be, the conclusion which I have reached is one which, in my judgment, is more consistent with the language used …’ (at 35).

Pending Appeal

Unsurprisingly, the decision has been appealed and is expected to be heard by the Court of Appeal in March 2013.

While the issues in dispute are of course specific to the particular contractual provisions in question, given the widespread use of similar prepayment provisions in such agreements, much interest will be focussed on any opinion expressed by the Court of Appeal as to the merits of the competing commercial arguments regarding such provisions.

Further, depending upon the arguments raised, the appeal proceedings may provide an opportunity for the Court of Appeal to provide guidance on the appropriate approach for a court to adopt in cases where (unlike in Rainy Sky) it considers the commercial arguments to be finely balanced. Eder J appears to have taken the view that, because the commercial factors were ‘not clear cut’ and ‘difficult to apply’, it was appropriate to abandon the purposive approach entirely in favour of a purely literal construction – even if that risked producing a result that was inconsistent with business common sense. Such an approach is arguably not supported by Rainy Sky or any of the other authorities endorsing the purposive approach to resolving contractual ambiguities. It is to be hoped that clear guidance on this point will be given by the Court of Appeal.

Key points

  • Regardless of the result on appeal, this judgment is a stark reminder that, although the purposive approach to contractual construction will often provide a welcome safeguard against poor drafting and unforeseen situations, there will always be some unpredictability as to how a judge will assess the ‘business common sense’ arguments in any case.  What might seem obvious to business people operating in a particular market cannot be guaranteed to be equally obvious to a judge looking at the issue afresh. As this case demonstrates, uncertainty is not limited to novel or unusual contractual provisions.
  • The message from surprising results such as this is, as always, that clear drafting is paramount. That applies not just to avoiding ambiguity in the first place but, potentially, giving consideration in appropriate cases to including in the contract a clear statement of the commercial purpose of the contract or of a specific provision, particularly where the provision is at all unusual or potentially one-sided, or otherwise where its purpose might not be obvious.

Damien Byrne-Hill
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