Summary

A recent UK Supreme Court judgment provides helpful guidance on the alternative pathways available to the courts in construing commercial contract provisions.

In Depth

In Wood v Capita Insurance Services Limited [2017] UKSC 24, the UK Supreme Court has unanimously affirmed a Court of Appeal decision, shedding much needed light on the various contractual interpretation pathways that have emerged in English law.

Background

A claim was brought under an indemnity provision contained in a share purchase agreement for the sale and purchase of the entire issued share capital of Sureterm Direct Limited, a specialist motor insurance broker. The buyer sought to rely on the indemnity terms and conditions to recover the losses it incurred in connection with the payment of compensation to customers affected by the seller’s mis-selling of certain insurance products. The seller argued that, on a proper “natural and ordinary” construction of the instrument wording, a claim of the nature claimed by the buyer was not caught by the indemnity scope.

The primary interest of this case concerns the significance of the Supreme Court’s propositions in relation to true contractual construction.

Decision

Where there are rival interpretations of commercial contractual language, some doubt has arisen concerning how a court ought to construe a contract in order to resolve them.

On one hand, there is the pathway forged by the Supreme Court in Rainy Sky SA v Kookmin Bank [2011] UKSC 50, whereby competing contractual interpretations would be resolved by preferring the relevant terms most consistent with commercial common sense. By nature, that is a contextual approach involving consideration of the wider factual matrix and circumstances in which the bargain is struck. Consequently, subsequent disputants posited the Supreme Court’s “business common sense” dicta in contending for a contextual contractual construction.

On the other hand, four years later, the Supreme Court in Arnold v Britton [2015] UKSC 36 traversed a different pathway placing greater emphasis on the natural and ordinary meaning of the words used. It thus favoured a more literal approach in construing contractual terms, and cautioned against the adoption of “business common sense” to relieve a party’s bad bargain. That, in many commentators’ eyes, marked a clear curial shift in emphasis to contractual interpretation and, in particular, a retreat from the preceding Rainy Sky guidance.

By concentrating its gaze on the common ground in Wood, the Supreme Court has squarely addressed and instructively reconciled some, if arguably not all, of that lingering doubt.

In lead judgment, with which the other Justices were in unanimous agreement, Lord Hodge JSC dismissed the buyer’s appeal and, on the question of contractual interpretation, opined the following key principles:

• The court’s task is to ascertain the objective meaning of the contractual language. That is not a literalist mechanism exclusively focused on parsing the given wording. Rather, the court must consider the contract as a whole and, depending on the nature, formality and quality of its drafting, attach the appropriate weight to wider contextual elements in arriving at the objective meaning.

• Interpretation is a unitary exercise, involving an iterative process by which each asserted interpretation is checked against the contractual provisions, and its commercial consequences investigated.

• Where rival constructions occur, the court can give according weight to their implications by determining the construction most consistent with business common sense. The drafting quality must, however, be considered in balancing the indications given by the language and the implications of the competing constructions, and the court must also be alive to one party possibly having agreed to something that in retrospect did not best serve its interests. The court must also not overlook the possibility that a provision may be a negotiated compromise, or that the negotiators were unable to agree more precise terms.

• “Textualism and contextualism are not conflicting paradigms”; both approaches may be utilised as “tools” to arrive at the objective meaning of the contractual language. The extent to which each tool assists contractual interpretation will vary depending on the particular circumstances and drafting quality of the relevant provisions. Some contracts might be successfully interpreted by textual analysis, for instance, owing to their sophistication or complexity, or because they were professionally prepared. Others may be better suited to heightened emphasis on the factual matrix because, for example, they are less sophisticated, informal or drafted without professional input. Where professionally drafted contracts contain provisions lacking clarity, “considering the factual matrix and the purpose of similar provisions in contracts of the same type” may assist their interpretation.

Observations

This is an important decision, as it provides helpful guidance on the alternative pathways available to the court in exercising contractual interpretation. Some significant points emerge from the Supreme Court’s analysis.

• Though somewhat trite, it emphasises that clear and precise drafting is essential to ensure that no ambiguity surrounds the meaning of a contractual provision. For a contract draftsperson, that means harmonising and safeguarding against any potential adverse impacts of one particular clause on others contained in the same instrument.

• Although an instrument drafted and negotiated by lawyers will be predisposed to a textual “natural and ordinary” interpretation, Lord Hodge acknowledged that a commercial instrument does not exist in the abstract and that its commercial context may also be relevant to any true construction.

• Where a contractual provision throws up rival meanings, the court will likely prefer the construction most consistent with business common sense. This powerfully rebuts the misconception that Arnold had “rowed back” on the role of business common sense in contractual construction. It is perfectly permissible under English law to apply all available tools to construction analysis, depending upon the surrounding circumstances, to avoid yielding erroneous conclusions.

• No recalibration of the Rainy Sky or Arnold approaches to contractual interpretation is required. Lord Hodge made that very plain by remarking the two authorities were, essentially, speaking the same language. Rather steering current common law contractual interpretation principles towards new waters, Wood merely exemplifies some of the tools at the courts’ disposal. As the court concluded per curiam:

The recent history of the common law of contractual interpretation is one of continuity rather than change. One of the attractions of English law as a legal system of choice in commercial matters is its stability and continuity, particularly in contractual interpretation.