English Contracts - Principles of Construction

For those of us connected with the legal profession keeping up to date with developments in English case law can be a time-consuming process.  Judgments can drag on and one can lose sight of important legal principles.

It was refreshing to see Mr Justice Coulson’s decision yesterday in Mutual Energy Ltd v Starr Underwriting Agents Ltd & Anor[2016] EWHC 590 (TCC) (23 March 2016) which helpfully summarised the key principles of construction that the courts currently adopt when interpreting contracts.

Here is the relevant extract from Mr Justice Coulson’s judgment:

“14.   It is unnecessary for me to set out in any detail the principles of construction to which I should adhere in undertaking this exercise. That is partly because they are now so well-known. But it is also because they have recently been summarised by Christopher Clarke LJ in language that is so lucid and so concise that it is unnecessary to do anything other than set out verbatim what he said. In the case of Wood v Sureterm Direct Ltd & Capita Insurance Services Ltd [2015] EWCA Civ 839 he dealt with the principles of interpretation in the follow passages:

28. The principles upon which contracts are to be interpreted have been stated and restated at the highest level, including most recently in Arnold v Britton [2015] UKSC 36. It is not necessary to review them again. The principles which, in my judgement, are most relevant for present purposes are as follows:
(i)      The aim of the court is to determine what a reasonable person who had all the background knowledge which would reasonably have been available to the parties when they contracted would have understood the parties to have meant: Rainy Sky SA v Kookmin Bank [2011] 1 WLR 2900 [14] and the cases there cited; this exercise relates to their understanding at the time that the contract was made: Arnold v Britton at [19].
(ii)     The exercise of construction is essentially one unitary exercise – Rainy Sky [21], which should be “neither uncompromisingly literal nor unswervingly purposive“: per Sir Thomas Bingham MR in Arbuthnott v Fagan [1995] CLC 1396, 1400. It is also an iterative exercise: Arnold [76]. The court looks to see where different constructions lead, how they fit with other provisions in the contract (or other phrases in the same clause), what obstacles to a particular interpretation are met upon the way, and what results are reached.
(iii)    In a case where, as here, parties have used language which is capable of more than one meaning, the court should consider the implications of the rival constructions: Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd [2001] CLC 1, 103 at [16]; and is entitled to prefer a construction which is consistent with business common sense and to reject one that is not.

29. Care must, however, be taken in using “business common sense” as a determinant of construction. What is business common sense may depend on the standpoint from which you ask the question. Further the court will not be aware of the negotiations between the parties. What may appear, at least from one side’s point of view, as lacking in business common sense, may be the product of a compromise which was the only means of reaching agreement. As Nicholas Strauss QC, sitting as a Deputy High Court judge, said in Churchill v Temple[2010] EWHC 3369at 37 (d):

“It is always necessary to keep in mind the position of both parties. It is not enough just to consider what the vendor may have wanted to achieve. There is also the consideration that the purchaser might not see what the vendor wants as being in his interests, and that the vendor might, as a result, find it difficult to sell, or to get his price, if he insists upon it. The resulting covenant may represent a compromise. It is therefore not surprising to find covenants which are not altogether logical from the point of view of either party, or do not entirely achieve the probable aims of either of them. See Bank of Nova Scotia v Hellenic Mutual War Risks Association (Bermuda) Ltd [1990] QB 818 at 870 (C.A.).”

30. Businessmen sometimes make bad or poor bargains for a number of different reasons such as a weak negotiating position, poor negotiating or drafting skills, inadequate advice or inadvertence. If they do so it is not the function of the court to improve their bargain or make it more reasonable by a process of interpretation which amounts to rewriting it. Thus:

“A court should be very slow to reject the natural meaning of a provision as correct simply because it appears to be a very imprudent term for one of the parties to have agreed … The purpose of interpretation is to identify what the parties have agreed, not what the court thinks that they should have agreed … when interpreting a contract a judge should avoid re-writing it in an attempt to assist an unwise party or to penalise an astute party”: Arnold at [20].

31. In effect a balance has to be struck between the indications given by the language and the implications of rival constructions. The clearer the language the less appropriate it may be to construe or confine it so as to avoid a result which could be characterised as unbusinesslike. The more unbusinesslike or unreasonable the result of any given interpretation the more the court may favour a possible interpretation which does not produce such a result and the clearer the words must be to lead to that result. Thus if what is prima facie the natural reading produces a wholly unbusinesslike result, the court may favour another, even if less obvious, reading. But, as Lord Neuberger observed in Arnold v Brittonat [17] “commercial common sense and surrounding circumstances … should not be invoked to under value the importance of the language of the provision which is to be construed”. It is material, however, to note that Arnold was a case where the interpretation argued for involved adding in the words “up to” in the relevant clause so as to constitute the sum specified a maximum and not a definition of the amount which had to be paid – a very radical change.””