All too often, a term might seem perfectly clear to the parties when the contract is agreed, but a dispute later arises as to how it is meant to apply in the circumstances that have come about.
If the parties cannot resolve the issue, the court may be called on to interpret the contract. Where the parties have not made themselves clear, the result may then be difficult to predict.
In this second of our updated and relaunched series of contract disputes practical guides, Gary Milner-Moore, Sarah McNally and Steven Dalton consider the court’s approach to interpreting contracts and some practical steps that can be taken to minimise the risks.
You can click here to download the PDF guide or contact webinars to access the archived version of our webinar exploring these issues.
We will be publishing further editions of the updated series of contract disputes practical guides in the coming months. In the meantime, the first edition in our relaunched series (When do you have a binding contract? It may be more (or less) often than you think), and the remaining editions from the original series, can be accessed from the home page for our contract disputes series (which is also linked under “our guides” in the top menu).
A recent Court of Appeal decision has illustrated the strict operation of the common law rule against relying on evidence of pre-contractual negotiations to interpret contracts. The decision confirms that, while it is permissible for a court to take into account pre-contractual material for the limited purpose of understanding the genesis and commercial aim of the transaction as a whole, this does not extend to admitting material in order to shed light on the genesis and aim of a particular contractual provision: Merthyr (South Wales) Ltd v Merthyr Tydfil County Borough Council  EWCA Civ 526.
Importantly, the decision illustrates that it is not only statements reflecting one party’s subjective intentions or aspirations which are excluded for the purpose of interpreting a contract, but also communications that are capable of showing that the parties reached a consensus on a particular point or used words in an agreed sense.
As a practical matter, the decision shows the importance of ensuring that all contractual provisions are drafted clearly. To the extent that any underlying assumptions or background information might be necessary to understand the purpose and intended operation of a particular provision, these should be included in the contract itself, if necessary as recitals. While evidence of negotiations may be admissible if there is a claim for rectification or estoppel, it is clearly preferable to avoid the need for recourse to such arguments.
In a recent decision, the Court of Appeal held that a clause providing for liquidated damages for delay did not apply where the contractor failed to complete the contracted work (the installation of a new software system). The employer under the contract was therefore entitled to recover damages for breach assessed on ordinary principles, rather than liquidated damages: Triple Point Technology Inc v PTT Public Company Ltd  EWCA Civ 230.
The Court of Appeal said that the question of whether such a clause applied in these circumstances would depend on the wording of the clause itself. In relation to the specific clause before the court, the clause was focused specifically on delay between the contractual completion date and when the work was actually completed by the contractor and accepted by the employer. If that never occurred, the liquidated damages clause did not apply. The case is a useful reminder that, when drafting a liquidated damages clause, it is important to ensure there is no room for doubt as to when the clause will apply.
The Court of Appeal also rejected the appellant’s argument that the liquidated damages clause should be struck out as a penalty clause, under the test established by the Supreme Court in the leading case of Cavendish v Makdessi (considered here). The court noted that the total sums as calculated under the clause were modest when compared to the financial consequences of delay in installing the software, and concluded that it was a genuine pre-estimate of loss.
Anthea Brookes, an associate in our disputes team, outlines the decision below. Continue reading
The Supreme Court has unanimously held that a binding agreement was reached between a property seller and an estate agent, despite the parties not having specified the circumstances in which the agreed rate of commission would fall due: Wells v Devani  UKSC 4.
In doing so it overturned the majority decision of the Court of Appeal (considered here) finding that the agreement was incomplete because of the failure to agree this essential term, and that the court could not imply a term in order to transform an incomplete bargain into a legally binding contract.
The Supreme Court found that the only sensible interpretation of the parties’ words and conduct was that the commission would be payable on completion of a purchase by a buyer introduced by the agent, so it was not necessary to imply a term. If it had been necessary, however, the court would have had no hesitation in doing so. It did not agree with the Court of Appeal that there is any general rule preventing the court implying a term where that will render the agreement sufficiently certain or complete to constitute a binding contract, and the conditions for implying a term are satisfied.
The decision emphasises the court’s reluctance to find that an agreement is too vague or uncertain to be enforced where the parties intended to be bound and have acted on their agreement. Of course, as a practical matter, to avoid the risk that the courts will find their bargain unenforceable – or, conversely, imply a term that is not in fact what they intended – parties should ensure that all essential terms are expressly agreed.
Chris Bushell and Maura McIntosh consider the decision further below. Continue reading
In the latest update to the Brexit series on our Herbert Smith Freehills Podcast channel, Paul Butcher, Julie Farley, Maura McIntosh and Tom Henderson discuss what businesses need to know about the impact of Brexit on their English law governed existing and future contracts. We have released two new podcasts:
- ‘The Impact on Existing and Future Contracts’ – In this podcast Paul Butcher, Julie Farley and Tom Henderson consider matters such as the continued use of references to the EU and EU legislation, continued compliance with EU and UK legislation and tips for drafting a “Brexit clause” to proactively address the possible consequences of Brexit.
- ‘Will Brexit allow parties to bring their contracts to an end?’ – Maura McIntosh, Julie Farley and Tom Henderson discuss what businesses need to know about the possibility of bringing contracts to an end as a result of Brexit. This podcast includes consideration of force majeure clauses, material adverse change clauses and frustration at common law, as well as the recent High Court case in which the European Medicines Agency is arguing that Brexit frustrates its Canary Wharf lease.
Our podcasts are available on iTunes, Spotify and SoundCloud and can be accessed on all devices. You can subscribe and be notified of all future episodes.
The Court of Appeal has upheld a decision granting summary judgment to a defendant in relation to an allegation that it had wrongfully terminated a distribution agreement. The court rejected arguments based on contractual construction, implied variation and implied duties of good faith : Ilkerler Otomotiv Sanayai ve Ticaret Anonim v Perkins Engines Co Ltd  EWCA Civ 183.
The decision provides useful guidance on when an express variation of a contract may result in the implied variation of other terms, a point on which there appears to have been no direct authority. The test is whether the express variation is consistent only with the existence of the alleged implied term. When agreeing variations to a contract, parties should be careful to consider whether the proposed changes have any knock-on effects on the rest of the contractual framework, which may need to be addressed by way of additional express amendments. It seems the courts are likely to assist a party in implying a variation only in relatively clear-cut cases.
The decision is also of interest in adding to a growing body of authorities rejecting a role for good faith in relation to contractual termination.
Gregg Rowan and Andrew Hillam, a partner and an associate in our dispute resolute team, consider the decision further below.
The Court of Appeal has found that an exclusion clause in an engineering services contract was effective to exclude any liability on the part of the defendant engineers for identifying and reporting on asbestos on a development site. This was based on the clear wording of the clause and commercial common sense. The traditional principles or canons of construction relating to exclusion clauses had no part to play: Persimmon Homes Ltd v Ove Arup & Partners Ltd  EWCA Civ 373.
In interpreting exclusion clauses, the courts have traditionally applied certain principles which tend toward a narrow construction, in particular: (i) the contra proferentem rule, which provides that any ambiguity should be resolved against the party who put the clause forward and relies upon it; and (ii) the so-called Canada Steamship guidelines, which essentially provide that clear words are required to exclude liability for negligence, and that the court will not interpret a clause to cover negligence if there is some other head of damage it might realistically have been intended to cover (eg strict liability in relation to a statutory duty).
In recent years, however, the courts have tended to cast doubt on the extent to which these principles remain applicable, at least where the clause is clear and unambiguous. This latest decision continues that trend, emphasising that the words used, the relevant context, and commercial common sense should normally be sufficient in determining the meaning of a contract term. The decision suggests that the tendency to assume exclusion clauses must be construed narrowly may be seen by the courts as outdated. As the Court of Appeal commented:
"In major construction contracts the parties commonly agree how they will allocate the risks between themselves and who will insure against what. Exemption clauses are part of the contractual apparatus for distributing risk. There is no need to approach such clauses with horror or with a mindset determined to cut them down."
However, for those who want to ensure their clause is effective, the practical advice remains to use clear and unambiguous drafting, rather than seeking to rely on general wording. Rachel Lidgate and Maura McIntosh, a partner and a professional support consultant in our disputes team, outline the decision below. For more on exclusion clauses, see Defining your liability in advance: Liquidated damages, limitation and exclusion clauses, the sixth edition in our contract disputes practical guides series.
The past few years have provided an abundance of case law on contractual interpretation, including cases at the highest levels. These have sometimes appeared to pull in different directions, particularly on the respective roles of natural meaning and "business common sense" in interpreting contracts.
Maura McIntosh has published a post on Practical Law’s Dispute Resolution blog which considers the key decisions and outlines her view that the more balanced approach promoted in the most recent Supreme Court decision, Wood v Capita Insurance  UKSC 24, is to be welcomed. Click here to read the post (or here for the Practical Law Dispute Resolution blog homepage).
In a judgment handed down yesterday (29 March), the Supreme Court has unanimously dismissed an appeal relating to the construction of an indemnity clause: Wood (Respondent) v Capita Insurance Services Limited (Appellant)  UKSC 24.
The Supreme Court emphasised that it did not seek, once again, to reformulate the guidance to the legal profession, noting that its judgments in Arnold v Britton  AC 1619 (considered here) and Rainy Sky SA v Kookmin Bank  1 WLR 2900 (considered here) provide sufficient statements of this nature.
Rainy Sky and Arnold are often seen as pulling in opposite directions, with the former having given a greater role to commercial common sense in interpreting contracts, while the latter re-emphasised the importance of the natural meaning of the words used.
The present judgment, however, emphasises the common ground, commenting that they were in fact saying the same thing – namely that interpretation is a unitary exercise, in which a balance must be struck between the indications given by the language used (in both the clause under scrutiny and the remainder of the contract) and the implications of rival constructions (which is usually thought of as the business common sense approach). Interestingly, Lord Hodge said that in striking a balance between these two tools to construction it does not matter which way round they are used, so long as the court balances the indications given by each.
The decision does however emphasise that the weight to be given to each tool will depend on the circumstances. Some agreements may be successfully interpreted by textual analysis, eg because they have been professionally drafted and their meaning is clear. Others may require a greater emphasis on the commercial background and implications to interpret a disputed provision. It also emphasises, in line with Arnold, that business common sense can only be taken so far, remembering that one side may have agreed to something which with hindsight did not serve his interest. It is not the role of the court to save the parties from a bad bargain.
For more detail on the decision, see our Banking litigation e-bulletin, or for more on contractual interpretation see What does your contract mean? How the courts interpret contracts from our Contract disputes practical guides series.
The Court of Appeal has confirmed that an insurer could not rely on a condition precedent relating to notification to avoid liability under a public and product liability policy: Zurich Insurance PLC v Maccaferri Limited  EWCA Civ 1302.
At first instance, the Commercial Court rejected an argument that the requirement to notify “as soon as possible” meant the obligation arose when the insured could with reasonable diligence discover that an event was likely to give rise to a claim. It held that this simply referred to the promptness with which notice was to be given once there had been an event likely to give rise to a claim. The words did not indicate an implied duty of reasonable inquiry. The Court of Appeal upheld this decision, noting "[i]f Zurich wished to exclude liability it was for it to ensure that clear wording was used to secure that results. It has not done so."
Although the insured in this case obtained a favourable outcome, notification clauses continue to remain a trap for the unwary and are often a source of dispute between insureds and insurers. The Court of Appeal's decision and its practical implications are considered further in our Insurance and Re-insurance Disputes e-bulletin.