A contract is a written or oral agreement between parties that are legally enforceable once incorporated by signature, notice, course of dealings or customs. Written contracts include terms such as conditions, warranties, misrepresentations and innominate terms. There are two type of terms named express and implied terms. Parties often come across issues relating to terms due to dissimilar interpretations. Lord Hoffmann put forward a test containing five principles in order to offer guidance on the interpretation of contractual terms. This derived from the case Investors Compensation Scheme Ltd v West Bromwich Building Society and others . This essay will lay emphasis on whether Lord Hoffmann's core principles on interpretation of contracts are unhelpful or not, and whether the modern approach is constructive and helpful enough to replace the traditional approach.
Investors Compensation Scheme case illustrates how investors took financial advice regarding home plans and how the house prices fell due to fluctuations in the stock markets. Investors assigned all their third-party claims to ICS against West Bromwich Building Society in pursuance of directly suing for the losses. Afterwards, investors sought to claim their right to rescind the mortgages . Lord Hoffmann reformulated a process of interpreting contracts to ensure the terms would illustrate commercial common sense and put forward five core legal principles .
1. Objectively, what would a reasonable person would do?
2. Follows Lord Wilberforce's concept of "matrix of facts" and it simply means the background of a contract. It includes 'absolutely anything' that would have induced the parties to form a contract.
3. Excludes subjective content, prior negotiations and intentions. It is only admissible in an action for rectification, estoppel since ordinary interpretations are completely different from legal interpretations.
4. What the parties reasonably understood at the time of contract must be incorporated to the interpretation procedures. It may or may not comply with the grammatical and literal sense of the language since the meaning of the words are different from what is conveyed to a reasonable person through a document.
5. Yields to business common sense and if something has gone wrong in the language, courts will not give a different intention than to what was intended by the parties.
Generally, the courts used the 'four corners' approach where a document is construed using ordinary grammatical meaning of the words. This limited the search for intention of consideration between parties and Lord Hoffmann adduced the traditional approach. However, the principles contradict with each other resulting uncertainties. Second principle illustrates how the parties should disclose background information and 'absolutely anything' that would have affected the contract, whereas the third and fourth principles state not to include prior negotiations, subjective content and only to integrate the background information which limits to the duration of the contract. This is controversial since the pre-negotiations and subjective content is part of the 'matrix of facts' which leads the parties to create a contract. A reasonable person would make decisions by analysing previous and current data along with the present circumstances to arrive at a rational result. Therefore, Lord Hoffmann's principles are unhelpful for the interpretation of contracts since it will often mislead the parties and the courts. Nevertheless, it was later modified in the case Bank of Credit and Commerce International SA v Ali and others by Lord Hoffmann. He asserted that factual background is restricted but can include the state of law since we assume the parties are reasonable people. He then highlighted the distinction of case law between the tight interpretation of literal construction against the favour of interpretation which depicts the commercial common sense.
"…. there is no conceptual limit to what can be regarded as background. It is not, for example, confined to the factual background but can include the state of the law (as in cases in which one takes into account that the parties are unlikely to have intended to agree to something unlawful or legally ineffective) or proved common assumptions which were in fact quite mistaken. "
Further, the exclusionary rule derived from the case Prenn v Simmonds where Lord Wilberforce went on to explain that pre-contractual negotiations are unhelpful except when deriving at the end of a contract. In some circumstances it is wise to be dependent on the words of the documents alone since prior negotiations portray subjective statements. However, admission of such evidence would lead to uncertainty and difficulty in interpretation, while prolonging the dispute and costs of the litigation. Further, it will sway the courts from looking at the core issue because the uncertainty may lead to more problems. Besides, courts tend to exclude what goes in a person's mind when dealing with cases as human minds are fickle and unpredictable. For example, party A might claim rights that were blocked from a clause presented by party B and applying subjective content and pre-negotiations may give rise to issues that were not there in the first place. This would misdirect the courts from the main issue. Therefore, there needs to be a balance of information which are taken in to account when construing documents since excluding pre-contractual negotiations could impact the third parties negatively. Lord Wilberforce also asserted that "evidence of negotiations, or of the parties’ intentions…ought not to be received, and evidence should be restricted to evidence of the factual background known to the parties at or before the date of the contract, including evidence of the “genesis” and objectively the “aim” of the transaction. "
Traditional approach is unhelpful as it requires the courts to interpret the contract even when there is no ambiguity. Moore-Bick LJ in Procter & Gamble Co v Svenska Cellulosa Aktiebolagest SCA , explained that the courts should not re-write the whole contract to arrive at a reasonable meaning and should consider the intention of the parties in the case of a carefully drafted agreement. This will allow the courts to give effect to the intention of the parties and not what the courts think it should be, to arrive at a more reasonable meaning. It was further affirmed by Aikens LJ in BMA Special Opportunity Hub Fund v African Minerals Finance ltd and by the Court of Appeal in Dear v Jackson . Since such issues were arising frequently, Lord Neuberger represented the UK Supreme Court and confirmed the criticality of the courts' duty to not re-write what parties should have agreed but to interpret what they agreed on, in the actual contract. He then emphasized that courts should avoid re-writing contracts to attempt assisting an unwise party or to penalise an astute party. Afterwards, Lord Neuberger (with the approval of Lord Sumption JSC and Lord Hughes JSC) introduced a modernized approach to interpret contracts in Arnold v Britton's last decision. Modern approach includes seven factors and it is a remodel to fill the gaps and the issues of the traditional objective approach.
1. Commercial common sense of the language and surrounding circumstances are used to interpret but doesn’t use it to override the language.
2. Centrally relevant words can be easier to be judged by the court when it is mixed and disordered. The less clear the words are, the readier the courts are to depart from its' natural meaning. However, if there is an error, it usually turns out to be non-applicable to the issue of interpretation.
3. Commercial common sense is not to be invoked retrospectively. If the issue at hand has caused the parties a bad result, it is not a reason to depart from the natural meaning of the document.
4. Parties' intention regarding the outcome is not taken in to account. This is because it doesn’t matter that the contract has worked out terribly for the parties since it is not an input to judges' decisions. Courts' duty is to identify what the parties have agreed on, not what they think the parties should have agreed on.
5. Only the facts and circumstances that were present during the time of the contract is taken to account, while excluding subsequent facts. Data that were only known to one party is not considered as well.
6. If the subsequent event is an intention of the parties, which depicts the objective of the contract, courts give effect to it.
7. There is no special interpretation method for leases.
Traditional approach has resulted in difficulties for commercial judges as most cases are held before the court for years and years. Yet, first principle has been accepted as a starting point by the highest courts. Some such cases are BCCi v Ali [2001] UKHL, Attorney General of Belize v Belize Telecom Ltd , Chartbrook ltd v Persimmon Homes Ltd , Rainy Sky SA v Kookmin Bank , and most importantly Arnold v Britton. However, it is only the first principle that have made sense to the courts when applying the ICS's approach. The traditional approach has flaws when catering to the parties' intentions since commercial common sense is limited on the grounds of interpretation due to barriers of implied terms, third parties’ intentions and 'matrix of facts'. Lord Steyn in Mannai Investments Co. Ltd v Eagle Star Life Assurance stated that "Words are therefore interpreted in the way in which a reasonable commercial person would construe them. And the standard of the reasonable commercial person is hostile to technical interpretations and undue emphasis on niceties of language".
Moreover, interpretation of contracts is unhelpful when it is done as soon as a document is presented to the judges. Interpretation should be carried out in cases of ambiguity or drafting problems and not at all because of the parties' object or dislike the outcome of the natural meaning of a clause. This was further backed up in the case Marks & Spencer plc v BNP Paribas Securities Services Trust Co. (Jersey) Ltd by the UK Supreme Court. It was identified that the first step in the interpretation process is to interpret the express terms of a contract. Thus, it can be argued that judges have been presenting new and reformed ways to solve the flaws in Lord Hoffmann's legal principles.
Further, Lord Hoffmann's principles are unhelpful in cases of linguistic mistakes. This is illustrated in the case Chartbrook ltd v Persimmon Homes. It was a land development case and finally it was sold at a price of the total value of land including 'Additional Residential Payment'(ARP). The fee ARP was defined in the contract and Chartbrook claimed that ARP was underpaid. Court of Appeal interpreted ARP based on ordinary syntax, since the words made a sense of their own. House of Lords however, stated that something must have gone wrong with the language (per Lord Hoffmann) even though courts make it a point not to assume language mistakes on a formal document. Lord Hoffmann's process of interpretation based on syntax does not depict what would a reasonable man would think or do. Therefore, Lords corrected the error through interpretation without resorting to rectification since the contract did not portray the commercial sense of the words. Besides, it is difficult to make a distinction between linguistic mistakes and a bad bargain, and it can be said that language mistakes are a gateway for a remedy of rectification.
Also, ICS's approach is unhelpful in areas where language have more than one potential meaning. This matter can be explained using the case Raink Sky SA v Kookmink Bank which was held by the UKSC. Case relates to refund guarantees and advance payment bonds which were issued by the bank to make sure the six shipbuilding contracts are being paid without defaults. Terms included a promise to pay 'all such sums due to you under the contract' and it was expressed to be in 'consideration of your agreement to make the re-delivery instalments under the contract'. Shipbuilder became insolvent and the buyers sought to enforce the advance payment bonds. Bank rejected since the various default events did not include 'insolvency'. UKSC held that the terms of the contract were relevant to the construction of bonds and it was preferable by the buyer. And it was said that insolvency is a situation where bonds are much needed . It was confirmed that however unreasonable, unlikely or surprising the effect of the language may be, courts are bound to apply it when the contract is clear and unambiguous. Nevertheless, UKSC also held that when a clause has different meanings, they can interpret the clause to arrive at a meaning that will benefit the objective of the overall contract, or at least to reflect business common sense. The difficulty is when the commercial common sense has relevance in the context of determining ambiguity, hence the modern approach would suggest that the courts should first construe the natural meaning of the words and then apply the interpretation, only, if it is unclear. This would avoid any additional problems that would have occurred due to interpreting before understanding the contract. This method however do not help implied terms of a contract since they are not ‘expressed’ in a contract.
Several judges have introduced new and improved methods that avoids the flaws in traditional approach. Post Arnold v Britton, Deutsche Trustee Co. Ltd v Cheyne Capital Management UK LLP suggests that there is considerable authority which reviews that the language is not confined, and that the iterative process should be carried out by checking each rival meanings of the provisions. Iterative process includes identifying the natural meaning of words and if there is more than one meaning, rival meanings of the provisions should be checked against each provision to remove ambiguity of the language. Further, Lewison LJ agreed to the iterative process asserting that commercial common sense is not merely a safety valve in cases of absurdity. He also said that commercial considerations have no part to play in deciding whether an interpretation is ambiguous or not. This was a judgement given in the case Napier Park European Credit Opportunities Fund ltd v Harbourmaster Pro-rata CLO.
In consideration of Investors Compensation Scheme case, Lord Hoffmann's legal principles have evolved to sway the flaws, and Lord Neuberger's modern approach has become more sensible to work with. However, the major question is whether pre-negotiations and exclusionary rule should be re-considered when interpreting terms of contracts. Yes, it should be applied only if it helps the situation but if it further unhelps the process, then it is best to not take prior evidence in to account. As Lord Nicholls said it would be the 'best evidence of all' to be aware of what happened before the contract since it drove the parties to construct the contract in the way that they did. Lord Hoffmann agreed to the above point as he stated that 'helpful' and 'relevant' evidence can be applied. He further explained his point as such; "Among the dirt of aspirations, proposals and counter-proposals there may gleam the gold of a genuine consensus on some aspect of the transaction expressed in terms which would influence an objective observer in construing the language used by the parties in their final agreement".
Additionally, parties usually use pre-contractual information and evidence to support claims for rectification or estoppel. This evidence was not an exception to the exclusionary rule but a point that operated outside the rule. This was held in Ocean-Bulk Shipping and Trading SA v TMT Asia Ltd . Lord Clarke went on to say that trial judges identify the pre-negotiations, factual matrix, and then previous data which doesn’t comply with the factual matrix is not admitted to the process of interpretation . The distinction between the two is done through a subjective or objective basis, and it is often a straightforward procedure except when it is not. Anything subjective and opinionated doesn’t go in the 'matrix of facts' and if anything is objective, it is admissible to the process.
In conclusion, ICS's approach is the main base for interpretation of contracts. Despite the flaws of the principles, it has helped the judiciary to evolve the legal interpretation principles to match the current, on-going cases. Principles of law is not set in stone as it evolves over time. In Chartbrook, Baroness Hale put forward a stimulating argument stating that abolition maybe the only legislative solution for the controversy of principles regarding 'matrix of facts', but since it is impossible to do so, it is best to work solutions for the flaws at hand because abolition may impact third parties in a negative way. Further, the courts have not put aside the traditional approach completely and have incorporated the basics to introduce new and improved solutions such as modern approach and the iterative process. ICS's approach is helpful to a limited extent, but it has accommodated as a base for the Lord Neuberger's modern approach where most of the issues have been filled by the modern approach as explained above. Therefore, it can be deduced that ICS's approach is unhelpful but has helped the courts to develop a more suitable approach.
Bibliography
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