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McMeel on The Construction of Contracts, 3rd Edition by McMeel, Gerard (12th October 2017)

Part I The General Part, 1 Principles and Policies

From: McMeel on The Construction of Contracts (3rd Edition)

Gerard McMeel

Breach of contract — Damages and contract — Formation of contract — Remedies for breach of contract

(p. 3) Principles and Policies


1.01  Ascertaining the meaning and effect of the language of contracts and other documents constitutes a central concern of private law and is of great significance to commercial and financial transactions. This book is concerned with the principles and policies of construction or interpretation which are utilized by the courts in discerning the meaning and effect of the words used to encapsulate the parties’ intentions. It also considers other related doctrines which have an impact on the meaning and effect of written contracts and instruments: principally the implication of terms and the rectification of documents. The governing principles are relatively few in number. The aim of this chapter is to provide an outline of the principles and policies of construction, and of the concerns of the book as a whole.

(p. 5) 1.02  The prevalence of disputes about the meaning and effect of contractual words is often ascribed to the fallibility of human language as a mode of communication, perhaps invoking the flexibility and vagueness of words. Such was the view of leading nineteenth-century judge, Lord Blackburn, who spoke robustly of ‘the imperfection of language’.1 Another view is that we should rather be impressed at the remarkable ability of humans to communicate highly sophisticated ideas and concepts by the written and spoken word, and at the remarkably low rate of failure of getting one’s meaning across in practice.2 There is also a temptation to lay the blame for such disputes at the door of supposedly pedantic and nit-picking lawyers, insistent on the deployment of legal jargon and always keen to identify an unintended ambiguity in words or a loophole in documentation.3 Whilst this factor cannot be entirely discounted,4 it is not the principal explanation of the problem. In practice most disputes which have to be resolved by resort to the technique of interpretation are not problems about the meanings of words or ones which require familiarity with grammatical niceties. Rather, they are problems about the application of the language of a contract to the (perhaps unexpected) events which subsequently transpired and form the core of the dispute between the parties. In a long-term contract there may be a wholly unforeseen turn of events where ‘the question is how its language best operates in the fundamentally changed and entirely unforeseen circumstances in the light of the parties’ original intentions and purposes.’5 Construction generally involves identifying in a document a rule for future cooperative behaviour from the language of the instrument, and then applying that rule to subsequent facts or situations. As (p. 6) such, issues concerning construction represent an unavoidable source of potential dispute.

Sources of disputes about contractual construction

1.03  Two principal sources of construction disputes are incompleteness and ambiguity.6 A third source is error or mistake in expression. First, human foresight being limited, the failure to foresee a particular turn of events and make explicit provision for it, or to fully spell out the implications of the agreement, entails that a solution does not appear on the face of the contract. Secondly, the failure to embody with sufficient clarity, precision, or accuracy the substance of the parties’ agreement in the language of the instrument is another common reason for interpretation disputes.7 Thirdly, problems commonly arise when a document appears to provide a clear and unambiguous solution, but one party contends that the text mistakenly records the agreement of the parties.8

1.04  In the first type of case, despite the apparent incompleteness, the courts will still treat the document as the source of the solution, using interpretation, often working in tandem with the process of implication, to find the solution in the interstices of the contract. In the second case, vagueness or ambiguity will have to be eliminated by the court in order to reach a binding resolution, often by reference to the remainder of the contract, the surrounding circumstances, and the overall aim or object of the agreement. In the third type of case, communication errors and poor drafting raise the problem of whether the court can override or disregard the apparent or grammatical meaning of the document and correct the mistake either through the process of construction or the related technique of rectification. Indeed, in English law such problems are at least as likely to be resolved through the technique of construction as by way of a formal rectification of the document embodying the agreement.9

(p. 7) 1.05  Other sources of dispute exist. A fourth source is deliberate equivocation. The leading American writer on contract law—Farnsworth—stressed that not all disputes arise from poor communication:

It would be wrong to assume that the failure of contract language to dispose of a dispute that later arises is invariably due to some inherent fallibility of language as a means of communication. The parties may not simply have foreseen the problem at the time of contracting … Or one or both may have foreseen the problem but deliberately refrained from raising it during the negotiations for fear that they might fail— the lawyer who ‘wakes these sleeping dogs’ by insisting that they be resolved may cost his client the bargain … Or both may have foreseen the problem but chosen to deal with it only in general terms, delegating the ultimate resolution of particular controversies to the appropriate forum.10

1.06  Experience suggests that Farnsworth’s last two suggested factors are commonly encountered in practice. Judges sometimes candidly admit this, in cases where the parties are more concerned to save the overall deal than sort out niggling specifics. For example according to Staughton J:

When two businessmen wish to conclude a bargain but find that on some particular aspect of it they cannot agree, I believe that it is not uncommon for them to adopt language of deliberate equivocation, so that the contract may be signed and their main objective achieved. No doubt they console themselves with the thought that all will go well, and that the terms in question will never come into operation or encounter scrutiny; but if all does not go well, it will be for the courts or arbitrators to decide what those terms mean.11

Artificial though it may appear, this judicial function is essential in a working law of contract.

Meaning and effect

1.07  As Brian Simpson insightfully observed: ‘difficulties in interpretation … seem to be difficulties about words [but] are really difficulties about the applicability of rules to facts.’12 It is often possible to separate out two distinct phases in construction disputes.13 First, on occasion the courts are concerned with ascertaining (p. 8) the meaning of the contractual language, whether through consideration of rival definitions of particular words or syntactical analysis of a phrase or sentence. Similarly, it may be necessary to tackle vagueness, ambiguity, or apparent inconsistency in expression. Secondly, and perhaps (as Simpson suggests) more common in practice, is the application of the rule to be found from the parties’ language to the particular facts or circumstances: that is ascertaining the legal effect of the words.

Commercial consequences

1.08  In defining and delimiting this contractual rule for conduct the courts may test rival formulations of the rule against various hypothetical situations which could have arisen in order to ensure that the proposition ultimately adopted is suitable for the range of disputes which could potentially arise, particularly where it is considering a standard form or a widely used provision.14 So Arden LJ has stated that ‘unless the contrary appears, the court must assume that the parties to a commercial document intended to produce a commercial result, and the court must thus take into account the commerciality of the rival constructions’.15 In Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd (No 2)16 Mance LJ suggested:

the subclause has no very natural meaning and is, at the least, open to two possible meanings or interpretations. … In these circumstances, it is especially important to undertake the exercise on which the judge declined to embark, that is to consider the implications of each interpretation. In my opinion, a court when construing any document should always have an eye to the consequences of a particular construction, even if they often only serve as a check on an obvious meaning or a restraint upon adoption of a conceivable but unbusinesslike meaning.

1.09  It has become somewhat modish to describe the process of weighing the consequences as ‘iterative construction’.17 Subsequently as Lord Mance his Lordship stated that ‘the resolution of an issue of interpretation in a case like the present is an iterative process’.18

(p. 9) Question of law or question of fact?19

Written contracts

1.10  As a matter of English law it is clear that questions of construction of documents, including contracts, are questions of law, and are to be determined by the court.20 In The Nema21 Lord Diplock was emphatic that this characterization of construction was unassailable, whatever might be the position in other jurisdictions:

The answer must depend upon the true construction of the agreement between the parties; and in English jurisprudence, as a legacy of the system of trial by juries who might not all be literate, the construction of a written agreement, even between private parties, became classified as a question of law … A lawyer nurtured in a jurisdiction that did not owe its origin to the common law of England would not regard it as a question of law at all … Nevertheless, despite the disappearance of juries, literate or illiterate, in civil cases in England, it is far too late to change the technical classification of the ascertainment of the meaning of a written contract between private parties as being ‘a question of law.’ …22

1.11  It may be that it was a desire of the judiciary to demarcate construction issues as questions of law in order to provide certainty on such questions which is the true explanation of the rule, rather than the alleged illiteracy of civil (p. 10) juries.23 It has been suggested that the continuation of the rule proceeded from another cause:

In the 18th and 19th centuries the rule was maintained because it was essential to the development of English commercial law. There could have been no precedent and no certainty in the construction of standard commercial documents if questions of construction had been left in each case to a jury which gave no reason for its decision.24

1.12  Accordingly each party may advance its preferred construction (or alternative constructions), and make submissions in support of it. But neither side bears a burden of proof.25 If a question as to the meaning and effect of the contract is an issue between the parties, which needs to be determined to resolve the case, the judge must grasp the nettle, and determine it. There is no doubt that the judge may prefer a construction which neither has advanced.

1.13  More recently, in the context of arbitration, the Supreme Court of Canada initially departed from the English rule, and characterized the interpretation of a contract as a mixed question of law and fact.26 However it has now revisited that conclusion, and made a significant exception for standard form contracts.27 It is unlikely that the English courts will depart from their long-established classification of such questions as legal ones because of the identification of the rule with the development of a coherent and predictable commercial law.28

Oral contracts

1.14  In contrast, the meaning and effect of oral contracts are questions of fact, and before the demise of civil juries, would have been entrusted to the jury.29 Accordingly a broader approach is taken to what is admissible evidence for the purpose of ascertaining and construing the terms in relation to contracts that are wholly (and perhaps partly) oral. The exercise can embrace the negotiations (especially given that it may not be clear precisely when the contract was concluded) and subsequent conduct.30 Nevertheless, even in relation to oral contracts, the common law (having considered all the evidence, including (p. 11) statements of subjective intent) still adopts an objective test for ascertaining the parties’ intentions.31

Integrated contract or partly in writing, partly oral?

1.15  Of practical importance is the common scenario of a contract which is alleged, usually by only one of the parties, to be partly oral and partly in writing, and often partly evidenced by conduct.32 The other is likely to insist that the agreement is exclusively evidenced by writing. The question whether an agreement, and all its terms, is exclusively contained or integrated in a written document, or has been reduced entirely to writing,33 is a question of fact, which is to be determined by the judge on the totality of the evidence.34

1.16  The leading case is Carmichael v National Power plc.35 Tour guides were engaged by the utility company to act ‘on a casual as required basis’. The guides later claimed to be employees and requested a written statement of terms as mandated by statute for employment contracts.36 The industrial tribunal37 took into account the language of the correspondence, the way in which the contract had operated, and the parties’ evidence as to their understanding of it, in reaching the conclusion that they were not employees. This was upheld by the Employment Appeal Tribunal, but overturned by the Court of Appeal, which held that it was a pure case of construction of documents. The House of Lords emphatically disagreed. Lord Irvine of Lairg LC stated:

… it would only be appropriate to determine the issue in these cases solely by reference to the documents … if it appeared from their own terms and/or from what the parties said or did then, or subsequently, that they intended them to constitute an exclusive memorial of their relationship. The industrial tribunal must be taken to have decided that they were not so intended but constituted one, albeit important, relevant source of material from which they were entitled to infer the parties’ true intentions.38

(p. 12) 1.17  Similarly, Lord Hoffmann considered that the letters evidencing the engagement were concise, if not ‘cryptic’ (‘on a casual as required basis’), and had not been drafted by lawyers. It was therefore unrealistic to regard them as a documentary exchange of offer and acceptance:

Putting the matter at its lowest, I think it was open to the industrial tribunal to find, as a fact, that the parties did not intend the letters to be the sole record of their agreement but intended it should be contained partly in the letters, partly in oral exchanges at the interviews or elsewhere and partly left to evolve by conduct as time went on.39

1.18  In contrast, Chadwick LJ in the Court of Appeal had insisted that ‘The question is not what the parties thought their obligations were’.40 Lord Hoffmann responded: ‘This austere rule would be orthodox doctrine in a case in which the terms of the contract had been reduced to writing. But I do not think it applies to a case like the present.’41 Here the agreement was founded partly on oral exchanges and conduct.

Integration and ‘entire agreement’ clauses

1.19  The factual inquiry required by the rule on integration or reduction to writing has been found inconvenient by many commercial actors and their advisers. It requires, or at least permits, a judge to examine the totality of the evidence in search of arguable collateral terms. It allows one party to undertake an exercise in ‘thrashing’42 through the undergrowth and finding in the course of negotiations some (chance) remark or statement (often long forgotten or difficult to recall or explain) on which to found a claim’.43 In contrast, the commercial purpose of drafting and incorporating a detailed written contract is to obviate such inquiries and to promote certainty. Accordingly modern commercial contracts have spawned a coterie of standard clauses—entire agreement and non-reliance—which are intended to protect the integrity of the written instrument, and, so far as possible, insulate it from easy qualification. In commercial cases the courts have shown themselves sympathetic to such provisions.44 However these provisions cannot affect the characterization of the question of whether an agreement has been integrated or reduced to writing, which remains an issue of fact for the (p. 13) judge. Nevertheless an ‘entire agreement’ clause does give rise to a presumption that the parties’ agreement has been reduced to writing in the form of the document containing the clause.45 In contrast, and demonstrating the proposition that freedom of contract trumps sanctity of contract, the Court of Appeal has recently affirmed on two occasions that a clause purporting to restrict informal variation or waiver of contractual cannot be effective. It is always open to the parties to change their bargain by any method (in the absence of statutory formalities).46

Interpretation, Implication, and Rectification

Construction and interpretation

1.20  The terms construction and interpretation are conventionally used interchangeably by most lawyers. Sometimes a more precise use is advocated whereby construction is the broader process which encompasses both the interpretation of the express terms of the contract and the neighbouring technique of the implication of terms into an agreement.47 The speech of Lord Steyn in Equitable Life Assurance Society v Hyman48 has echoes of this usage, insisting on a two-stage process of interpreting the express terms, and then identifying any implied terms. Lord Steyn saw both techniques as part of the overall process of construction.49 This more rarefied usage is not widespread, and in this work interpretation and construction are used interchangeably.

Interpretation and implication

1.21  In Equitable Life Assurance Society v Hyman50 Lord Steyn stated: ‘It is necessary to distinguish between the processes of interpretation and implication. The purpose of interpretation is to assign to the language of the text the most appropriate meaning which the words can legitimately bear.’ The process of implication goes further and permits the court to plug what it perceives to be gaps in the (p. 14) express terms or explicit language of the parties’ agreement.51 Two of the principal architects of the modern approach to the interpretation of express terms—Lords Steyn and Hoffmann—insisted that the process of implication is part of the overall process of construction.52 In South Australia Asset Management Corporation v York Montague Ltd 53 Lord Hoffmann stated, in respect of ascertaining the scope of an implied term to use reasonable care and skill in providing a professional service: ‘As in the case of any implied term, the process is one of construction of the agreement as a whole in its commercial setting.’ In Equitable Life Assurance Society v Hyman54 Lord Steyn agreed that the process of implication was ‘entirely constructional in nature’.55 In Marks and Spencer plc v BNP Paribas Securities Services Trust Co (Jersey) Ltd 56 Lord Neuberger (with the concurrence of Lords Clarke, Sumption, and Hodge) accepted that ‘both (i) construing the words which the parties have used in their contract and (ii) implying terms into the contract, involve determining the scope and meaning of the contract’.57 However, given the obvious potential of the technique of implication to supplement, or some might say vary or override, the parties’ expressed intentions, English judges have consistently exercised a self-denying ordinance, which only permits them to imply a term when it is necessary to do so, not merely when it may appear reasonable to do so. This important distinction has been emphatically restated by the Supreme Court in Marks and Spencer plc v BNP Paribas Securities Services Trust Co (Jersey) Ltd 58 where Lord Neuberger (with the concurrence of Lords Sumption and Hodge) insisted that ‘construing the words used and implying additional words are different processes governed by different rules’.59 Whilst interpretation is approached from the perspective of the reasonable person (most prominently in Investors Compensation Scheme Ltd v West (p. 15) Bromwich Building Society),60 the threshold for the implication of terms (or more precisely terms implied in fact) is the more exacting standard of necessity. When it is argued that the court should fill an alleged gap in a contract by reference to the technique of interpretation, the court should be cognizant of the potential of such an argument to circumvent the stricter test which operates for implication. In the Marks and Spencer case the Supreme Court was emphatic that the benchmark for implication was necessity.61

Terms implied in law and terms implied in fact

1.22  Whilst attempts have been made to attribute all implication of terms to the ‘intentions of the parties’, in Liverpool City Council v Irwin Lord Wilberforce identified three or four sub-categories of implied term existing over a ‘continuous spectrum’.62 The most important distinction is that between the two sub-categories of terms implied by law and terms implied in fact.63 In Equitable Life Assurance Society v Hyman Lord Steyn preferred the terminology of ‘general default rules’ and ‘ad hoc gap fillers’, but this North American terminology has not gained any traction in the English authorities.64

Terms implied in law or ‘general default rules’

1.23  The identification of terms in the first sub-category is a matter of positive law, based on public policy. In the words of Karl Llewellyn, the court is engaged in ascertaining ‘what the minimum decencies are which the court will insist upon as essential to an enforceable bargain of that type, or as being inherent in a bargain of that type’.65 The implication of terms in law is not grounded in ascertaining the intentions of the parties (even applying an objective test), but will often be based directly on statute or precedent or reasoning analogically from such materials. Despite judicial statements suggesting that the test is one of necessity, in practice broader standards of reasonableness and an analysis of competing factors will determine whether or not the courts will recognize a new implied term in (p. 16) law. An example is the recognition by the House of Lords in Mahmud v Bank of Credit and Commerce International SA66 of the implied duty of trust and confidence as a standard incident of the relationship of employer and employee.67 In Crossley v Faithful & Gould Holdings Ltd 68 Dyson LJ (also in the employment context) suggested that ‘questions of reasonableness, fairness and the balancing of competing policy considerations’ are more important than the elusive standard of necessity.69

Terms implied in fact or ‘ad hoc gap-fillers’

1.24  In contrast, in the second sub-category of terms implied in fact the cases insist on a threshold standard of necessity before a bespoke term is read into a particular contract. Some insist that there is a discrete category of ‘it goes without saying’ where this precondition is not relevant.70 Traditionally two time-honoured tests of ‘business efficacy’71 and the ‘officious bystander’72 have been deployed to aid the courts in applying this requirement.73

1.25  As stated above, modern appellate pronouncements accept that the technique of implication in fact is related to the interpretation of express terms. A prominent example of this constructional approach is in the speech of Lord Steyn in the Equitable Life case74 in the House of Lords. This has yielded useful practical guidance on the technique in that broadly similar principles are used in both interpretation and implication cases. Accordingly stress is laid on the objective nature of the exercise; regard is had to the contractual provisions as a whole; due account is taken of the wider context or setting; and the purpose of the transaction or the particular provision is identified. In Attorney-General for Belize v Belize Telecom Ltd 75Lord Hoffmann explicitly linked the process of implication with the (p. 17) leading case on the interpretation,76 laying particular emphasis on the objective nature of the court’s approach, which deploys a reasonable person or addressee of an instrument:

The question of implication arises when the instrument does not expressly provide for what is to happen when some event occurs. The most usual inference in such a case is that nothing is to happen. If the parties had intended something to happen, the instrument would have said so. Otherwise, the express provisions of the instrument are to continue to operate undisturbed. …In some cases, however, the reasonable addressee would understand the instrument to mean something else. He would consider that the only meaning consistent with the other provisions of the instrument, read against the relevant background, is that something is to happen. The event in question is to affect the rights of the parties. The instrument may not have expressly said so, but this is what it must mean. In such a case, it is said that the court implies a term as to what will happen if the event in question occurs. But the implication of the term is not an addition to the instrument. It only spells out what the instrument means.77

1.26  In Marks and Spencer plc v BNP Paribas Securities Services Trust Co (Jersey) Ltd78 Lord Neuberger expressed concern, in part based on a considerable body of academic comment on Belize Telecom,79 that there had been some perception that that authority had changed the law. Lord Neuberger (with Lords Sumption and Hodge concurring) insisted there had been ‘no dilution’ of the traditional requirements and that those commentators who thought it had done so were wrong.80 Accordingly Lord Hoffmann’s advice in Belize Telecom needs to be treated with some circumspection, given Lord Neuberger’s view that it was open to misinterpretation and his curious statement that it should now be seen as ‘a characteristically inspired discussion rather than authoritative guidance’.81 In contrast, Lord Carnwath’s thoughtful judgment, whilst accepting that the necessity threshold had survived Belize Telecom, refused to question the continuing authority of Lord Hoffmann’s advice. Rather: ‘properly understood, I regard it as a valuable and illuminating synthesis of the factors which should guide the court’.82 Lord Clarke (agreeing with both Lord Neuberger and Lord Carnwath) was clear that the Privy Council ‘was not watering down the traditional test of necessity’.83(p. 18) With that caveat it is submitted that Lord Carnwath’s view is to be preferred to Lord Neuberger’s, and that Lord Hoffmann’s approach will continue to be seen as a useful additional part of the judicial armoury, alongside the traditional tests, for answering the intensely practical and contextual questions which arise when a court is invited to imply a term or words into a contract.84

1.27  Overall the implication of terms performs a vital function in ensuring the validity of contracts, in accordance with the principle that contracts should, where possible, be given lawful effect: ‘Gap-filling is quite simply essential for contracting to work. It would be intolerable for the courts to declare contracts void simply because some unforeseen possibility had not been considered by the parties at the time of contracting, thus rendering the contract void for uncertainty.’85

Implied terms and contractual discretion

1.28  The courts have developed general principles to constrain broadly expressed contractual terms which confer wide discretionary power on one party. The Equitable Life case is the most prominent example, and even draws an analogy with public law principles controlling administrative discretion. Many contractual discretions are unfettered on their face. However, it is clear that judges do not interpret such language literally: ‘a contract where one party truly found himself subject to the whim of the other would be a commercial and practical absurdity.’86 The principles for constraining contractual discretions inevitably emerged in terms of the second category of terms implied in fact (as in the Equitable Life case), but the governing principles have now become well-settled and this text now treats them as having migrated to the first sub-category of terms implied in law (and therefore akin to rules of law).87

Interpretation and rectification

1.29  In many cases the courts have corrected by construction (what must be seen as) mistakes of expression or linguistic slips in legal instruments. Some have seen (p. 19) such intervention as improperly trespassing upon the role more properly assigned to the equitable remedy of rectification of written instruments, which operates where there is a disparity between what the instrument records and the parties’ agreement.88 This remedy entails correcting the document to reflect the agreement accurately. The conditions for obtaining this species of equitable relief—including proof of either a prior agreement (or consensus) or knowledge of the other’s mistake—are stringent, and, traditionally, convincing evidence (apparently a heightened version of the usual civil standard of proof) was required. In the modern law, the technique of interpretation has taken over much of the work traditionally supposed to be the province of the equitable remedy of rectification.89 A major difference between the two techniques is that the courts may consider all the background evidence in rectification cases (including previous drafts, prior negotiations, and declarations of subjective intent), whilst long-standing exclusionary rules prevent the use of such materials in construing the contract. Indeed in one of its last judgments, the House of Lords in Chartbrook Ltd v Persimmon Homes Ltd confirmed the exclusionary rule preventing the use of prior negotiations in the process of consruction (before going on to consider such material in its discussion of rectification).90 There, as in a significant proportion of the recent cases, rectification is merely an alternative ratio to construction.91 However Chartbrook also upset the traditional perception of rectification as a subjective qualification to the common law’s robustly objective approach to ascertaining the parties’ intentions.92 Technically the discussion was obiter, but it has subsequently been treated as authoritative, leading to much complexity and confusion.93 It is likely that when the appellate courts revisit the question the law will revert to a test of common subjective intention.94

Interpretation and characterization or categorization

1.30  A related but distinct process to construction is characterization or categorization or classification of contracts. This is necessary for a number of purposes. First, at (p. 20) common law, standard incidents or principles have developed for particular categories of contract or other private law concepts, often by way of implied terms. In order to determine whether these standard incidents or implied terms are applicable it is necessary to determine whether a contract falls within a particular category. Is a supply of goods a sale or a bailment? Is a charterparty a demise charter (conferring a possessory interest on the charterer) or a time charter (which is merely a contract for services to be provided by the owner and his vessel)? Secondly, many statutes either confer privileges or attach obligations on one or both parties to transactions which fall into particular legal categories or concepts (and often leave it to the judges to define or describe with precision the boundaries of those concepts). Does an interest in a flat create a lease or licence for the purposes of statutory rights of tenure or (when applicable) rent control? Does a retention of title clause effectively reserve title to goods or is it properly classified as a security interest which must be recorded in a statutory register to be effective? Is a security interest a fixed or floating charge for the purpose of determining the incidence of statutory rules on priority? Is an undertaking to answer for the debt of another a guarantee or indemnity? The resulting questions are not pure questions of construction because policy questions are more prominent. One or more parties responsible for drafting the instrument may have the intention of ensuring that it is classified by the judges as one particular species of legal transaction. This was demonstrated by the saga of leases and licences in land law. Therefore Street v Mountford 95 remains the leading case on characterization. Achieving the desired characterization or classification of a transaction may result in various juridical advantages or the evasion of some potentially applicable statutory regulation. The parties’ own nomenclature or ‘labelling’, whilst it will be taken into account as a factor to be weighed, will not be determinative of the proper legal category to which the transaction belongs.96 As a result the courts are willing to have recourse to the widest possible evidence, including prior dealings and subsequent actings in order to determine the reality of the transaction.97

1.31  The decision of the Privy Council in Agnew v Commissioner of Inland Revenue98 makes clear that there is a distinction between characterization and interpretation. It related to the proper characterization of charges over the book debts of (p. 21) companies as either fixed or floating. A decision of the English Court of Appeal, In Re New Bullas Trading Ltd 99 had approached the question as a purely interpretative one. Lord Millett, delivering the advice of an exceptionally strong Privy Council, disagreed:

The question is not merely one of construction. In deciding whether a charge is a fixed charge or a floating charge, the Court is engaged in a two-stage process. At the first stage it must construe the instrument of the charge and seek to gather the intentions of the parties from the language they have used. But the object at this stage of the process is not to discover whether the parties intended to create a fixed or a floating charge. It is to ascertain the nature of the rights which the parties intended to grant each other in respect of the charged assets. Once these have been ascertained, the Court can then embark on the second stage of the process, which is one of categorisation. This is a matter of law. It does not depend on the intention of the parties. If their intention, properly gathered from the language of the instrument, is to grant the company rights in respect of the charged assets which are inconsistent with the nature of fixed charge, then the charge cannot be a fixed charge however they may have chosen to describe it. A similar process is involved in construing a document to see whether it creates a licence or a tenancy. The Court must construe the grant to ascertain the intention of the parties; but the only intention which is relevant is the intention to grant exclusive possession.100

1.32  In addition to its clear recognition of the distinction between characterization and interpretation, which was implicit in a number of prior authorities, the case is also clear authority for the proposition that in respect of characterization all extrinsic evidence is admissible on the question, including evidence of subsequent conduct.101 Similarly in Re Spectrum Plus Ltd 102 Lord Scott confirmed that the nomenclature of the document does not constrain the court:

the question as to how a particular charge should be categorised depends upon the nature of the rights over the charged asset that have been granted to the chargee or reserved to the chargor. The label that the parties have attributed to the charge may be some indication of the rights the parties were intended to have but is not conclusive. …

The categorisation depends upon the commercial nature and substance of the arrangement, not upon a formalistic analysis of how the bank clearing system works.103

(p. 22) In that case, Lord Walker, concurring, went on to spell out the policy issue underlying the characterization process:

Whether or not it is appropriate to describe this by some disparaging term such as camouflage, it is the court’s duty to characterise the document according to the true legal effect of its terms. … In each case there is a public interest which overrides unrestrained freedom of contract. On the lease/licence issue, the public interest is the protection of vulnerable people seeking living accommodation. On the fixed/floating issue, it is ensuring that preferential creditors obtain the measure of protection which Parliament intended them to have.104

Accordingly questions of characterization, whilst related to pure questions of construction, are different. They should be approached by looking at substance, not form and labels, and informed by the public policy underlying the need to carry out the exercise.105

The Evolution of the Principles of Construction

1.33  Four or five decades ago the subject matter of this work would probably have been conceived as the rules governing the construction of deeds106 and other formal contracts.107 Deeds were as likely, if not more likely, to comprise declarations of trust or provide for the conveyance of real property. The rule-based approach applied to deeds was in turn naturally applied to other formal instruments, including contracts ‘under hand’ (that is signed). With the rise of mass printing the courts became familiar with the ‘small print’ on the back of order forms, delivery notes, bills of lading, and other commercial documentation. In due course a modified version of the formal rules of construction was applied to such instruments. During the second half of the twentieth century the approach to (p. 23) the construction of documents adopted in the Commercial Court in London—which emphasized context and business purpose—became the dominant technique in the English courts.108 The subject is now more commonly described as contractual interpretation.109 However it is possible to go further and state that the modern principles apply to all private law instruments, including trust deeds and unilateral notices. Indeed the common-sense approach to the interpretation of language adopted in the leading modern cases now applies to all documents and utterances in a business or private context. Most broadly, it could be said that the principles and rules examined in this work are concerned with the private law of construction, as opposed to the public law of construction, which is concerned with statutes, delegated legislation, and other instruments which regulate or distribute public power.110

Statutory construction: a comparison

1.34  In an ideal world it should be possible to accommodate the governing principles for the construction of all legal texts in a single volume.111 The current position in English law is that no current treatise pursues that ambition. There are clear indications that distinguished judges consider that the same approach underlies the interpretation of statutes, contract, and wills. A seminal example is the well-known statement of principle by Lord Blackburn in River Wear Commissioners v Adamson.112 More recently, in Trump International Golf Club Scotland Ltd v Scottish Ministers Lord Hodge noted:

There is a modern tendency in the law to break down divisions in the rules on the interpretation of different kinds of document, both private and public, and to look for more general rules on how to ascertain the meaning of words. In particular, there has been a harmonisation of the interpretation of contracts, unilateral notices, patents and also testamentary documents.113

(p. 24) Nevertheless English law is currently served by volumes on each species of text.114 Furthermore, in The Antaios115 Lord Diplock cautioned against ‘the extension of the use of the expression “purposive construction” from the interpretation of statutes to the interpretation of private contracts’.116 However by 2013 Lord Mance in the Supreme Court was emphatic that in respect of contractual construction ‘the proper approach is contextual and purposive’.117 Other judges have preferred ‘commercial’ or ‘contextual’ construction of contracts. So in Mannai Investments Ltd v Eagle Star Assurance Co Ltd,118 Lord Steyn stated:

there has been a shift from strict construction of commercial instruments to what is sometimes called purposive construction of such documents. Lord Diplock deprecated the use of that phrase in regard to the construction of private contracts as opposed to the construction of statutes[119] … That is understandable. There are obvious differences between the processes of interpretation in regard to private contracts and public statutes. It is better to speak of a shift towards commercial interpretation.

Furthermore, it can be observed that the modernization of statutory construction took place before the parallel developments in contractual construction.120 The traditional approach (deploying three time-honoured rules: the literal rule, (p. 25) the mischief rule, and the golden rule) was replaced by purposive construction over the course of the post-war period, being firmly entrenched by the end of the 1970s.121 In contrast, it was the last three decades of the twentieth century which saw the development of commercial or contextual interpretation of contracts.

1.35  Obviously statutory construction and contractual construction share similarities, especially in respect of core principles of objectivity, adopting a holistic reading, having regard to contextual dimension and to the identification of purpose. However there are also disparities which encourage their separate treatment. Statutes concern the conferral and exercise of significant state power, and constitutional constraints are prominent in discussions of construction.122 The Interpretation Act 1978, which does not purport to set out principles of construction, but principally aims to consolidate certain recurring definitions, applies generally to statutes. By its express provisions it only has limited application to contracts and other instruments.123

1.36  In terms of the materials which are admissible as an aid to intepretation, statutory construction employs a liberal approach to pre-legislative government and law reform bodies’ papers (together with, where they are available, travaux preparatoires124), and a decisively permissive, but still controversial, step was taken in Pepper v Hart125 in 1991, in permitting recourse to Parliamentary debates in Hansard. There are respectable constitutional arguments (based principally on the separation of powers) that that may have been a step too far.126 It is an interesting point of contrast with contractual construction that Lord Mackay’s dissenting (p. 26) speech in Pepper v Hart127 instanced the costs of investigation as an objection to the permissive approach. That argument has been better received in the context of contractual construction.128

The ‘literalist’ school and the ‘purposive’ school

1.37  The approach of the courts to contractual interpretation is often said to have shifted over recent decades from a formalistic insistence on adhering to the strict letter of the language of the contract to an approach which is more commercial or commonsensical in its attitude.129 In the words of the great American scholar on the law of evidence, Wigmore, it is ‘the history of a progress from a stiff and superstitious formalism to a flexible rationalism’.130 The development of English law in this regard is often described so as to produce two rival (perhaps caricatured) schools of contractual interpretation; namely, the literalists (or the more traditional approach)131 and those favouring a more purposive approach (supposedly the more modern view). In the words of Lloyd LJ many questions of construction seem ‘designed to separate the purposive sheep from the literalist goats’.132 That supposed dichotomy is too simplistic.

(p. 27) 1.38  In Arbuthott v Fagan133 Sir Thomas Bingham MR observed (in a dictum which is simultaneously eye-catching and fence-sitting): ‘construction is a composite exercise, neither uncompromisingly literal nor unswervingly purposive …’134 Subsequently, Lord Bingham described his own dictum as the ‘sober truth’, and further remarked that ‘it is one thing to abjure pedantic literalism, as we all do; it is quite another to suggest that the terms in which the contracting parties have chose to express their bargain are not in all cases important and in most decisive’.135 His Lordship neatly captures the continuing commitment of judges to take very seriously the actual language of the contractual documentation, and not to depart from its conventional meaning except where the wider context and business common sense clearly indicated that an alternative construction was to be preferred. The relative strictness of the approach to contractual construction of the judiciary is undoubtedly a factor in the success of English commercial law. So too is the commitment to giving effect to business common sense, and that necessarily entails a rejection of literalism and pedantry. The repudiation of literalism by the modern judiciary was encapsulated by Lawrence Collins J’s observation that ‘the relevant principles are that words should be interpreted in the way in which a reasonable commercial person would construe them, and literalism is to be avoided in the interpretative process’.136 Similarly in the reinsurance context Lord Mustill has cautioned that clauses ‘should not be interpreted in the manner of a philologist or a pedant’.137 Lord Mance was emphatic that ‘the proper approach is contextual and purposive’.138 More recently it might be thought (p. 28) that the Supreme Court’s emphasis on the language of the contract in Arnold v Britton139 indicates that the pendulum is swinging back to a stricter, and less liberal, approach.140 However subsequent authorities make clear that the common sense approach prevails, and that literalism has been firmly rejected.141 It is nevertheless still useful to consider the principal tenets of the traditional approach before going on to consider the more modern pronouncements on construction.

The traditional approach to construction

1.39  A century ago the approach of the court to construction of contracts was encapsulated by Cozens-Hardy MR in these terms: ‘it is the duty of the court … to construe the document according to the ordinary grammatical meaning of the words used therein, and without reference to anything which has previously passed between the parties.’142 The traditional approach to construction is nowadays often stigmatized as tainted with the vice of literalism. However most older judicial and juristic pronouncements are rarely unthinkingly strict or expressed as cast-iron rules. Often there is an escape route from the strict letter of the contract. For example, in Ford v Beech Parke B warned that ‘greater regard is to be had to the clear intent of the parties than to any particular words which they may have used in the expression of their intent’.143 One classic pronouncement from 1803 is Lord Ellenborough CJ in Robertson v French,144 which concerned a marine policy:

[T]he same rule of construction which applies to all other instruments applies equally to this instrument of a policy of insurance, viz, that it is to be construed according to its sense and meaning, as collected in the first place from the terms used in it, which terms are themselves to be understood in their plain, ordinary and popular sense, unless they have generally in respect of the subject-matter, as by the known usage of trade, or the like, acquired a peculiar sense distinct from the popular sense of the same words; or unless the context evidently points out that they must … be understood in some other special and peculiar sense.145

Lord Ellenborough, whilst applying the ‘plain meaning’ approach, recognizes at least three express qualifications: first, the impact of the other terms; secondly, technical or trade usage; and thirdly, the impact of the surrounding circumstances.

(p. 29) 1.40  Similarly, the classic text Norton on Deeds in its last edition in 1928, which might be expected to be a bastion of literalism, provides for plain meaning to yield to context in appropriate cases, and that lack of ambiguity should be a precondition of applying the literal meaning:

When the words used in a deed are in their literal meaning unambiguous, and when such meaning is not excluded by the context, and is sensible with respect to the circumstances of the parties at the time of executing the deed, such literal meaning must be taken to be that in which the parties used the words.146

It may be that the differences between the traditional approach and the modern approach are largely differences of emphasis. It is necessary to try to identify with more precision these differences of emphasis by comparing the responses of each approach to three foundational questions.

The traditional approach encapsulated

1.41  The traditional approach to contractual interpretation can be encapsulated by three oft-repeated core principles.

The traditional approach: what is the purpose of construction?

1.42  First, interpretation is an exercise in ascertaining the ‘intentions of the parties’. This is immediately qualified by the objective principle which entails that English law is not concerned with either or both parties’ actual or subjective intentions. It is focused on the intentions as manifested in the document which embodies the agreement. In this sense the parties’ intentions are objectively ascertained.

The traditional approach: what is the approach of the court to language?

1.43  Secondly, these common intentions are to be discerned from the ‘plain’ or ‘natural and ordinary meaning’ of the language which they have employed. A relatively strict or formal approach to language is adopted. Associated with this is a supposed ‘plain meaning’ rule whereby if the language used is unambiguous the court must apply it.

The traditional approach: what materials or evidence will the court consider?

1.44  Thirdly, the court will not ordinarily consider evidence outside the four corners of the document being construed in order to supplement, vary, or contradict the written terms. This restrictive approach to ‘extrinsic evidence’ was known as the (p. 30) ‘parol evidence’ rule (working in tandem with the plain meaning rule). On occasion extrinsic evidence was admitted, but usually only in cases of ambiguity or other problems of expression.147

Each of these core beliefs has been challenged by more recent judicial pronouncements.

The shift to the modern approach to construction

1.45  The modern approach, which has come to predominate, spurns ‘literalism’ and artificial restrictions on the circumstances which the tribunal can take into account. This approach can be traced back nearly five decades to the early 1970s148 with the judgments of Lord Wilberforce in Prenn v Simmonds149 and Reardon Smith Line Ltd v Yngvar Hansen-Tangen150 being treated as seminal in Investors Compensation Scheme Ltd v West Bromwich Building Society.151 Whilst I have used the appellation ‘modern approach’, the precise name for this style of construction is controversial. It has variously been described as the ‘purposive’ approach, the ‘commercial’ approach, the ‘common sense’ school, or perhaps (most fittingly) the ‘contextual’ approach.

1.46  The emphasis on common sense or commercial sense was stressed by the House of Lords in the 1980s. In the Miramar case Lord Diplock advocated identifying a meaning which made ‘good commercial sense’.152 The same judge returned to the fray in The Antaios; whilst disclaiming a purposive approach to contractual construction, his Lordship nevertheless insisted on ‘semantic and syntactical analysis’ yielding to ‘business commonsense’ in the construction of commercial documents.153

1.47  Authorities in the 1990s shifted the emphasis to contextualism, which is perhaps the most characteristic feature of the modern school, rather than purposive reasoning or the well-established insistence on objectivity. It was perhaps best encapsulated by Sir Robert Goff (as he then was) writing extra-judicially:

(p. 31)

there is only one principle of construction so far as commercial documents are concerned: and that is to make, so far as possible, commercial sense of the provision in question, having regard to the words used, the remainder of the document in which they are set, the nature of the transaction, and the legal and factual matrix.154

By 2013 in the Supreme Court Lord Hope noted favourably ‘the way strict rules for the interpretation of contracts have been discarded in favour of giving effect to what a reasonable person would have understood the parties to have meant by the language used’.155

The Investors Compensation Scheme restatement

1.48  In a sequence of cases in the late 1990s156 the House of Lords refined the modern approach to contractual construction, culminating in the decision in Investors Compensation Scheme Ltd v West Bromwich Building Society. In that landmark case (which has been cited and relied upon on innumerable occasions) Lord Hoffmann’s speech explicitly restated the governing principles of contractual construction:157

I do not think that the fundamental change which has overtaken this branch of the law, particularly as a result of the speeches of Lord Wilberforce in Prenn v Simmonds and Reardon Smith Line Ltd v Yngvar Hansen-Tangen, is always sufficiently appreciated. The result has been, subject to one important exception, to assimilate the way in which such documents are interpreted by judges to the common sense principles by which any serious utterance would be interpreted in ordinary life. Almost all the old intellectual baggage of ‘legal’ interpretation has been discarded. The principles may be summarised as follows.

  1. (1)  Interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.

  2. (2)  The background was famously referred to by Lord Wilberforce as the ‘matrix of fact’, but this phrase is, if anything, an understated description of what the background may include. Subject to the requirement that it should have been reasonably (p. 32) available to the parties and to the exception to be mentioned next, it includes absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man.

  3. (3)  The law excludes from the admissible background the previous negotiations of the parties and their declarations of subjective intent. They are admissible only in an action for rectification. The law makes this distinction for reasons of practical policy and, in this respect only, legal interpretation differs from the way we would interpret utterances in ordinary life. The boundaries of this exception are in some respects unclear. But this is not the occasion on which to explore them.

  4. (4)  The meaning which a document (or any other utterance) would convey to a reasonable man is not the same thing as the meaning of its words. The meaning of words is a matter of dictionaries and grammars; the meaning of the document is what the parties using those words against the relevant background would reasonably have been understood to mean. The background may not merely enable the reasonable man to choose between the possible meanings of words which are ambiguous but even (as occasionally happens in ordinary life) to conclude that the parties must, for whatever reason, have used the wrong words or syntax: see Mannai Investments Co Ltd v Eagle Star Life Assurance Co Ltd.

  5. (5)  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. Lord Diplock made this point more vigorously when he said in Antaios Compania Naviera SA v Salen Rederierna AB [1985] AC 191, 201: ‘if detailed semantic and syntactical analysis of words in a commercial contract is going to lead to a conclusion that flouts business commonsense, it must be made to yield to business commonsense.’

Each of those five propositions will require further consideration in this treatise. The first three are principally concerned with the admissible background and are considered further in Chapter 5. Principles 4 and 5 relate to the power to correct mistakes by construction which is considered, alongside rectification, in Chapter 17.

The modern approach to construction encapsulated

1.49  We shall now consider in turn the three principal features of the modern approach, posing the three same questions we used in respect of the traditional approach.

The modern approach: what is the purpose of construction?

1.50  First, construction is concerned with ascertaining the meaning which the document (or utterance) would convey to a reasonable person. It is not concerned with identifying some (fictional) common intention of the parties. The parties are taken to have contracted on the basis that they both accept the determination of an independent tribunal as to the meaning and effect of the language they have (p. 33) deployed, applying the standard of the reasonable person. In this sense the meaning is ‘objectively ascertained’.

The modern approach: what is the approach of the court to language?

1.51  Secondly, the court adopts a common-sense approach to the meaning of contractual language taking the actual language used seriously, but rejecting literalism and cautious of technical arguments of syntax and semantics. Whilst the general principle is that a common-sense reading is to be preferred, in respect of some contracts or some species of contractual clause a stricter approach to language may be adopted on the grounds of legal policy.

The modern approach: what materials or evidence will the court consider?

1.52  Thirdly, the tribunal considers as relevant not just the immediate context of the remainder of the instrument, but all the admissible surrounding circumstances, being the legal, regulatory, and factual background (albeit not the prior negotiations or declarations of subjective intention) when interpreting the language. Crucially this approach is adopted whether or not a particular phrase or clause is unclear or ambiguous. Ambiguity is no longer a precondition for recourse to such ‘extrinsic evidence’.

Principles and Policies

Canons of construction

1.53  One aspect of recent developments is that the ‘canons of construction’ and the Latin maxims (expressio unius, ejusdem generis) which many lawyers associate with the exercise of interpretation are conspicuous largely by their absence in modern judicial pronouncements and appear for most practical purposes to be redundant. Over 60 years ago this rule-based approach was famously ridiculed by the great American jurist Karl Llewellyn in the context of statutory interpretation. Llewellyn, as a legal realist, advocated a pragmatic or purposive approach to construction. Until that happened the courts would continue to rely on contradictory rules of construction, selecting the appropriate one for a fair disposal of the case. Llewellyn happily observed: ‘there are two opposing canons on almost every point.’158 Llewellyn appended to his discussion some 28 examples of contradictory canons. The argument can be readily transposed to private law interpretation. For example, one party may ‘thrust’ with: ‘If language is plain and unambiguous it must be given effect.’ The other may ‘parry’ with: ‘Not when the literal interpretation would lead to absurd or mischievous consequences or thwart manifest (p. 34) purpose.’ Similarly one party may propound: ‘Every word and clause must be given effect to.’ The other may riposte: ‘If inadvertantly inserted or if repugnant to the rest of the [document], they may be rejected as surplusage.’159 Given that the modern English approach to construction of contracts has adopted a more pragmatic approach, argumentation in terms of opposing canons and the deployment of Latin maxims is less in evidence. However it will be necessary in this work to examine whether there is any remaining role for such propositions.160

Common law and equity

1.54  As a matter of history there may have been a divergence in the approach to construction of documents between the common law and the equity courts.161 Any disparity of approach is unprincipled. It was rejected as long ago as 1779 by Lord Mansfield in Hotham v East India Company where he pronounced: ‘In construing agreements, I know no difference between a Court of Law and a Court of Equity.’162 In the wake of the fusion of (the administration of) law and equity by the Judicature Acts of 1873–1875 any such distinction would be untenable as a matter of English law. It is now firmly established that the modern or common-sense approach to construction is adopted in both the Queen’s Bench Division and the Chancery Division of the High Court.

That approach remains qualified by the exclusionary rules of evidence, which either developed on the Chancery side or were more firmly adhered to in that division, prior to their formal adoption by the House of Lords. In the 1970s the House of Lords confirmed that construction should be strictly contemporaneous with the moment of contractual formation. Accordingly judges should disregard as irrelevant and inadmissible both the prior negotiations163 and the subsequent conduct of the parties.164 This was despite the existence of earlier authority evidencing a broader approach to such materials as aids to construction.165 As Lord Denning MR recorded in AIP v Texas Bank, whilst the (p. 35) common law courts had previously had ready recourse to subsequent conduct ‘it was always repudiated by the more logical minds in Chancery. Eventually the logicians prevailed’.166

1.55  In Bank of Credit and Commerce International SA (in compulsory liquidation) v Ali 167 the House of Lords emphatically and unanimously rejected any suggestion that there were different rules of interpretation at common law and in equity. Lord Bingham agreed with the view expressed in the Court of Appeal that ‘there are no such things as rules of equitable construction of documents’.168 Lord Nicholls stated: ‘Today there is no question of a document having a legal interpretation as distinct from an equitable interpretation.’169

Principles of construction, not rules

1.56  As long ago as 1941 in Luxor (Eastbourne) Ltd v Cooper170 Lord Wright cautioned against analysing the courts’ approach to construction as rule-based:

I deprecate in general the attempt to enunciate decisions on the construction of agreement as if they embodied rules of law … the decision as to each must depend on the consideration of the parties’ contract read in the light of the material circumstances of the parties in view of which the contract is made.171

1.57  Many judges have cautioned against too slavish an adherence to any supposed rule of construction. According to Salmon LJ: ‘rules of construction are merely our guides and not our masters.’172 Similarly the modern approach deploys broad principles, not a detailed body of rules. In Investors Compensation Scheme Ltd v West Bromwich Building Society Lord Hoffmann described his restatement of English law as ‘principles’.173 In contrast, in Bank of Credit and Commerce International SA v Ali his Lordship scathingly described the old approach as deploying ‘rules (p. 36) of construction’.174 In the same case Lord Clyde observed that ‘the exercise is not one where there are strict rules’.175

Standard form contracts

1.58  The approach of the courts to the interpretation of terms in standard form contracts which are used repeatedly is influenced by policy concerns of facilitating transactions and promoting certainty. Accordingly in respect of many standard forms a body of learning has developed: for example the National Conditions of Sale promulgated by the Law Society in respect of domestic conveyancing. Similarly in the commercial context there exist various standard forms of marine insurance policy, charterparties, bills of lading, and contracts for the sale of commodities. In this context the exegesis of such standard terms helps to promote certainty in commercial transactions and therefore case law is reported in the (specialist) law reports.176

1.59  In The Nema177 Lord Diplock (in the arbitration context) emphasized the need for certainty and consistency in construction of the commercial standard forms:

My Lords, when contracts are entered into which incorporate standard terms it is in the interests alike of justice and of the conduct of commercial transactions that those standard terms should be construed and treated by arbitrators as giving rise to similar legal rights and obligations in all arbitrations in which the events have given rise to the dispute do not differ from one another in some relevant respect. It is only if parties to commercial contracts can rely upon a uniform construction being given to standard terms that they can prudently incorporate them in their contracts without the need for detailed negotiation or discussion … English commercial law has achieved a degree of comprehensiveness and certainty that has made it acceptable for adoption as the appropriate proper law to be applied to commercial contracts wherever made by parties of whatever nationality.178

Similarly Lord Goff of Chieveley, whilst noting the absence of an English commercial code, nevertheless insisted on the importance of the long-established (p. 37) commercial standard forms: ‘In a sense, we do not have one commercial code but several, to be found in all the standard forms so widely used throughout the world—the Lloyds form of standard marine policy, the various forms of charter party and commodity trade contract, and so on.’179 Both judicial and specialist textbook exegesis of these forms is central to English and international commercial law and practice. In this context it may often be more important that a particular clause or phrase has received an authoritative judicial interpretation, than that it has received the best possible judicial analysis. The prevalence of these standard forms, with their judicial and juristic commentary, provides a further imperative to have regard to the objectives of certainty and predictability.180 However in The Echa Moore-Bick LJ cautioned against excessive reliance on the historical development of standard forms at the expense of the commercial background of the actual deal:

The parties and the judge were content to treat the history and development of the IDDCO form as part of the commercial background to the contract. In cases where it is possible to identify with a degree of confidence the reason for a particular amendment to a standard form, for example, where a change has been made to respond to the effect of a particular decision of the courts, a change in legislation or a widely publicised event, that may be appropriate. Such cases are usually well-known within the industry and are often documented in the trade press. Both parties are therefore likely to be aware of them. I am doubtful, however, whether it is legitimate simply to compare the earlier and later versions of the contract form on the assumption that the parties consciously intended to achieve a particular result by adopting the later version. Such an exercise is not wholly removed from that of referring to drafts produced during the course of negotiations, which are not a proper aid to construction. The earlier version does, of course, serve as an example of how the contract could have been worded differently, but in that respect it has no greater persuasive force than a text created for the purposes of the trial. The fact is that in the present case we have no evidence of why specific changes were made, nor any evidence that the parties turned their minds to the differences between the two forms and there must be a real likelihood that they simply reached for the current form without any consideration of the earlier version. In any event, times have moved on and one cannot assume that the commercial background has not moved with them. In my view the right course when seeking to ascertain the intention of the parties is to consider this contract on its own terms against the commercial background as it existed at the time it was made.181

Furthermore, a more restrained approach to the consideration of evidence of the background to a particular dispute may be appropriate: ‘In general, the court (p. 38) ought to be more reluctant to allow extrinsic evidence to affect standard form contracts and commercial documents.’182

Standard forms versus bespoke alterations

1.60  Where a standard form is employed, particularly in a commercial context, it is not uncommon for typed or handwritten alterations to appear on the face of the instrument. This is a common way in which standard trading forms are ‘customized’ for particular transactions. In the event of inconsistency between the boilerplate text and the additions or alterations, the approach of the courts has always been to give precedence to the latter. The classic statement was that of Lord Ellenborough CJ in Robertson v French 183 where his Lordship favoured the written words over the printed text:

if there should be any reasonable doubt upon the sense and meaning of the whole, to have a greater effect attributed to them [the written words] than to the printed words, inasmuch as the written words are the immediate language and terms selected by the parties themselves for the expression of their meaning, while the printed words are a general formula, adapted equally to their case and that of all other contracting parties upon similar occasions and subjects.184

The principles of construction are universal

1.61  One feature of modern pronouncements is that the rules of construction which originated in respect of deeds and formal instruments now apply to contracts generally.185 Furthermore they have been applied to deeds of assignment186 and unilateral notices issued pursuant to a contract.187 For example, in the context of (p. 39) commercial landlord and tenant, in Mannai Investments Ltd v Eagle Star Assurance Co Ltd, Lord Steyn observed: ‘There is no justification for placing notices under a break clause in leases in a unique category.’188

1.62  In Bank of Credit and Commerce International SA (in compulsory liquidation) v Ali189 it was held that there were no special rules for construing compromises. The ordinary rules of contractual interpretation applied.190 According to Lord Nicholls:

there is no room today for the application of any special ‘rules’ of interpretation in the case of general releases. There is no room for any special rules because there is now no occasion for them. A general release is a term in a contract. The meaning to be given to the words used in a contract is the meaning which ought reasonably to be ascribed to those words having due regard to the purpose of the contract and the circumstances in which the contract was made. This general principle is as much applicable to a general release as to any other contractual term.191

1.63  The contrary approach was criticized in Beaufort Developments (NI) Ltd v Gilbert-Ash NI Ltd where Lord Lloyd of Berwick observed: ‘standard forms of building contract have often been criticised by the courts for being unnecessarily obscure and verbose. But in fairness one should add that it is sometimes the courts themselves who have added to the difficulty by treating building contracts as if they were subject to special rules of their own.’192 Similarly the application of the modern principles to contracts of guarantee was confirmed by the Court of Appeal in Egan v Static Control Components (Europe) Ltd.193

The role of reasonableness (or unreasonableness)

1.64  Prominent pronouncements on construction by appellate judges over the last five decades reveal a number of propositions which undermine the tenets of the traditional approach. First and foremost in the 1970s, Lord Reid in L Schuler AG v Wickman Machine Tool Sales Ltd194 observed:

The fact that a particular construction leads to a very unreasonable result must be a relevant consideration. The more unreasonable the result the more unlikely it is (p. 40) that the parties can have intended it, and if they do intend it the more necessary it is that they shall make that intention abundantly clear.

1.65  This is a candidate for the most important principle to be enumerated in this treatise, as it must always be considered.195 However there is no general principle of construction in English law that judges are equipped with a general power or discretion to override the clearly expressed intentions of the parties on the basis that the result contended for is unfair or unreasonable. Nevertheless Lord Reid’s warning encapsulates a suspicion of technical or literalist submissions which fly in the face of the judicial instinct as to what reasonable business people might have agreed. It is clear that the approach of the courts to contractual construction is objective; that is, it adopts the perspective of a reasonable business person.

1.66  This point was emphasized by Lord Steyn:

Loyalty to the text of a commercial contract, instrument or document read in its contextual setting is the paramount principle of interpretation. But in the process of interpreting the meaning of the language of a commercial document the court ought generally to favour a commercially sensible construction. The reason for this approach is that a commercial construction is likely to give effect to the intention of the parties. Words ought therefore to be interpreted in the way in which a reasonable commercial person would have construed them. And the reasonable commercial person can safely be assumed to be unimpressed with technical interpretations and undue emphasis on niceties of language.196

The role of good faith and fair dealing

1.67  Most legal systems would consider that one of the factors which a court should take into account in interpreting a contract (or implying a term) are considerations of good faith and fair dealing, based on objective standards of acceptable commercial behaviour. This factor is strikingly absent from English law. This distinguishes English law from many other legal systems, including the civil law countries of the European Union, and the United States of America under the Uniform Commercial Code.197 The (p. 41) principle of good faith also appears in international restatements of contract law.198

The orthodox position is that English law does not recognize any overarching obligation to act in good faith in the negotiation or performance of contracts, or in their construction.199 In Walford v Miles, where Lord Ackner described a duty to negotiate in good faith as ‘inherently repugnant’ to the adversarial position of negotiating parties and ‘unworkable in practice’.200 In contrast in Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd  201 Bingham LJ identified ‘piecemeal solutions’ developed at common law, in equity, and by legislation which played an analogous or functionally equivalent role to good faith in civil law systems. Lord Falconer, then Lord Chancellor, proclaimed in 2005:

English commercial law provides predictability of outcome, legal certainty, and fairness. It is clear and built upon well-founded principles, such as the ability to require exact performance and the absence of any general duty of good faith.202

This represents a widely held view that it is absence of any direct recourse to a principle of good faith in contract law is one of the strengths of English contract law. In a widely discussed and much-cited judgment in 2013, Leggatt J in Yam Seng Pte Ltd v International Trade Corporation Ltd203 observed that if the orthodox position was correct then: ‘In refusing, however, if indeed it does refuse, to recognise any such general obligation of good faith, this jurisdiction would appear to be swimming against the tide’.204 Interestingly Leggatt J rejected concerns that an overarching duty might entail uncertainty by noting that it involves ‘no more uncertainty than is inherent in the process of contractual interpretation’.205 However that appears to be a minority view. In MSC Mediterranean Shipping Company SA v Cottonex Anstalt206 Leggatt J returned to the fray and in 2015 referred to the ‘increasing recognition in the common law world of the need for good faith in contractual dealings’. In stark contrast on appeal in the same case207 Moore-Bick LJ observed: ‘There is in my view a real danger that if a general (p. 42) principle of good faith were established it would be invoked as often to undermine as to support the terms in which the parties have reached agreement. The danger is not dissimilar to that posed by too liberal an approach to construction, against which the Supreme Court warned in Arnold v Britton.’208 That explicitly made the link with the stricter approach to contractual language emphasized in more recent Supreme Court pronouncements. Given English law’s preference for certainty and predictability in this field it is at present unlikely, even in the wake of Yam Seng, that there will be an explicit recognition of the role of good faith and reasonableness in the construction of contracts, or more generally.

The intentions of the parties and the objective approach

1.68  Classically, interpretation was concerned with discerning the intentions of the parties. This phrase is less prominent in modern pronouncements but it is unlikely that it will be jettisoned altogether.209 This is because the ultimate rationale of contract law is to give effect to the intentions of the parties to transact or cooperate with each other. In English law this must necessarily be immediately qualified by the objective principle of construction. For example, in The Nema210 Lord Diplock said:

The object sought to be achieved in construing any commercial contract is to ascertain what were the mutual intentions of the parties as to the legal obligations each assumed by the contractual words in which they (or brokers acting on their behalf) chose to express them; or, perhaps more accurately, what each would have led the other reasonably to assume were the acts that he was promising to do or to refrain from doing by the words in which the promises on his part were expressed.211

1.69  Accordingly the courts adopt an objective approach to the construction of contract. Commenting on Lord Hoffmann’s first principle of construction in Cavell USA Inc v Seaton Insurance Co Gross J observed: ‘Manifestly—and this is beyond dispute—this is an objective approach.’212 Indeed it has been asserted that the objective principle is ‘the cornerstone of the theory of contract and permeates our entire approach to contractual interpretation’.213 The underlying rationale of this is that commercial parties should be free to act upon the expressed intentions of (p. 43) other parties, without having to worry about any subjective or secret intentions which were held back. The courts are not concerned with finding a common subjective view of what the parties meant, but rather with an objective understanding of what reasonable people in their shoes would have meant by the language deployed. In Shore v Wilson in 1842 Coleridge J stated: ‘the object of all exposition of written instruments must be to ascertain the expressed meaning or intention of the writer, the expressed meaning being equivalent to the intention.’214 Giving legal effect to the parties’ manifested contractual intention remains for many the whole purpose of the law of contract. Whilst a judge may ultimately hope that his construction coincides with at least one of the parties’ subjective intentions, the emphasis on the manifestation of intention is preferred as a matter of policy. English law has not hampered itself with the time-consuming and potentially fruitless task of trying to discern the parties’ actual common intentions. It has generally been content to regard the document to which the parties have subscribed as embodying their intentions, jointly expressed.

1.70  Lord Hoffmann, writing extra-judicially, has even suggested that a subjective approach to intention is ultimately unobtainable in the very nature of things:

for the purpose of interpreting what other people say, we have no direct access to their subjective mental states, no window into their minds. The best we do is to use the background against which the utterance was made, including our knowledge of the speaker, to the maximum extent that we can lay our hands on it. In the end, however, our interpretation is bound to be objective in the sense that it will be our best effort to construe what such person, using those words against that background, would have meant. We may hope that our interpretation corresponds with his or her subjective intentions, but we cannot be sure.215

1.71  Obviously in other contexts English law is concerned with ascertaining (so far as possible) the subjective state of mind of a party. For example, in civil law where a contractual vitiating factor (fraud, misrepresentation, mistake, duress) is alleged the state of mind of one or both parties may need to be ascertained, or (arguably) where the question is whether a party has dishonestly assisted in a breach of trust or fiduciary duty. However even in such inquiries the courts are ultimately driven to making inferences from the evidence before them.216 Such inquiries are necessitated in the contexts considered in this work in the case of ‘snapping up’ (p. 44) of mistaken offers and in the context of rectification, at least in the case of rectification for unilateral mistake. Otherwise English law adopts a generally objective approach to the meaning and effect of written contracts and accordingly the ‘intentions of the parties’ is seen by some as a construct, and there is often a whiff of fiction when it is invoked. In Bromarin v IMD Investments217 Chadwick LJ accepted the criticism that interpretation was often ‘an artificial exercise’, where it entailed imputing to the parties an intention which they did not have.218 More modern pronouncements attempt to circumvent the apparent artificiality of the exercise, and therefore speak directly of the meaning which the document would convey to a reasonable person. Most recently, Sir George Leggatt has argued that even this description of the approach of the courts is insufficiently objective and too psychological. He prefers a rational choice theory posited on the assumptions that the parties have deliberately chosen their contractual language to express a certain meaning and that they are to be assumed to be reasonable people with the knowledge and aims of reasonable persons in their position.219

‘Natural and ordinary meaning’

1.72  This is one of the shibboleths of the traditional approach to construction. It remains common to hear judges say that the golden rule of interpretation is to give effect to the ‘natural’ or ‘plain’ meaning of the words. Many would sympathize with the great American jurist, Judge Learned Hand, who insisted: ‘there is a critical breaking point … beyond which no language can be forced.’220 In contrast, Hoffmann LJ has suggested: ‘language is a very flexible instrument and, if it is capable of more than one construction, one chooses that which seems most likely to give effect to the commercial purpose of the agreement.’221

1.73  A moment’s reflection on the diversity of human languages and dialects suggests that an assumption that words have a ‘natural’ meaning is suspect. Glanville Williams, writing over 70 years ago,222 observed that words have only a ‘commonly-accepted’ meaning, or as we might now say a ‘conventional’ meaning, or indeed, with very many words, a number of possible conventional meanings. The multiple entries for many commonly employed words in the dictionaries provide further evidence against the ‘natural’ meaning view. In some contexts particular persons or classes of persons may assign a special meaning to particular words. Otherwise Williams insists:

(p. 45)

Apart from such ordinary or assigned meanings words have no ‘actual’, ‘correct’, ‘essential’, ‘grammatical’, ‘legitimate’, ‘literal’, ‘natural’, ‘necessary’, ‘rational’, ‘real’, or ‘reasonable’ meaning (all of which adjectives are common in legal literature).223

1.74  Similarly ‘strict’, ‘narrow’, ‘technical’, and ‘legal’ meanings are labels indicating the assignment of a special meaning to particular words. These are simply the conventional usages of lawyers. Accordingly the modern approach has jettisoned reference to the discredited notions of the ‘plain’ or ‘natural’ meaning of words, preferring to speak of the ‘ordinary’, ‘conventional’, or ‘common sense’ meaning of words, usually with emphasis on the context in which those words are deployed. A forthright statement of this position is to be found in the speech of Lord Hoffmann in Charter Reinsurance Co Ltd v Fagan:

I think that in some cases the notion of words having a natural meaning is not a very helpful one. Because the meaning of words is so sensitive to syntax and context, the natural meaning of words in one sentence may be quite unnatural in another.224

1.75  Not all judges are so sceptical. Compare Lord Mustill in the same case: ‘I believe that most expressions do have a natural meaning, in the sense of their primary meaning in ordinary speech.’225

1.76  In the subsequent, landmark case of Investors Compensation Scheme Ltd v West Bromwich Building Society the phrase ‘natural and ordinary meaning’ does not appear in Lord Hoffmann’s restatement, save towards the end, in principle (5), where it is described as a ‘rule’, albeit both its description as a ‘rule’ and the phrase ‘natural and ordinary meaning’ are accorded sceptical (or perhaps ironic) speech marks by his Lordship.226 It is submitted that it is unhelpful to speak of words having a ‘natural’ meaning, however attractive that phrase sounds. It is preferable to speak of the ‘conventional’ or ‘common sense’ meaning (or range of meanings) of particular words. The context in which those words are used will always be relevant in selecting which conventional meaning is most likely to accord with the parties’ intentions. Nevertheless in the recent shift in emphasis signalled by the Supreme Court in Arnold v Britton227 this dated and linguistically unsound nostrum makes a re-appearance.

(p. 46) The importance of business common sense

1.77  The classic statement of the importance of business common sense came in the 1980s in Antaios Compania SA v Salen AB (The Antaios)228 where the House of Lords upheld the conclusions of commercial arbitrators who had favoured a ‘purposive construction … so as not to defeat the commercial purpose of the contract’. Lord Diplock broadly agreed in these terms:

While deprecating the extension of the use of the expression ‘purposive construction’ from the interpretation of statutes to the interpretation of private contracts, I agree with the passage I have cited from the arbitrators’ award and I take this opportunity of re-stating that if detailed semantic and syntactical analysis of words in a commercial contract is going to lead to a conclusion that flouts business commonsense, it must be made to yield to business commonsense.

1.78  Whilst Lord Diplock there expressly rejected the label of purposive construction, this dictum is consistently cited in support of arguments favouring greater regard to the commercial object of a contract or particular provision rather than a strict adherence to the letter of the agreement. Nevertheless what Lord Diplock in fact approved explicitly was an approach grounded in business common sense, as opposed to strict or literal exegesis of the contractual language.

1.79  Writing extra-judicially, Lord Bingham colourfully insisted on the need for business common sense: ‘Any other approach would flout the principle that the law should be the handmaid of commerce, not its dominatrix.229 This has proved to be one of the most contentious principles in recent authorities. Arden LJ has stated that ‘unless the contrary appears, the court must assume that the parties to a commercial document intended to produce a commercial result, and the court must thus take into account the commerciality of the rival constructions, if that commerciality can be identified. The commerciality of a particular construction may be a crystallising factor in its favour where it is implausible that parties would have intended any other result.’230 Subsequently Lord Diplock’s language was toned down, with business common sense taking on the role of a tie-breaker. Longmore LJ restated the approach: ‘If a clause is capable of two meanings, as on any view this clause is, it is quite possible that neither meaning (p. 47) will flout common sense. In such circumstances, it is much more appropriate to adopt the more, rather than the less, commercial construction.’231 This formulation found favour in the Supreme Court in 2011, in Rainy Sky SA v Kookmin Bank,232 where in a judgment delivered by Lord Clarke, he rejected any ‘plain meaning’ rule, and clearly held that where there were two tenable constructions of a commercial contract judges were entitled to prefer the one which accorded with business common sense. Lord Clarke cited Lord Steyn’s extra-judicial statement that:

Often there is no obvious or ordinary meaning of the language under consideration. There are competing interpretations to be considered. In choosing between alternatives a court should primarily be guided by the contextual scene in which the stipulation in question appears. And speaking generally commercially minded judges would regard the commercial purpose of the contract as more important than niceties of language. And, in the event of doubt, the working assumption will be that a fair construction best matches the reasonable expectations of the parties.233

However more recently judges have expressed doubts about their ability to weigh considerations of commercial common sense.234 These doubts reflect the change of emphasis which prioritises the language of the document over context and commercial common sense most closely associated with the 2015 Supreme Court decision of Arnold v Britton.235 However this is over-stated and irreconcilable with the other leading pronouncements over the last four decades and the actual results in a significant number of cases including decisions of the Supreme Court.236

(p. 48) The relevance of the contract as a whole

1.80  Both the traditional and the modern approaches to construction stress the importance of having regard to the instrument as a whole. It is important not to fixate on one particular word or phrase and thereby neglect the overall purpose of the document or to give disporportionate importance to one phrase or clause. This is a long-standing rule. For example in 1774, in Moore v Magrath Lord Mansfield observed:

The deed begins with the preamble usual in all settlements; that is, by reciting what it is the grantor intends to do; and that, like the preamble to an Act of Parliament, is the key to what comes afterwards.237

In 1812 in Barton v Fitzgerald Lord Ellenborough stated:

The sense and meaning of the parties in any particular part of an instrument may be collected ex antecedentibus et consequentibus; every part of it may be brought into action in order to collect from the whole one uniform and constant sense, if that may be done.238

Similarly in 1893 Lord Watson applied ‘the well-known rule that a deed ought to be read as a whole, in order to ascertain the true meaning of its several clauses; and that the words of each clause should be so interpreted as to bring them into harmony with the other provisions of the deed, if that interpretation does no violence to the meaning of which they are naturally susceptible.’239

1.81  Nevertheless seeking harmony or unity in a document may be a frustrating and ultimately fruitless pursuit, as the courts have on occasion recognized. In The Starsin 240 Lord Bingham of Cornhill stated that ‘to seek perfect consistency and economy of draftsmanship in a complex form of contract which has evolved over many years is to pursue a chimera’.241

The primacy of the contractual language or loyalty to the text

1.82  A defining feature of English contract and commercial law is that the actual language chosen by the parties is taken very seriously indeed, with the words of the document often determinative of the result. It is the jumping off point for all exercises in construction, and often the ultimate destination. Many have trumpeted this loyalty to the contractual language, coupled with the absence of (p. 49) any general principle of good faith, as virtues of the common law approach.242 Even leading proponents of the modern approach to construing commercial contracts, who favour a broad approach to evidence outside the four corners of the contract, nevertheless stress that primacy ought to be accorded to the document which records the parties’ agreement. This is the principle of the ‘primacy of the contractual language’ or of ‘loyalty to the text’.243 In the words of Lord Steyn in Society of Lloyd’s v Robinson: ‘Loyalty to the text of a commercial contract, instrument or document read in its contextual setting is the paramount principle of interpretation.’244 Furthermore, Lord Steyn, writing extra-judicially, pronounced:

The mandated point of departure must be the text itself. It does not mean that contextual materials in aid of the interpretation of a text must be ruled out or downgraded. After all, a statement is only intelligible if one knows under what conditions it was made. But extrinsic materials are subordinate to the text itself. The primacy of the text is the framework of reference for the judge considering a point of interpretation. But all legal texts must be construed against the contextual setting in which they come into existence. Taking full account of such aids to construction the judge must concentrate on the different meanings which the text is capable of letting in. What falls beyond that range of possible meanings will not be a result attainable by interpretation.245

This principle of the primacy of the document is reflected in the first sentence of principle (5) of Lord Hoffmann’s restatement in Investors Compensation Scheme Ltd v West Bromwich Building Society which endorses ‘the common sense proposition that we do not easily accept that people have made linguistic mistakes, particularly in formal documents’.246 In Bank of Credit and Commerce International SA (in compulsory liquidation) v Ali 247 Lord Hoffmann reaffirmed that ‘the primary source for understanding what the parties meant is their language interpreted in accordance with conventional usage’.248 In 2015 the majority of the Supreme Court in Arnold v Britton249 put the principle of loyalty to the text at the centre of its discussion of contract interpretation.250

(p. 50) The role of the legal, regulatory, and factual matrix

1.83  One of the most significant features of modern pronouncements on contractual interpretation is a broad approach to the surrounding circumstances which the judges take into account when interpreting a contract. As we observed, the traditional approach was not to look outside the four corners of the document being construed, a restrictive approach known as the parol evidence rule.. Nevertheless even nineteenth-century judges paid regard to the surrounding circumstances.251 The seminal speeches of Lord Wilberforce have popularized the phrase factual matrix as shorthand for a broad approach to the context in which a transaction took place. In Reardon Smith Ltd v Yngvar Hansen-Tangen (The Diana Prosperity)252 his Lordship, having rejected the relevance of evidence of custom and practice unknown to the contracting parties, continued:

But it does not follow that, renouncing this evidence, one must be confined within the four corners of the document. No contracts are made in a vacuum: there is always a setting in which they have to be placed. The nature of what is legitimate to have regard to is usually described as ‘the surrounding circumstances’ but this phrase is imprecise: it can be illustrated but hardly defined. In a commercial contract it is certainly right that the court should know the commercial purpose of the contract and this in turn presupposes knowledge of the genesis of the transaction, the background, the context, the market in which the parties are operating.253

1.84  The modern approach adopts a generally permissive attitude to the admissibility of matters within the legal, factual, and regulatory matrix.254 Nowadays all the background circumstances which are relevant and which were reasonably available to the parties are admissible. The traditional approach of supposedly not looking outside the four corners of the document being construed—the parol evidence rule—is dead.255

(p. 51) 1.85  The modern approach adopts a generally permissive attitude to the admissibility of matters within the legal, factual, and regulatory matrix. According to Lord Hoffmann in Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd: ‘In the case of commercial contracts, the restriction on the use of background has been quietly dropped.’256 The modern test for admissible background is now encapsulated in Lord Hoffmann’s first three principles in Investors Compensation Scheme Ltd v West Bromwich Building Society (quoted above).257 In Bank of Credit and Commerce International SA (in compulsory liquidation) v Ali 258 Lord Hoffmann felt compelled to emphasize that relevance was also a threshold question for admissibility. Accordingly all the reasonably available and relevant background information is now admissible for the purposes of construing private law documents, subject to the traditional policy-based exclusionary rules (subjective intentions, prior negotiations, and subsequent conduct).259

1.86  Overall this liberalization of the evidential rules appears to have yielded sensible results in terms of the results reached. Despite some fears expressed in the initial reaction to the Investors Compensation Scheme case,260 judges do not appear overburdened by extraneous and irrelevant evidence.261

1.87  In Chartbrook Ltd v Persimmon Homes Ltd,262 Lord Hoffmann noted that Investors Compensation Scheme ‘was viewed with alarm by some distinguished commercial lawyers as having greatly increased the quantity of background material which courts or arbitrators would be invited to consider’.263 Nevertheless his Lordship doubted ‘whether the ICS case produced a dramatic increase in the amount of material produced by way of background for the purposes of contractual interpretation’.264

(p. 52) Balancing the principles

1.88  Loyalty to the text, the holistic principle, the relevance of the wider legal and factual matrix, commercial common sense, and regard to the commercial purpose of the parties are all essential principles guiding the technique of interpretation. The question arises: how are these potentially competing principles to be balanced? It is because each may point in a different direction that parties and lawyers can disagree in good faith about the meaning and effect of contractual language so routinely. Ultimately it is a question of judgement how the different principles are traded off in a particular case, and where the parties cannot resolve the dispute a judge or arbitrator must give a reasoned resolution. The majority of the Supreme Court in Arnold v Britton insisted that loyalty to the text is the dominant principle. The majority reasoning there can be criticized as giving insufficient weight to the holistic principle and common sense.265 But soon afterwards the Supreme Court reverted to a more contextual approach in the majority judgment of BNY Mellon Corporate Trustee Services Ltd v LBG Capital No 1 plc.266 The pendulum may have swung back a little to loyalty over the last decade.267 It has always been one of the defining features of English contract and commercial law that its judges take the actual language of the text very seriously. Nevertheless there has been no retreat to literalism. The modern approach is firmly entrenched and each of the principles outlined in this chapter are potentially in play in each case, and the balancing exercise ultimately one of judgement.

Prior negotiations and subsequent conduct

1.89  The broad approach to context is still constrained by the traditional insistence that the exercise in construction is to be carried out as though it were contemporaneous with the formation of the contract. According to Lord Mance in Wasa International Insurance Co Ltd v Lexington Insurance Co: ‘under English law, a contract has a meaning which is to be ascertained at the time when it is concluded, having regard to its background and the surrounding circumstances within the parties’ knowledge at that time.’268 The exercise is carried out in the light of the objectively ascertainable background facts (including, where appropriate, the legal and regulatory environment) available to both parties. Accordingly, as a general rule the declarations of subjective intent, the prior negotiations269 and subsequent conduct270 of the parties are (p. 53) inadmissible.271 According to Lord Hoffmann the exclusion of the declarations of subjective intent and prior negotiations is the only respect in which ‘legal interpretation differs from the way we would interpret utterances in ordinary life.’ Furthermore, the exclusionary rule is grounded in considerations of legal policy.272 There are often real difficulties in identifying whether a particular piece of evidence constitutes admissible surrounding circumstances or inadmissible prior negotiations. In the dozen years which followed the landmark ruling in Investors Compensation Scheme Ltd v West Bromwich Building Society 273 there was vigorous debate as to whether or not the traditional restrictions should be jettisoned. The debate was in part provoked by Lord Hoffmann’s caution with regard to the scope of the exclusionary rules in Investors Compensation Scheme, and by Lord Nicholls’s subsequent remarks in Bank of Credit and Commerce International SA (in compulsory liquidation) v Ali.274

1.90  Advocates of the liberalization of the admissible evidence cited a number of factors, including an argument that such a development was the logical outcome of the modern approach which embraced a permissive attitude to context, the difficulty of distinguishing prior negotiations from surrounding circumstances,275 and the artificiality of admitting such evidence in the context of rectification, but not in respect of interpretation. Accordingly, whilst countervailing factors, such as the need for certainty, concerns about cost, and the position of third parties, had to be considered, overall it was suggested that the better view was that such arguments went to the weight to be placed on such evidence, not their admissibility.276 The academic advocates of liberalization received the imprimatur of an important extrajudicial contribution by Lord Nicholls of Birkenhead.277(p. 54) Opponents to change stressed the importance of certainty in commercial transactions and the need for practitioners to be able to advise clients promptly on the implications of contractual documents without the need to trawl through other documentation.278

1.91  In 2009 this debate was resolved in favour of the traditional exclusionary approach by the House of Lords in one of its last judgments. In Chartbrook Ltd v Persimmon Homes Ltd279 Lord Hoffmann considered pragmatic arguments favouring certainty and predictability of outcomes, together with the avoidance of costly and time-consuming investigations into the background, he favoured the restriction of such evidence:

It reflects what may be a sound practical intuition that the law of contract is an institution designed to enforce promises with a high degree of predictability and that the more one allows conventional meanings or syntax to be displaced by inferences drawn from background, the less predictable the outcome is likely to be.280

1.92  Nevertheless it was also conceded that the policy would on occasion exclude evidence which was relevant, and the House also failed to adopt Lord Wilberforce’s original justification that such evidence was not helpful. At present, it seems that the matter has been resolved authoritatively, albeit not emphatically, in favour of the conservative arguments, at least so far as the courts are concerned.281

Purposive construction

1.93  In understanding the meaning and effect of a contract or the language of a particular provision, an appreciation of the purpose of the transaction or the clause under consideration is clearly a useful aid in understanding its scope and operation. Lord Diplock’s words in The Antaios (quoted above),282 despite his Lordship’s express disavowal of the purposive approach, are often cited in support of submissions based on business common sense, based on the aim of the contract. Similarly in the Sinochem case, Mance LJ invoked ‘our instinctive (p. 55) appreciation of commercial likelihood’.283 However Lord Lloyd of Berwick, in his dissenting speech in Investors Compensation Scheme v West Bromwich Building Society, cautioned:

Purposive interpretation of a contract is a useful tool where the purpose can be identified with reasonable certainty. But creative interpretation is another thing altogether. The one must not be allowed to shade into the other.284

1.94  Often the importance of the tool of commercial purpose is negative rather than positive in character. It may demonstrate a dog which fails to bark. In a commercial context one party may wish to advocate a strict or literal reading of the contract. Many such arguments will succeed, but not if the literal approach flies in the face of the commercial purpose of the transaction or the particular clause. This will particularly be so in cases where the party arguing for a strict or literal interpretation is unable to identify any obvious or sensible commercial purpose which supports a strict approach to the language of the clause. A prominent example was Charter Reinsurance Co Ltd v Fagan 285 where the House of Lords unanimously rejected the argument that the presence of the words ‘actually paid’ in a reinsurance treaty entailed that the (now insolvent) reinsured had to demonstrate that he had discharged his liability to the underlying insured before he could claim from the reinsurer. The absence of a sensible commercial justification for this reading weighed heavily with Lord Hoffmann:

Mr. Sumption [counsel for the reinsurers] suggested a stratagem which insurers might use to avoid having to pay the whole claim themselves. They could pay a part, even a very small part, of the reinsured liability and then, having to this extent actually paid, they could call upon the reinsurer to reimburse them. Having thus primed the pump, they could by successive strokes draw up the full amount from the reinsurance well. I cannot imagine that the parties could ever have contemplated such a strange procedure and one is bound to ask what commercial purpose the reinsurer could have expected to achieve by being able to insist upon it.286

More recently in Rainy Sky SA v Kookmin Bank287 counsel for the bank submitted it was not necessary for it to formulate any credible commercial reason for a construction which was linguistically tenable, but otherwise surprising. This received short shrift from Lord Clarke in the Supreme Court who sagely noted that if any such reason could have been discerned it would have featured prominently in the bank’s case.288 Accordingly the absence of a commercial purpose may doom many strict readings of contractual terms.289

(p. 56) 1.95  Commercial purpose may not be enough to override the express contractual language. In Total Gas Marketing Ltd v Arco British Ltd290 a construction of a contract for the supply of gas was adopted despite the concerns of the two judges that it permitted one party to withdraw in circumstances which neither party actually intended.291

Public policy and strict construction

1.96  Generally speaking the interpretation of private law documents is not a field where questions of public policy are prominent. The main policies are the common law default principles of freedom of contract and sanctity of contract. Where rival constructions of a document lead to one possible mode of performance which is lawful and one which is not, the law prefers the former.292 Otherwise the main issue of public policy that may arise is whether and to what extent the courts should adopt a stricter reading of certain contracts or certain species of clause. The modern approach to construction favours a common-sense or commercial reading of instruments. On one view that approach should be universal. However even modern pronouncements on interpretation accept that on occasion a stricter or more legalistic reading of a contract or provision is apt. The rule of strict construction in favour of the consumer of provisions in a business to consumer contract is now mandated by the Consumer Rights Act 2015.293 Exemption clauses in commercial contracts are always construed strictly, or contra proferentem, that is against the person relying on tthe clause.294 This was because such clauses were traditionally seen as one-sided, resulting from an inequality of bargaining power. In modern commercial contexts that assumption may not be safe, where sophisticated commercial parties allocate or distribute the risks of untoward events by contractual clauses on an arm’s-length basis. Nevertheless the courts continue (p. 57) to approach exemption and other risk-allocation clauses on a contra proferentem basis.295 The proper realm of strict construction other than in respect of exemption clauses —to which contracts or clauses it should apply—is a pervasive theme of this work. It is addressed as always being a matter of public policy. The matter is further considered in Chapter 6 and Chapter 8 in respect of the contra proferentem principle.296

1.97  Public policy may also favour a more restrictive approach to the admissible background circumstances in certain contexts. For example, where documents embody contractual rights which can be assigned or negotiated to third parties, policy may favour only consideration of the general context in which the bargain was struck. It has also been suggested that standard form contracts should be construed against a limited backdrop given the desirability of each transaction being treated alike.297 So too with public documents such as statutorily registrable charges over land.298

The need for certainty

1.98  The various pronouncements, presumptions, and maxims of construction propounded over the years have all tended towards the great goal of commercial lawyers, namely certainty or predictability in transactions. According to Lord Mansfield in 1774 in Vallejo v Wheeler:299 ‘In all mercantile transactions the great object should be certainty: and therefore, it is of more consequence that a rule should be certain, than whether the rule is established one way or the other. Because speculators in trade then know what ground to go upon.’ More recently, in The Chikuma300 Lord Bridge of Harwich pronounced (in the context of withdrawal clauses in time charterparties):

It has often been pointed out that shipowners and charterers bargain at arm’s length. Neither class has such a preponderance of bargaining power as to be in a position to oppress the other. They should be in a position to look after themselves (p. 58) by contracting only on terms which are acceptable to them. Where, as here, they embody in their contracts common form clauses, it is, to my mind, of overriding importance that their meaning and legal effect should be certain and well understood. The ideal at which the courts should aim, in construing such clauses, is to produce a result, such that in any given situation both parties seeking legal advice as to their rights and obligations can expect the same clear and confident answer from their advisers and neither will be tempted to embark on long and expensive litigation in the belief that victory depends on winning the sympathy of the court. This ideal may never be fully attainable, but we shall certainly never even approximate to it unless we strive to follow clear and consistent principles and steadfastly refuse to be blown off course by the supposed merits of individual cases.301

Similarly in a famous passage in The Scaptrade,302 Robert Goff LJ proclaimed:

It is of the utmost importance in commercial transactions that, if any particular event occurs which may affect the parties’ respective rights under a commercial contract, they should know where they stand. The court should so far as possible desist from placing obstacles in the way of either party ascertaining his legal position, if necessary with the aid of advice from a qualified lawyer, because it may be commercially desirable for action to be taken without delay, action which may be irrevocable and which may have far-reaching consequences. It is for this reason, of course, that the English courts have time and again asserted the need for certainty in commercial transactions—for the simple reason that the parties to such transactions are entitled to know where they stand, and to act accordingly.303

1.99  The long attachment to the ‘natural and ordinary meaning’ of language was motivated by a desire to ensure predictable decision-making on commercial disputes. This may have been more attainable with a smaller coterie of judges (and barristers) with similar educational, social, and professional backgrounds, whose shared conventional use of words was probably highly predictable. The contexts and communities in which disputes about written transactions now arise are probably more diffuse, and therefore the need for some background understanding more keen. Even in modern statements the need for predictability is stressed, particularly where insurable risks may be in play. According to Steyn LJ in The Ulyanovsk:

Certainty of rights and duties, and predictability of dispute resolution, is the first imperative of a system of commercial law. It is of fundamental importance, not so as to ease the task of Judges, but because it enables businessmen and their advisers in the drafting and negotiating stage to consider properly the risks attendant upon an adventure, and to make suitable arrangements by way of contractual stipulations (p. 59) and the procuring of insurance cover. Moreover, certainty and predictability is also of vital importance when a dispute arises, so that in so far as it is possible, the way in which it will probably be resolved will not usually be a complete mystery to businessmen and their advisers.304

1.100  However, many will sympathize with Cooke P’s observation that ‘Businessmen and lawyers are often loud in their stress on the need for certainty in commercial law. When it seems expedient, however, many are ready to destroy certainty by contending that an apparently complete written bargain was not what it seemed’.305 Certainty may be a factor against overturning a long-established precedent on the construction of a commercial instrument.306 Conversely, in appropriate cases the need for certainty may be overridden as a factor even in a context such as bankers’ security documents where it is of great importance, if it can be shown that a precedent, relied on for many decades, nevertheless approached a question of construction, or more properly characterization, on the wrong basis. This was demonstrated by the overruling of the 1978 decision of Siebe Gorman & Co Ltd v Barclays Bank Ltd307 by the House of Lords in Re Spectrum Plus Ltd308 in 2005, re-classifying most charges over book debts as floating charges and not fixed securities. According to Lord Walker in Spectrum Plus: ‘The wish to achieve legal certainty by use of a standard precedent cannot override the need to construe any document in its commercial context.’309 In Chartbrook Ltd v Persimmon Homes Ltd310 the first and most prominent reason given by Lord Hoffmann for refusing to admit prior negotiations as background for the purposes of construction was that to do so would ‘create greater uncertainty of outcome in disputes over interpretation and add to the cost of advice, litigation or arbitration’.311

1.101  Lastly, it should go without saying that the perceived merits of an underlying dispute are entirely irrelevant to the construction of a commercial agreement, and should be disregarded: ‘In the construction of commercial documents a hard-headed approach is necessary.’312

(p. 60) Lawful effect

1.102  A construction which upholds the validity of a transaction will be preferred to one which renders it invalid or too uncertain or ambiguous to enforce.313 This principle which dates back at least to Coke upon Littleton has recently been restated by the Supreme Court of Canada: ‘When a contract may be construed in two ways, a lawful interpretation ought to be preferred over an unlawful one.’314 This is reflected in the maxim ut res magis valeat quam pereat315 or ‘the contract should be interpreted so that it is valid rather than ineffective’.316

Apparent incompleteness

1.103  The perusal of the express terms of an agreement may at first sight suggest that the event or circumstance which has arisen is not explicitly provided for. The event or circumstance may not have been foreseen. Nevertheless as a matter of principle the courts will attempt to find the solution in the interstices of the contract, having regard to its overall nature and purpose, the other terms, and the context. The contract is the governing instrument and must be made to yield a solution. This may be done by interpretation of the express terms, or by deployment of the related technique of implication. It might involve a determination that, in the light of the contract and the admissible background, the contract does not apply to the events which have arisen. Conversely, it might lead to the application of the contract’s provisions to the unexpected event. The appropriate solution is sometimes said to arise from the ‘presumed common intention’ of the parties, as suggested in the leading House of Lords’ case of British Movietonews v London and District Cinemas.317 There Viscount Simon observed:

(p. 61)

The parties to an executory contract are often faced, in the course of carrying it out, with a turn of events which they did not at all anticipate—a wholly abnormal rise or fall in prices, a sudden depreciation of currency, an unexpected obstacle to execution, or the like. Yet this does not in itself affect the bargain they have made. If, on the other hand, a consideration of the terms of the contract, in the light of the circumstances existing when it was made, shows that they never agreed to be bound in a fundamentally different situation which has now unexpectedly emerged, the contract ceases to bind at that point—not because the court in its discretion thinks it just and reasonable to qualify the terms of the contract, but because on its true construction it does not apply in that situation.318

It can obviously be said that this approach involves a legal fiction, but it is one that is inextricably tied up with the process of construction, and in particular the objective principle. A more recent statement to like effect is that of Chadwick LJ in Bromarin v IMD Investments,319 who acknowledged the criticism that this approach can be castigated as artificial:

It is not, to my mind, an appropriate approach to construction to hold that, where the parties contemplated event ‘A’, and they did not contemplate event ‘B’, their agreement must be taken as applying only in event ‘A’ and cannot apply in event ‘B.’ The task of the court is to decide in the light of the agreement that the parties made, what they must have been taken to have intended to the event, event ‘B’, which they did not contemplate. That is, of course, an artificial exercise, because it requires there to be attributed to the parties an intention which they did not have (as a matter of fact) because they did not appreciate the problem which needed to be addressed. But it is an exercise which the courts have been willing to undertake for as long as commercial contracts have come before them for construction.320

1.104  In contrast, it is open to the courts to hold as a matter of construction that an uncontemplated turn of events resulted in a situation in which the parties had not intended their agreement to bind, in the sense of their presumed common intention, and that the contract ceases to apply in such events.321

Badly drafted contracts

1.105  As Lord Carnwath laconically observed in Arnold v Britton: ‘As Tolstoy said of unhappy families, every ill-drafted contract is ill-drafted “in its own way”.’322 There are no particular rules applicable to badly drafted contracts.

It is obvious that this is a badly drafted contract. This, of course, affords no reason to depart from the fundamental rule of construction of contractual documents that (p. 62) the intention of the parties must be ascertained from the language that they have used interpreted in the light of the relevant factual situation in which the contract was made. But the poorer the quality of the drafting, the less willing the court should be to be driven by semantic niceties to attribute to the parties an improbable and unbusinesslike intention, if the language used, whatever it may lack in precision, is reasonably capable of an interpretation which attributes to the parties an intention to make provision for contingencies inherent in the work contracted for on a sensible and businesslike basis.323

If the aim of good drafting is to avoid disputes or litigation all reported cases would fall within this category. Unclear, ambiguous, contradictory, and mangled words or phrases often attract judicial strictures.324 For example, in Kuwait Airways Corporation v Kuwait Insurance Co SAK Lord Hobhouse lamented that the issues before the House of Lords were all points of construction and were:

all points which could easily have been avoided by the exercise of care in the preparation and drafting of the insurance contract. Very large sums of money are involved … Such disputes are unnecessary. They can be avoided, as has been repeatedly pointed out by those before whom such disputes come for determination, by the exercise of proper care in the drafting of the documents which create and define the relevant contractual obligations.325

1.106  In contrast, this disciplinary approach was rejected by Denning LJ in British Movietonews Ltd v London and District Cinemas Ltd where his Lordship observed:

The day is done when we can excuse an unforeseen injustice by saying to the sufferer ‘It is your own folly. You ought not to have passed that form of words. You ought to have put in a clause to protect yourself.’ We no longer credit a party with the foresight of a prophet or his lawyer with the draftsmanship of a Chalmers.326

Similarly sympathetic, the pressure of ‘severe time constraints’ on some instances of legal drafting was acknowledged by Lord Walker in the Sirius International Insurance case.327

1.107  Particular standard forms often come in for particular criticism.328 On occasion the courts have to make sense of non-existent or mangled words. Diplock J (p. 63) in Louis Dreyfus & Cie v Parnaso had to make sense of ‘approximative’ in a notice served under a charterparty.329 Perhaps more common nowadays is the employment of a law firm’s internal precedent form (or somebody else’s precedent) which most closely resembles the proposed transaction, with insufficient consideration given to customizing the provisions to the situation at hand.330 In the context of hand-made agreements, assembled without the benefit of legal advice: ‘the Court has to do the best it can on the basis of the intended purpose of the arrangement as understood by both parties, the practical consequences of alternative contentions, and such other tools as the law makes available in such cases.’331

Vagueness and ambiguity

Distinguishing vagueness and ambiguity

1.108  It is common to read or hear of contractual provisions lambasted for being vague and ambiguous. However a useful distinction can be drawn between vagueness and ambiguity. It is submitted that ambiguity exists where two or more tenable constructions can be placed upon a particular word, phrase, or clause. In contrast, vagueness is present where a word, phrase, or concept is one where it may be generally clear which central case examples fall within its meaning, and which examples fall outside, but where a shadowy region exists where it is debatable whether a particular instance falls inside or outside the category.

Vagueness and the ‘penumbra’ of words and concepts

1.109  The shadowy or penumbral region at the edges of words or concepts, in the language of H L A Hart, is the source of vagueness.332 The philosopher Quine famously used the word ‘red’ to illustrate the concept of vagueness.333 Some will use this term more promiscuously than others in describing various permutations of colours. The background circumstances may exacerbate the problem: ‘words are sometimes penumbral; the context of the contract breaks down the rigidly-defined boundaries of (p. 64) meaning, introduces hues and shades, and defines the contours and limits of the penumbra.’334

Farnsworth’s analysis: ambiguities of term and syntax

1.110  Adopting this analysis the leading American contract scholar, Farnsworth, argued that ‘ambiguity’ is an ‘entirely distinct concept from that of vagueness’.335 This is where a word has two entirely different connotations, which may render a word either appropriate or inappropriate, when used in a particular context. Farnsworth suggests the word ‘light’ when applied to ‘dark feathers’.336 Farnsworth also distinguished between ambiguities of term and ambiguities of syntax. The former are unusual in contract law, for example an oral contract for ‘tons/tonnes’. The famous case of the ships Peerless337 was a rare example of proper name ambiguity. Syntactical ambiguities, arising from inadequate punctuation or the slippery use of ‘and’ and ‘or’ are more common.338

‘Latent’ ambiguity and ‘patent’ ambiguity

1.111  Traditionally a distinction was drawn between patent ambiguity and latent ambiguity. A patent ambiguity is clear on the face of the document. A latent ambiguity can only be identified by recourse to evidence outside the four corners of the document.339 The traditional rules puzzlingly provided that extrinsic evidence was not admissible to resolve a patent ambiguity, but was admissible to resolve a latent ambiguity. In the latter instance, this could extend to evidence of the subjective intentions of the parties.340 Furthermore, in the latter instance the ambiguity was only identified by reference to circumstances outside the four corners of the document. The distinction between patent and latent ambiguity was abandoned during the articulation of the modern approach to construction.

(p. 65) Abandonment of the patent and latent ambiguity distinction

1.112  The modern approach does not adopt the arcane distinction between patent ambiguity and latent ambiguity. This was prefigured by Lord Simon of Glaisdale in L Schuler AG v Wickman Machine Tool Sales Ltd: ‘the distinctions between patent ambiguities, latent ambiguities and equivocations as regards admissibility of extrinsic evidence are based on outmoded and highly technical and artificial rules and introduce absurd refinements.’341 Nowadays the common-sense approach is adopted as to what constitutes an ambiguity. Vagueness and ambiguity are not always clearly distinguished, but this has little impact in practice. The removal of the ambiguity threshold for the admission of extrinsic evidence has removed any need for consideration as to whether a problem is one of ambiguity, as opposed to vagueness. Similarly the distinction between patent and latent ambiguity is rarely adverted to. The problems in leading cases such as Investors Compensation Scheme Ltd v West Bromwich Building Society342 and Mannai Investments Ltd v Eagle Star Assurance Co Ltd343 were cases where the patent meaning of the contractual language was unambiguous. Any ambiguity was only discernible from the surrounding circumstances. In classical terms these were cases of ‘latent’ ambiguity. The decisive rejection of a restrictive approach to the admissibility of evidence of background in cases of ambiguity came in the speech of Lord Hoffmann in Mannai Investments Ltd v Eagle Star Assurance Co Ltd,344 where his Lordship considered that the strict approach of prior case law to contractual notices was influenced by the traditional, restrictive common law approach as to when evidence was admissible to resolve an ambiguity.345 Lord Hoffmann concluded:

I think that the rule is not merely capricious but also, for reasons which I need not develop at length, incoherent. It is based upon an ancient fallacy which assumes that descriptions and proper names can somehow inherently refer to people or things. In fact, of course, words do not in themselves refer to anything; it is people who use words to refer to things.346

(p. 66) It is submitted therefore that in modern English law the distinction between latent and patent ambiguity has no useful role to play. The admissible background is available in all cases of vagueness and ambiguity.347

Difficulty of construction not equated to ambiguity

1.113  It is sometimes said that merely because a phrase is open to rival (at least tenable) interpretations, does not render it ambiguous. One construction is the most appropriate, albeit that may not be possible to determine until the court has pronounced its verdict. For example, in Ailsa Craig Fishing Co Ltd v Malvern Fishing Ltd Lord Wilberforce said: ‘The possibility of construction of a clause does not amount to ambiguity: that disappears after the court has pronounced the meaning.’348 In L Schuler AG v Wickman Machine Tool Sales Ltd 349 Lord Wilberforce repeated a similar sentiment: ‘ambiguity in this context is not to be equated with difficulty of construction, even difficulty to a point where judicial opinion as to meaning has differed.’350 With respect to his Lordship, and the other judges who have expressed similar views, this deployment of the word ‘ambiguity’ is at best highly technical, or at worst misleading. On a common-sense view it is clear that such provisions were ambiguous as there existed different tenable views as to their meaning and effect, and the common-sense view of what constitutes an ambiguity is to be preferred. The concern behind such pronouncements may have been a desire to ensure that difficulty of construction did not easily render a contract void or unenforceable on the ground of uncertainty. However it is submitted that this rarefied deployment of the word ‘ambiguity’ is misleading, and not necessary to further this policy choice. The common-sense meaning of ‘ambiguity’ is to be preferred.

Ambiguity no longer a precondition to the contextual approach

1.114  One of the most striking developments of recent decades is the rejection of a requirement that the language of the contract had to be demonstrated to be ambiguous before the court would admit extrinsic evidence. Lord Steyn, writing extra-judicially, declared:

Language is a labyrinth. As in ordinary life, words in a legal text cannot be understood except in relation to the circumstances in which they are used. It is sometimes assumed by judges that the existence of an ambiguity is a precondition to (p. 67) admitting evidence of the context of a legal text. That is wrong. Language can never be understood divorced from its context.351

This change was prefigured in Arbuthott v Fagan.352 According to Steyn LJ both context and commercial purpose were always admissible, even if the language appeared clear:

I readily accept Mr. Eder’s [counsel for the reinsurer’s] submission that the starting point of the process of interpretation must be the language of the contract. But Mr. Eder went further and said that, if the meaning of the words is clear, as he submitted it is, the purpose of the contractual provisions cannot be allowed to influence the court’s interpretation. That involves approaching the process of interpretation in the fashion of a black-letter man. The argument assumes that interpretation is a purely linguistic or semantic process until an ambiguity is revealed. That is wrong. Dictionaries never solve concrete problems of construction. The meaning of words cannot be ascertained divorced from their context. And part of the contextual scene is the purpose of the provision. In the field of statutory interpretation the speeches of the House of Lords in Attorney-General v Prince Ernest Augustus of Hanover … showed that the purpose of a statute, or part of a statute, is something to be taken into account in ascertaining the ordinary meaning of words in the statute …[353] It is true that such a purpose may also be called in aid at a later stage in the process of interpretation if the language of the statute is ambiguous but it is important to bear in mind that the purpose of the statute is a permissible aid at all stages in the process of interpretation. In this respect a similar approach is applicable to the interpretation of a contractual text. That is why in Reardon Smith Line Ltd v Yngvar Hansen-Tangen (trading as H E Hansen-Tangen) [354] … Lord Wilberforce, speaking for the majority of their Lordships, made plain that in construing a commercial contract it is always right that the court should take into account the purpose of a contract and that presupposes an appreciation of the contextual scene of the contract.355

1.115  The decisive rejection of any ambiguity threshold came in Investors Compensation Scheme Ltd v West Bromwich Building Society.356 This was confirmed by Lord Steyn in Westminster City Council v National Asylum Support Services who stated that it was ‘crystal clear that an ambiguity need not be established before surrounding circumstances may be taken into account’.357

(p. 68) Reaction to the Investors Compensation Scheme restatement

1.116  The principles espoused by Lord Hoffmann in Investors Compensation Scheme Ltd v West Bromwich Building Society,358 and in particular the wide statements about admissible background, were not immune from criticism. Indeed there was an almost immediate backlash from a number of judges of the Court of Appeal. The criticisms were essentially threefold. First, an attempt was made to defend the merits of the traditional ‘plain and ordinary meaning’ approach – that is, a ‘plain meaning’ rule – which necessitated proof of ambiguity before there could be recourse to extrinsic evidence. Secondly, fears were expressed that abandonment of that principle would generate greater uncertainty in the context of commercial transactions. Thirdly, concerns were articulated about the costs and length of litigation if such a broad approach were to be adopted.

1.117  In National Bank of Sharjah v Dellborg Saville LJ attempted a last ditch defence of the more traditional emphasis:

To my mind there is much to be said for the simple rule that where the words the parties have chosen to use have only one meaning, and that meaning (bearing in mind the aim or purpose of the agreement) is not self-evidently nonsensical, the law should take that to be their intended agreement, and should not allow the surrounding circumstances to override what (ex hypothesi) is clear and obvious.359

1.118  Saville LJ also claimed that the new approach would ‘do nothing but add to the costs and delays of litigation and indeed of arbitration, much of which is concerned with interpreting agreements’. His Lordship foresaw widespread deployment of discovery (now disclosure), interrogatories (now requests for further information), cross-examination, and indeed the whole armoury of modern civil justice techniques to tease out some surrounding circumstances which might contradict the plain meaning of an instrument.

1.119  In similar vein in Scottish Power plc v Britoil Exploration Ltd360 Staughton LJ complained:

[I]t is often difficult for a judge to restrain the enthusiasm of counsel for producing a great deal of evidence under the head of matrix, which on examination is found to contribute little or nothing to the true understanding of the parties’ contract. All, or almost all, judges are now concerned about the huge cost of litigation. I have to say that such a wide definition of surrounding circumstances, background or matrix seems likely to increase the cost, to no very obvious advantage.

(p. 69) 1.120  Others sought to downplay the significance of the case. In Bromarin AB v IMD Investments Ltd 361 Chadwick LJ appeared to doubt that Investors Compensation Scheme had changed anything:

But, for my part, I am not persuaded that Lord Hoffmann intended, in the passage in the Investors Compensation Scheme case … which is so often relied upon, to propound any novel principle. To my mind, he was doing no more than emphasising that words are to be construed in the context of the agreement which the parties are making, having regard to the other provisions in the agreement, and the commercial purpose for which the agreement was made.362

1.121  Chadwick LJ went on to say that if the commercial purpose of a transaction was clear from the whole of the instrument there was no need to have regard to external evidence. To the extent that Chadwick LJ was seeking to confine the available evidence to the internal context, his judgment does not accurately reflect Lord Hoffmann’s principles, and further overlooks the prefatory reference to ‘fundamental change’.

1.122  A more plausible view appears to have been Timothy Walker J’s take on the Investors Compensation Scheme restatement in NLA Group Ltd v Bowers:

For my part, I do not read either of the speeches of Lord Hoffmann as departing from the approach of Lord Wilberforce … Lord Hoffmann was simply overruling old and outdated cases by reference to an approach to construction which has been followed in the Commercial Court for many years.363

Reaffirmation and entrenchment

1.123  Despite the criticisms expressed, in 2001 the House of Lords unanimously applied Lord Hoffmann’s Investors Compensation Scheme restatement in Bank of Credit and Commerce International SA (in compulsory liquidation) v Ali,364 clearly signalling that there would be no retreat from the broad approach to context. Nevertheless Lord Hoffmann felt it necessary to comment on the reaction to his earlier contention that the admissible background included ‘absolutely anything’. His Lordship observed:

I did not think it necessary to emphasise that I meant anything which a reasonable man would have regarded as relevant … I was certainly not encouraging a trawl through ‘background’ which could not have made a reasonable person think that the parties must have departed from conventional usage.365

(p. 70) Explicit judicial criticism of Lord Hoffmann’s Investors Compensation Scheme restatement has since been muted, and it remains one of the most widely cited and followed pronouncements in English commercial law.366 For example, in the Commercial Court in Absalom v TRCU Ltd Aikens J stated that in the reinsurance dispute before him there was no dispute as to the governing principles of construction:

The key principles can be summarised as follows: (i) the aim of the exercise is to ascertain the meaning of the relevant contractual language in the context of the document and against the background to the document. The object of the enquiry is not necessarily to probe the ‘real’ intention of the parties, but to ascertain what the language they used in the document would signify to a properly informed observer; (ii) the interpretive exercise must not be done in a vacuum, but in the milieu of the admissible background material. That comprises anything that a reasonable man would have regarded as relevant in order to comprehend how the document should be understood, provided that the material was reasonably available to both parties at the time (ie up to the time of the creation of the document); (iii) however, evidence of negotiations and subjective intent are not admissible for the purposes of this exercise; (iv) a commercial document must be interpreted so as to make business common sense in its context. But if a ‘detailed semantic and syntactical analysis of a word in a commercial contract is going to lead to a conclusion that flouts business common sense, it must be made to yield to business common sense’.367

On appeal to the Court of Appeal, Longmore LJ concurred: ‘Neither side dissented from this summary and I endorse it.’368 The Investors Compensation Scheme principles were unanimously applied by the House of Lords in one of its last judgments, Chartbrook Ltd v Persimmon Homes Ltd,369 and by the UK Supreme Court in its first judgment in respect of contractual construction, In re Sigma Finance (p. 71) Corporation (in administrative receivership).370 Whilst it did not explicitly feature in the Supreme Court’s 2015 decision in Arnold v Britton it did feature prominently in Beatson LJ’s summary of the applicable principles in Globe Motors, Inc v TRW Lucas Varity Electric Steering Ltd.371

Discarding intellectual baggage?

1.124  The Investors Compensation Scheme restatement certainly represented a watershed, representing a decisive endorsement of the modern approach at the expense of more traditional principles. The prefatory remarks about discarding the ‘intellectual baggage’ of ‘legal’ intepretation also provoked much reaction. On balance the statement was probably too reductionist, but was explicitly qualified by the vague phrase ‘almost all’. In The BOC Group v Centeon Evans LJ commented: ‘The old intellectual baggage has been discarded but the courts are not travelling light. The cabin trunks have been replaced by airline suitcases; the contents are much the same though they are expressed in more modern language.’372 In The Tychy (No 2) the Court of Appeal found the need for ‘a little intellectual hand luggage’.373

1.125  It is clear that other principles and rules have survived. For example the Canada Steamship guidelines374 were dusted down and revisited in HIH Casualty and General Insurance Ltd v Chase Manhattan Bank.375 Traditional accounts of the interpretation of deeds and contracts are notoriously replete with Latin maxims embodying supposed rules of construction.376 In modern accounts of the principles of contractual interpretation these wise saws have been largely conspicuous by their absence. In the twenty-first century, when the judiciary has made (p. 72) it clear that the courts are no longer hospitable to legal Latin, it is unsurprising that Latin maxims are fading from the scene. Nevertheless it may be desirable to rehabilitate some of these traditional rules in order to determine whether any of them still have a contribution to make to construction.377 It is suggested that in the modern law some of them may be reformulated in one of two ways. First, a maxim may reflect a rule of public policy which may still need to be weighed by a court in carrying out an exercise in construction. Secondly, a maxim may represent a presumptive rule of language which may assist in determining the result where the contract is vague or ambiguous. It will be necessary to consider in due course to what extent Lord Hoffmann’s assessment was accurate. In particular, we shall consider the extent to which traditional Latin maxims, presumptions, and rules of preference survive in the modern law (see Chapters 7 and 8).

The role of construction in the wake of discharge for breach or termination

1.126  Where an agreement has been discharged in response to a repudiatory breach, or brought to an end pursuant to an express termination provision, the role of construction is not necessarily diminished. It is clear that discharge at common law is prospective only, in obvious contrast to rescission or avoidance in response to vitiating factors, such as misrepresentation or duress, occurring during negotiations.378 It is also important not to over-state the significance of an election to terminate or discharge for breach, especially where the contract is of any significant duration. It is not simply that it is prospective and not retrospective in its effect. Discharge refers specifically to the release of the innocent party from future unperformed primary obligations, but the law continues to hold the party in breach accountable for future lost performance by substitutionary relief in the form of damages. Significantly, in the post-discharge hinterland, the express provisions of the contract may have plenty to say about the new relationship the parties find themselves in. The reality that, as a matter of construction, the contract continues to regulate the parties’ relationship is taken as a given in everyday contractual drafting. To take a commonplace example, middle-ranking to senior employees of an enterprise will usually find extensive provision for non-competition and respect for trade secrets explicitly continuing beyond termination of the (p. 73) employment relationship in their service contracts. However it can be difficult to identify much judicial explicit recognition of the phenomenon.379

1.127  It first became obvious in the context of arbitration clauses that certain contractual provisions must have been intended to govern both pre- and post-discharge. It is no accident that Heyman v Darwins Ltd 380 is a locus classicus of prospectivity. Could a party which alleged that the other was in repudiatory breach ignore an arbitration clause which governed disputes ‘in respect of this agreement’ and instead issue a writ? No. The House of Lords unanimously upheld the operation of the arbitration clause and sidelined prior authority to the contrary. Whether or not alleged to have been discharged by acceptance of repudiatory breach or automatically by frustration, an appropriately drafted arbitration clause still applied to the determination of these issues. According to Viscount Simon LC it was not the case that the contract had ‘come to an end’; rather ‘it is the performance of the contract which has come to an end’.381 Similarly Lord Macmillan thought that the ‘contract is not put out of existence’ but ‘survives’ for various purposes.382 Lord Porter was most emphatic:

To say that the contract is rescinded or has come to an end or has ceased to exist may in individual cases convey the truth with sufficient accuracy, but the fuller expression that the injured party is thereby absolved from future performance of his obligations under the contract is a more exact description of the position.383

The separateness of the arbitration clause is now on a statutory footing384 and the common-sense approach to construction was decisively applied to the construction of such provisions in Fiona Trust v Privalov385 by both the Court of Appeal and the House of Lords favouring ‘one stop shop’ dispute resolution.

1.128  Many commercial transactions, and also many consumer transactions (especially if of any duration), will be accompanied by detailed written terms, with these often being mandatory in important parts of the economy such as consumer (p. 74) credit and other consumer financial services. The ugly jargon of ‘boilerplate’386 now has the imprimatur of usage in the House of Lords387 but it is worth reflecting on its etymology. Its literal or primary conventional meaning is rolled steel plates for making boilers. Its modern metaphorical usage is as ‘standardized pieces of text for use as clauses in contract or as part of a computer program’.388

1.129  Nevertheless the literal meaning conjures up the image of an old boiler on a steam train clad in numerous repairs of different vintages and perhaps differing efficacy prolonging as far as possible its life. In similar fashion many standardized terms are there ‘just in case’, for the worst case scenarios: for example, deliberate and debilitating breaches, such as key employees running off with the customer lists, or the impecuniosity or looming insolvency of the co-contractor. Numerous clauses are dormant or of limited impact whilst a contract is successful. Many only spring to life when the evil day descends. There are a cluster of such clauses.

1.130  First, there are the dispute resolution terms: arbitration or other alternative dispute resolution mechanisms, jurisdiction, and choice of law clauses. Secondly, there are clauses seeking (so far as public policy allows) to protest a firm’s business by imposing restrictions, and in particular seeking to prolong them post-termination, on competitive economic activity, on the use of trade secrets or other confidential information, and to protect interests in intellectual property. Another cluster creates or modifies contractual and other legal remedies: express termination clauses,389 exemption clauses,390 retention of title clauses,391 accelerated payment clauses, and clauses to restrict set-off.392 Finally, there is a cluster to protect the integrity of the written instrument itself by restricting its easy modification and the parties’ recourse to extra-contractual remedies: clauses requiring variations or waivers to be in writing, negating reliance on statements (p. 75) during negotiations, and entire agreement clauses (often working in tandem with exemption clauses).393 We shall consider a number of these species of standard clause in this text.

The position of third parties and transferees

1.131  The position of third parties, including transferees, whether by way of assignment, negotiation, or novation is often a consideration in the courts’ approach to construction. Many commercial instruments are readily transferable, including bills of lading and bills of exchange. Other commercial contracts or rights of action are assigned. Where transfer is likely, the imperative to reach a construction which would not take a transferee by surprise is strong.394 The existence of such third parties is a powerful argument favouring an objective approach to interpretation and predictable conclusions.

1.132  It also militates in favour of a stricter approach to the admissible background in contexts where transfer is likely. English law already contains the seeds of a rule that third parties, such as transferees or assignees of a contract, are not bound by any collateral contracts or terms which may obtain between the original parties.395 There is some authority which goes further and insists on a stricter approach to construction and the admissibility of evidence of background wherever the commercial context involves a network or other complex structure of contractual relations, as in many construction, trading, or banking scenarios.396

Precedential force and the citation of authorities

1.133  The precedential weight of decisions on the construction of particular contracts is a controversial matter. Obviously there are many one-off disputes of interest only to the parties themselves and their advisers. Much of the learning on the subject consists of more general pronouncements by leading judges as to how the technique is to be implemented in practice. As Lord Morris remarked in (p. 76) L Schuler AG v Wickman Machine Tool Sales Ltd:397 ‘I doubt whether, save in so far as guidance on principle is found, it is of much value (although it may be of much interest) to consider how courts have interpreted various different words in various differing contracts.’ That warning is accepted here insofar as the general principles of construction are concerned. There have also been salutary warnings against the excessive citation of authorities in the context of statutory construction where an unnecessary ‘line of authorities’ accumulate around clear statutory language.398 This has been endorsed in the context of the Arbitration Acts in The Amazon Reefer.399 Lord Diplock had earlier complained about ‘superfluity of citation’400 and of the ‘difficulty of seeing the wood of legal principle for the trees of paraphrase’.401 Obviously improved information technology has exacerbated the problem,402 and care must be taken to ascertain whether a case introduces or modifies a particular principle or rule, or is merely an illustration of it. The editors of the Incorporated Council of Law Reporting have struggled with the Council’s own guidelines403 in respect of the construction of contracts. Clearly the significant statements of principle in Prenn v Simmonds,404 Reardon Smith Ltd v Yngvar Hansen-Tangen (The Diana Prosperity),405 Investors Compensation Scheme Ltd v West Bromwich Building Society,406 and Rainy Sky SA v Kookmin Bank407 should all have been reported in the Appeal Cases, whereas it is arguable that a manifestly one-off case like Arnold v Britton,408 which did not articulate any new principles, should not.

1.134  One-off cases can be contrasted with decisions on standard forms and clauses in widespread use in particular markets, trades, or other contexts. Here a clear determination of the meaning and effect of a particular provision will be treated as a precedent by other users of the form or provision. In this context certainty and predictability are important. In such cases the role played by context may be modified to accommodate the more general employment of such forms and provisions. Much of the detailed learning in English contract and commercial (p. 77) law consists of the exegesis of the particular forms and provisions, from the Law Society’s National Conditions of Sale, which form the bedrock of English domestic conveyancing, via the forms employed by commodity traders and those who charter vessels to ship goods around the globe, and the standard clauses underpinning modern financial instruments.

Twelve Leading Decisions of the House of Lords and the Supreme Court

1.135  The modern approach can be seen in action in cases at all levels. Perhaps the most significant was a trilogy of significant House of Lords’ cases in the late 1990s which entrenched the modern contextual approach leading to results which surprised many practitioners and commentators.409 We now survey twelve of the most significant cases on contractual construction at the UK’s highest appellate level.410 The twelve cases are: Prenn v Simmonds,411 L Schuler AG v Wickman Machine Tool Sales Ltd,412 Reardon Smith Ltd v Yngvar Hansen-Tangen (The Diana Prosperity),413 Antaios Compania Naviera SA v Salen Rederierna AB (The Antaios),414—then comes the famous trilogy from the later 1990s—Charter Reinsurance Co Ltd v Fagan,415 Mannai Investments Ltd v Eagle Star Assurance Co Ltd,416 and Investors Compensation Scheme Ltd v West Bromwich Building Society,417 next the entrenchment of the modern approach in Bank of Credit and Commerce International SA (in compulsory liquidation) v Ali,418 Hombourg Houtimport BV v Agrosin Private Ltd (The Starsin),419 Chartbrook Ltd v Persimmon Homes Ltd,420 Rainy Sky SA v Kookmin Bank,421 and the most recent but least satisfactory of the sequence, Arnold v Britton.422

(p. 78) 1.136  These cases demonstrate the myriad commercial and other contexts in which interpretation issues surface as they concern, respectively, a corporate contract, a distribution agreement, charterparties, a reinsurance treaty, a notice under a commercial lease, an assignment in the consumer financial services context, a compromise arising out of the termination of an employment relationship, a bill of lading, a building licence in the context of property development, a performance bond issued by a bank in respect of repayment obligations under shipbuilding contracts, and lastly, a non-commercial case concerning a service charge in long lease on a holiday park. The documents under consideration include bilateral contract forms and also unilateral documents such as assignments and notices.

Prenn v Simmonds

1.137  Prenn v Simmonds,423 decided in 1971, nearly five decades ago, is the first significant modern authority on the construction of contracts, and the speech of Lord Wilberforce is widely cited as seminal in authorities decided over the last 15 years.424 The context was a corporate deal, and the issue of construction concerned an option to purchase shares. The question was whether a profit trigger which constituted a condition precedent of the option had been met. Did the word ‘profits’ embrace only the profits of the principal company, or did it encompass the corporate group’s profits? The House of Lords unanimously preferred the latter construction.

1.138  Lord Wilberforce’s speech is a seminal one in insisting on the need for a contextual approach to contractual construction. His Lordship stated that the agreement ‘must be placed in its context. The time has long passed when agreements, even those under seal, were isolated from the matrix of facts in which they were set and interpreted purely on internal linguistic considerations’.425 The principal English authority relied upon was the speech of Lord Blackburn in River Wear Commissioners v Adamson.426 The other principal authority cited by Lord Wilberforce was a decision of the great American jurist, Cardozo J sitting in the New York Court of Appeals, thereby introducing into English law reference to ‘the genesis and aim of the transaction’. Cardozo J emphasized that surrounding circumstances may ‘stamp upon a contract a popular or looser meaning’ than the strict or legal meaning. It is preferable to render a contract workable: ‘It is easier to give a new shade of meaning to a word than to give no meaning to a whole transaction.’427 Lord Wilberforce’s adoption of Benjamin Cardozo’s reasoning (p. 79) signalled a clear preference for a commercial or purposive approach, over a strict or literal approach.

1.139  However Lord Wilberforce, having accepted that the background and genesis of the transaction were clearly admissible, nevertheless rejected the argument that evidence of the parties’ intentions should also be admissible. First, the submission was rejected as a matter of authority.428 His Lordship continued:

On principle, the matter is worth pursuing a little, because the present case illustrates very well the disadvantages and danger of departing from established doctrine and the virtue of the latter. There were prolonged negotiations between solicitors, with exchanges of draft clauses, ultimately emerging in clause 2 of the agreement. The reason for not admitting evidence of these exchanges is not a technical one, or even mainly one of convenience (though the attempt to admit it did greatly prolong the case and add to its expense). It is simply that such evidence is unhelpful. By the nature of things, where negotiations are difficult, the parties’ positions, with each passing letter, are changing and until the final agreement, though converging, are still divergent. It is only the final documents which record a consensus. If the previous documents use different expressions, how does construction of those expressions, itself a doubtful process, help on the construction of the contractual words? If the same expressions are used, nothing is gained by looking back; indeed, something may be lost since the relevant surrounding circumstances may be different. And at this stage there is no consensus of the parties to appeal to …429

However Lord Wilberforce was clear that that evidence of mutually known facts was admissible to identify the meaning of a descriptive term.430 The surrounding circumstances in Prenn were held to include the acquisition by the defendant of the shares in a non-trading company, which had a trading subsidiary, which in turn employed the plaintiff, a key manager and technician. The purpose of the acquisition of that non-trading company (with its subsidiary) was to secure the services of that individual. Lord Wilberforce was also prepared to treat as a mutually known matter of fact the requirement of the companies legislation for the holding company to file a consolidated profit and loss account, together with the facts that such accounts had been prepared by the company and considered at board level. This is a clear example that the surrounding circumstances can extend to legal, accounting, and regulatory matters, where these would have been reasonably known by the parties. Having considered the language of the contract as a whole in the light of this background, Lord Wilberforce concluded that the alternative approach, limiting ‘profits’ to those of the non-trading holding company, was a construction which ‘does not fit in any way the aim of the (p. 80) agreement, or correspond with commercial good sense, nor is it, even linguistically, acceptable’.431

Schuler v Wickman Machine Tool Sales

1.140  The 1973 case of L Schuler AG v Wickman Machine Tool Sales Ltd 432 concerned an exclusive distributorship agreement in the motor trade between a German manufacturer of panel presses (Schuler) and an English agent (Wickman). By clause 7(a) Wickman agreed to use its ‘best endeavours’ to promote Schuler products in the defined territory, which included the United Kingdom. By clause 7(b): ‘It shall be [a][433] condition of this agreement that [Wickman] shall send its representatives to visit the six firms whose names are listed in the Schedule hereto at least once in every week for the purpose of soliciting orders for panel presses.’

The six firms were some of the UK’s largest motor manufacturers. Further provision required Wickman to identify the visiting representatives, and required the same person to attend unless ‘unavoidable reasons’ required a substitute representative to be used. Clause 11 provided that the contract was for an initial period of just over four-and-a-half years, with an express termination provision by 12 months’ notice at the end of that period and on each subsequent anniversary. A proviso (clause 11(a)(i)) stated that either party could terminate forthwith on giving notice in writing ‘if the other shall have committed a material breach of its obligations hereunder and shall have failed to remedy the same within 60 days of being required to do so in writing’. Wickman failed to make a number of visits and Schuler purported to determine the contract after a year and a half.

1.141  The House of Lords held by a majority of 4 to 1 that the word ‘condition’ did not have its Sale of Goods Act meaning of a fundamental term of the contract, any breach of which gave rise to a right to terminate. For its initial period of just over four-and-a-half years some 1,400 visits were required. Missing just one would suffice, on Schuler’s argument, to entitle it to terminate forthwith.

Lord Reid, giving the principal speech of the majority, famously observed:

The fact that a particular construction leads to a very unreasonable result must be a relevant consideration. The more unreasonable the result the more unlikely it is that the parties can have intended it, and if they do intend it the more necessary it is that they shall make that intention abundantly clear.434

His Lordship observed that no provision was made for the death, retirement, or illness of any sales representative. Therefore ‘if the parties gave any thought (p. 81) to the matter at all they must have realised the probability that in a few cases out of 1,400 required visits, a visit as stipulated must be impossible’.435 In such circumstances it was so unreasonable that any single breach would suffice that the preferable construction was that any breach of clause 7(b) was a deemed material breach, entitling Schuler to use the procedure under clause 11(a)(i) to require that breach to be remedied. Only if Wickman failed to cure, in the sense of putting matters right for the future, would a right to terminate arise. Lords Morris and Kilbrandon agreed. Lord Wilberforce dissented on the principal question.436

1.142  In contrast, the House of Lords was unanimous in following its earlier decision in James Miller & Partners Ltd v Whitworth Street Estates (Manchester) Ltd 437 that subsequent conduct was generally inadmissible for the purpose of construing a contract. Lord Wilberforce concurred on this question:

In my opinion, subsequent actions ought not to have been taken into account. The general rule is that extrinsic evidence is not admissible for the construction of a written contract; the parties’ intentions must be ascertained, on legal principles of construction, from the words they have used. It is one and the same principle which excludes evidence of statements, or actions, during negotiations, at the time of the contract, or subsequent to the contract, any of which to the lay mind might at first sight seem to be proper to receive. As to statements during negotiations this House has affirmed the rule of exclusion in Prenn v. Simmonds … as to subsequent actions (unless evidencing a new agreement or as the basis of an estoppel) in Whitworth Street Estates (Manchester) Ltd. v. James Miller & Partners Ltd.438

Presumably, by analogy with his Lordship’s speech in Prenn v Simmonds, the reason for excluding subsequent conduct is because it is unhelpful to the task at hand.439

Reardon Smith v Hansen-Tangen (The Diana Prosperity)

1.143  In Reardon Smith Ltd v Yngvar Hansen-Tangen, The Diana Prosperity440 a charterer purportedly terminated one of two charterparties on the ground that the vessel which was the subject-matter of the charter, whilst described in all the documents as ‘Osaka 354’, in fact bore the yard or hull number of ‘Oshima 004’. Questions arose as to the evidence admissible as aids to construction.

(p. 82) 1.144  Lord Wilberforce (Lords Salmon and Kilbrandon agreeing) rejected the evidence of Japanese shipbuilding practices relied on, and provided the following oft-quoted guidance:

But it does not follow that, renouncing this evidence, one must be confined within the four corners of the document. No contracts are made in a vacuum: there is always a setting in which they have to be placed. The nature of what is legitimate to have regard to is usually described as ‘the surrounding circumstances’ but this phrase is imprecise: it can be illustrated but hardly defined. In a commercial contract it is certainly right that the court should know the commercial purpose of the contract and this in turn presupposes knowledge of the genesis of the transaction, the background, the context, the market in which the parties are operating. … what the court must do must be to place itself in thought in the same factual matrix as that in which the parties were.441

Lord Wilberforce rejected the extension of the reasoning in Sale of Goods Act authorities as to ‘description’ (under section 13) to the charterparties, and indicated that those cases should be re-examined.442 The House of Lords unanimously rejected the contention that the words ‘yard 354’ were to be part of the description of the vessel, but held that they were only a means of identifying it. Accordingly the vessel tendered was the vessel that had been contracted for.

The Antaios

1.145  In The Antaios443 a three-year time charterparty contained a ‘withdrawal clause’ which provided that ‘failing the punctual and regular payment of the hire or on any breach of this charter party, the owners shall be at liberty to withdraw the vessel’. The shipowners purported to withdraw on a rising freight market on the basis that the charterer had issued inaccurate bills of lading. The commercial arbitrators found that this was a breach of contract, but not a repudiatory breach. Interpreting the clause, the arbitrators stated: ‘The owners relied on what they said was “the literal meaning of the words in the clause.” We would say that if necessary, in a situation such as this, a purposive construction should be given to the clause so as not to defeat the commercial purpose of the contract.’

Accordingly the arbitrators construed ‘any breach’ as limited to ‘any repudiatory breach’ and rejected the shipowners’ construction that they could withdraw upon any breach, which they said was ‘wholly unreasonable, totally uncommercial and in total contradiction to the whole purpose of the NYPE time charter form’.444

(p. 83) 1.146  The House of Lords agreed and similarly construed ‘breach’ as meaning ‘repudiatory breach’. Lord Diplock famously stated:

While deprecating the extension of the use of the expression ‘purposive construction’ from the interpretation of statutes to the interpretation of private contracts, I agree with the passage I have cited from the arbitrators’ award and I take this opportunity of re-stating that if detailed semantic and syntactical analysis of words in a commercial contract is going to lead to a conclusion that flouts business commonsense, it must be made to yield to business commonsense.445

Charter Reinsurance v Fagan

1.147  Charter Reinsurance Co Ltd v Fagan336 was arguably the case which first signalled that a radical new approach to construction had been adopted by the House of Lords. However, given its specialist reinsurance setting, it has never achieved the same prominence as the Investors Compensation Scheme case. This dispute arose under a reinsurance contract under which an insurance company, having agreed to cover a risk under an underlying policy of insurance, sought to pass on a share of that risk to a reinsurance company. The portion of the risk accepted under the contract by the reinsurer was the loss in excess of the ‘ultimate net loss’ (or ‘UNL’) over a specified amount. The ‘ultimate net loss’ was further defined by the contract as meaning ‘the sums actually paid by the reinsured in settlement of losses or liability after making deductions’. The insurers were in liquidation, and were unable to make payments to the insured under the main contracts. The insurers claimed that the reinsurer was liable to indemnify it even though it had not yet paid the insured. Mance J, the majority of the Court of Appeal, and the House of Lords (unanimously) held that ‘actually paid’ in its context in this contract meant ‘actually payable’. Therefore contrary to the strict language of the contract the reinsured was not required to pay his insured first before seeking money from the reinsurer.

Charter Reinsurance v Fagan: Staughton LJ’s dissent

1.148  Alone of the nine judges who heard the case Staughton LJ dissented, holding that ‘actually paid’ literally meant what it said. His judgment represents an unashamed exposition of the traditional approach favouring a strict approach to the language of commercial instruments. His Lordship concluded:

This dispute is about the meaning of two words, ‘actually paid.’ There must come a time when efforts to bend meaning (or, as I would say, reverse it) have to stop. The literal meaning of the words in the contracts requires that the insurers shall have paid before the reinsurers are liable. To the extent, if at all, that this produces (p. 84) a result which is unreasonable, it is not so unreasonable that it requires us to depart from the plain meaning of the words. Indeed I doubt whether it is unreasonable at all. Mance J held that the object of reinsurance is to spread the load. So indeed it is. But it does not follow that any term in a reinsurance contract which results in anything other than an equal division of the loss is to be disregarded. The load is to be spread upon and subject to the terms of the contract.446

Charter Reinsurance v Fagan: the judgments in the House of Lords

1.149  Charter Reinsurance was the pivotal case when the pendulum finally swung fully behind the tenets of the modern approach, spurning the traditional approach. This is most obvious in the contrast between the principal speech of Lord Mustill and the reasons advanced by Lord Hoffmann and Mance J (at first instance). Lord Mustill confessed to having changed his mind from an instinctive view that the words meant what they said:

This is, however, an occasion when a first impression and a simple answer no longer seem the best, for I recognise now that the focus of the argument is too narrow. The words must be set in the landscape of the instrument as a whole. Once this is done the shape of the policy, and the purpose of the terms … become quite clear.447

1.150  His Lordship’s judgment is a classic of the school of detailed technical analysis of all the relevant provisions of the contract. Having examined the whole contract rigorously Lord Mustill concludes that the ‘ultimate net loss’ clause in the context of the instrument as a whole was merely intended as a quantification clause for measuring the liability of the reinsurer, and limiting it to the net liability: ‘I am now satisfied that the purpose of “the sum actually paid” … is not to impose an additional condition precedent in relation to the disbursement of funds, but to emphasise that it is the ultimate outcome of the net loss calculation which determines the final liability of the syndicates under the policy.’448 The treaty did not say in terms: ‘It shall be a condition precedent to the reinsurer’s liability that the reinsured shall have actually paid the underlying insured party.’ The parties could have used that formulation if they had wished. Lord Mustill’s judgment did not venture beyond the four corners of the contract, but contented itself with the immediate contractual context. His Lordship’s judgment ends with a paean to commercial certainty (faintly echoing Staughton LJ), albeit some may feel it does not sit comfortably with the conclusion which Lord Mustill had reached:

There comes a point at which the court should remind itself that the task is to discover what the parties meant from what they have said, and that to force upon the words a meaning which they cannot fairly bear is to substitute for the bargain (p. 85) actually made one which the court believes could better have been made. This is an illegitimate role for a court. Particularly in the field of commerce, where the parties need to know what they must do and what they can insist on not doing, it is essential for them to be confident that they can rely on the court to enforce their contract according to its terms.449

All the other Law Lords agreed with Lord Mustill’s speech.

1.151  In contrast, Lord Hoffmann’s speech (whilst concurring with Lord Mustill) ventured further afield. His Lordship’s speech repays careful study, but its approach will be briefly summarized here. First, Lord Hoffmann articulated his philosophical position that because ‘the meaning of words is so sensitive to syntax and context, the natural meaning of words in one sentence may be quite unnatural in another’ to rebut the trenchant submissions of counsel for the reinsurers insisting on the plain meaning: ‘Take, for example, the word “pay”. In many contexts, it will mean that money has changed hands, usually in discharge of some liability. In other contexts, it will mean only that a liability was incurred, without necessarily having been discharged.’450 Secondly, Lord Hoffmann (following the lead of Mance J at first instance) considered external materials including the history of reinsurance clauses, market factors, and the regulatory, accounting, and solvency regime for insurance:

Considerations of history, language and commercial background therefore lead me to the conclusion that the word ‘actually’ in the UNL clause is used to emphasise that the loss for which the reinsurer is to be liable is to be net and that the clause does not restrict liability to the amount by which the liability of the reinsured for the loss has been discharged. I think that this is the natural meaning of the clause.451

1.152  In summary, whilst the approaches of Lord Mustill and the majority adopted an holistic reading of the contract in order to override the apparent impact of two words, Mance J (as he then was) and Lord Hoffmann were prepared to examine the wider legal, regulatory, and factual matrix to reinforce this conclusion. As we shall see, the latter approach (rather than the narrower holistic approach of Lord Mustill) has come to predominate.

Mannai Investments v Eagle Star Assurance

1.153  In Mannai Investments Ltd v Eagle Star Assurance Co Ltd 452 two commercial leases in respect of office premises in Jermyn Street, London, were entered into for 10 years from and including 13 January 1992. By an express term (‘the break (p. 86) clause’) it was agreed that the tenant could bring the leases to an end by serving not less than six months’ notice in writing on the landlord to expire ‘on the third anniversary of the term commencement date’. This was a once-only opportunity. The market rent for the area fell. Accordingly the tenant purported to exercise this option to terminate by giving notices to determine the leases ‘on 12 January 1995’. It was common ground that the true anniversary of the term commencement date was 13 January 1995. By a majority of 3 to 2 the House of Lords held that a reasonable recipient of the notices would have been left in no doubt that the tenant wished to determine the leases on 13 January 1995 but had wrongly described the anniversary date as 12 January. Accordingly the notices were effective to determine the leases. The tenant was held to have successfully communicated his intention to terminate despite the slip.

1.154  For Lord Steyn (of the majority) the same rules applied to (unilateral) contractual notices as applied to contracts. Both context and the purpose of the document were crucial:

It is important not to lose sight of the purpose of a notice under the break clause. It serves one purpose only: to inform the landlord that the tenant has decided to determine the lease in accordance with the right reserved. That purpose must be relevant to the construction and validity of the notice. Prima facie one would expect that if a notice unambiguously conveys a decision to determine a court may nowadays ignore immaterial errors which would not have misled a reasonable recipient.453

Similarly Lord Hoffmann could see no reason for maintaining a rule which artificially restricted the relevant context. Lord Hoffmann’s thoughtful speech prefigured his later restatement of principle, especially in his insistence that the background was always available as an aid to the process of construction:

In the case of commercial contracts, the restriction on the use of background has been quietly dropped. There are certain special kinds of evidence, such as previous negotiations and express declarations of intent, which for practical reasons … it is unnecessary to analyse, are inadmissible in aid of construction. They can be used only in an action for rectification. But apart from these exceptions, commercial contracts are construed in the light of all the background which could reasonably have been expected to have been available to the parties in order to ascertain what would objectively have been understood to be their intention: Prenn v. Simmonds … The fact that the words are capable of a literal application is no obstacle to evidence which demonstrates what a reasonable person with knowledge of the background would have understood the parties to mean, even if this compels one to say that they used the wrong words. In this area, we no longer confuse the meaning of words with the question of what meaning the use of the words was intended to convey.454

(p. 87) Properly construed against the background of the underlying leases the notices were valid and effective. Lord Clyde concurred. Lords Goff and Jauncey dissented. Lord Goff expressed concern at departing from a long-settled meaning and the uncertainty which would result: ‘There is a wide range of possible errors, and there are bound to be cases on the borderline in which there is doubt whether the intention is sufficiently clear.’455

Investors Compensation Scheme v West Bromwich Building Society

1.155  In Investors Compensation Scheme Ltd v West Bromwich Building Society456 large numbers of elderly investors were persuaded to enter into unsuitable ‘home income plans’ by a firm of independent financial advisers, which subsequently became insolvent. In essence the investors were encouraged to remortgage their homes and to invest the proceeds in shares or bonds. In practice the value of the investments were not sufficient to provide income and to meet the obligations under the mortgage. Accordingly the investors had claims for compensation against the independent financial advisers. In addition they had claims for compensation and for rescission of the mortgages provided by the sponsoring building society. The Investors Compensation Scheme (ICS) was set up under section 54 of the Financial Services Act 1986457 to provide a safety net compensation scheme for the victims of bad investment advice. The ICS agreed to provide compensation to the investors in return for an assignment of the investors’ causes of action against the advisers and others.

1.156  It seems that what the draftsperson of the relevant form intended was to exclude from the assignment any right to rescind the mortgage against the sponsoring building society, together with any financial orders consequential upon rescission. However, what the claim form in fact said was that it excluded ‘Any claim (whether sounding in rescission for undue influence or otherwise) that you have or may have against the West Bromwich Building Society in which you claim an abatement of the sums which you would otherwise have to repay to the Society’. The investors brought claims against the Society, including causes of action for compensation for misrepresentation, contending that they had retained all (p. 88) claims against the Society. The ICS and the Society argued that the investors had retained the right to rescind and any consequential orders, but had effectively assigned all their causes of action for compensation for loss.

1.157  The majority of the House of Lords held that when placed in its wider legal, regulatory, and factual context the arguments of the ICS and the Society prevailed. The House of Lords was happy to move words from within the brackets in the document of assignment so that properly construed it read: ‘Any claim sounding in rescission (whether for undue influence or otherwise) …’ This had the effect of radically extending the nature of the subject matter transferred.

Bank of Credit and Commerce International v Ali

1.158  The case of Bank of Credit and Commerce International SA v Ali 458 concerned a contract of compromise at the end of an employment relationship. As is well known the bank was wound up in 1991 amid revelations that it had been massively concerned in fraud and corruption. Previously in 1990 a number of employees had been made redundant. In consideration of payment the employees signed a compromise, which included a ‘general release’ in favour of the employer. The clause (found in ACAS Form COT-3) provided:

The applicant agrees to accept the terms set out in the documents attached in full and final settlement of all or any claims whether under statute, common law or in equity of whatsoever nature that exist or may exist and, in particular, all or any claims rights or applications of whatsoever nature that the applicant has or may have or has made or could make in or to the industrial tribunal, except applicant’s rights under [the bank’s] pension scheme.

1.159  In another case it was held that an employer might be liable for ‘stigma damages’ for breach of contract, in that the employer’s duty of trust and confidence included an obligation not to carry on a corrupt business, which might adversely affect the employee’s future prospects: Mahmud v BCCI.459 In BCCI v Ali it was held that such a claim against the employer for ‘stigma damages’ for disadvantage on the labour market, only invented post-release by the House of Lords in Mahmud, was not comprised in the wide language of the general release. The intentions of the parties had to be gauged in the context in which the release was entered into, when such a claim was not in the contemplation of the parties. The majority paid great heed to a line of cases going back to the eighteenth century in which judges showed a consistent disposition to refuse to construe general releases literally or strictly. According to Lord Bingham: ‘a long and in (p. 89) my view salutary line of authority shows that, in the absence of clear language, the court will be very slow to infer that a party intended to surrender rights and claims of which he was unaware and could not have been aware.’460 Lord Nicholls stated: ‘The question is whether the context in which the general release was given is apt to cut down the apparently all-embracing scope of the words of the release.’461 His Lordship answered the question in the affirmative. Indeed Lord Nicholls would have construed the release as limited to ‘claims arising out of the ending of the employment relationship’.462 The House of Lords also suggested that personal injury claims would not be barred even though when read literally the release would cover such claims.463

1.160  More generally, the judges were emphatic that the same rules of construction applied at common law and in equity.464 Further, there were no special rules for construing compromises.465

1.161  On the main question Lord Hoffmann dissented, stating that the view of the majority gave ‘too little weight to the actual language and the background’ and gave too much weight to elderly dicta uttered in different contexts.466 The insistence on clear words indicated that judges thought that the effect of such clauses was unfair and that they were implementing rules of public policy, as with the traditionally hostile approach to exemption clauses.467 However, no such policy intervention was required here. One can ask, with Lord Hoffmann, how could the language of the release be any wider? Overall BCCI v Ali shows that policy can override clear contractual language, where such language is perceived as having an unfair effect.

The Starsin

1.162  The Starsin468 is noteworthy in a number of respects, including Lord Bingham of Cornhill’s own summary of the applicable principles of construction for commercial contracts. The principal substantive question concerned the distinct (but related) question of identifying the parties to the contract. In modern bills of lading where various enterprises have an interest in the vessel, identifying the (p. 90) contractual carrier for the purpose of a cargo claim is not always a straightforward matter. Their Lordships held that the clear identification of the charterer as carrier on the face of the bill overrode any contradictory small-print boilerplate on the back.469 In respect of another issue—the apparent omission of words in a Himalaya clause470—it was a case which some may think both crosses the boundary from interpretation to implication and trespasses on the province of rectification.

Lord Bingham’s four canons of construction

1.163  Lord Bingham of Cornhill471 declared:

When construing a commercial document in the ordinary way the task of the court is to ascertain and give effect to the intentions of the contracting parties. Here, the task is to ascertain who, on one side, the contracting party was. But a similar approach is appropriate. Mr Milligan [counsel for the shipowner] urged that the House should not seize on a single canon of construction and give it effect to the exclusion of all others. I am sure that warning is salutary. But there are a number of rules, some of very long standing, which give valuable guidance.

First is the rule to which Lord Halsbury LC alluded in Glynn v Margetson & Co,[472] ‘that a business sense will be given to business documents.’ The business sense is that which businessmen, in the course of their ordinary dealings, would give the document. It is likely to be a reasonably straightforward sense since, as Lord Mansfield famously observed (Hamilton v Mendes[473]):

‘The daily negotiations and property of merchants ought not to depend upon subtleties and niceties; but upon rules, easily learned and easily retained, because they are the dictates of common sense, drawn from the truth of the case.’

Secondly, it is common sense that greater weight should attach to terms which the particular contracting parties have chosen to include in the contract than to pre-printed terms probably devised to cover very many situations to which the particular contracting parties have never addressed their minds. It is unnecessary to quote the classical statement of this rule by Lord Ellenborough in Robertson v French[474] …

(p. 91) Thirdly, it has long been recognised by very distinguished commercial judges that to seek perfect consistency and economy of draftsmanship in a complex form of contract which has evolved over many years is to pursue a chimera … [475] The court must of course construe the whole instrument before it in its factual context, and cannot ignore the terms of the contract. But it must seek to give effect to the contract as intended, so as not to frustrate the reasonable expectations of businessmen. If an obviously inappropriate form is used, its language must be adapted to apply to the particular case … [476]


‘In all mercantile transactions the great object should be certainty: and therefore, it is of more consequence that a rule should be certain, than whether the rule is established one way or the other. Because speculators in trade then know what ground to go upon’: Vallejo v Wheeler.[477]

This observation is, I suggest, particularly pertinent where the issue is one which, like that now under consideration, has been the subject of repeated litigation over the years …478

The missing words in the Himalaya clause

1.164  One question concerned clause 5 of the bill of lading (which was a Himalaya-type provision). It was common ground that some word or words were missing from the clause. The first instance judge had been content to interpolate the single word ‘who’. Counsel for the cargo-owners argued that any addition should be ‘the least intrusive reasonably possible to make sense of the clause’.479 In contrast, counsel for the shipowners identified the problem as being that common problem of transcription where the typist’s eye wanders from one word to the same word further down the passage being transcribed, leading to the entire omission of part of the passage.480 Accordingly he boldly contended that the missing words were ‘acting as aforesaid and for the purpose of all the foregoing provisions of this clause the carrier …’; some 17 words. This was justified by the fact that those were the words appearing at the same place in another standard form bill of lading on which the instant contract was closely modelled.481 The House of (p. 92) Lords briskly and unanimously adopted this bold submission.482 According to Lord Steyn: ‘The deletion was plainly a mistake.’483 Lord Millett insisted that the interpolation adopted by the House was the ‘minimum necessary for the clause to make grammatical sense’. His Lordship insisted that the ‘process was one of construction, not rectification’.484

Chartbrook v Persimmon Homes

1.165  One of the final significant judgments of the House of Lords as a judicial body concerned the construction of contracts. Chartbrook Ltd v Persimmon Homes Ltd 485 also included Lord Hoffmann’s last judicial contribution to a subject which he had so greatly influenced. Three issues were addressed. First, what was the correct construction of the contract? Secondly, was it permissible to have regard to pre-contractual negotiations in carrying out that exercise? Thirdly, was rectification available as a remedy in the alternative?

1.166  The dispute arose out of a building licence agreement under which Chartbrook (‘the owners’) retained ownership of a site in Wandsworth, London, but Persimmon (‘the developers’) had a licence to develop a mixture of commercial and residential properties upon it. The construction issue centred around an element of the price, labelled an ‘additional residential payment’, defined as ‘23.4% of the price achieved for each residential unit in excess of the minimum guaranteed residential unit value [MGRUV] less the costs and incentives’.

The developer contended that what was intended was that the owner would be paid either a fixed percentage (23.4 per cent) of the sales revenue for the flats or the minimum guaranteed amount, whichever was greater. The former would allow the owner to participate in any increase in the market value of the residential units and the figure of 23.4 per cent roughly equated to the then market price of flats of that size. In contrast, the owners contended that on the language of the provision they were entitled to both. In financial terms, on the former view the developers were bound to pay an additional £897,051, whereas on the latter view, its liability rose to £4.4 million. Bluntly, on a literal reading of the contract, and (p. 93) in particular the governing provision, the owner’s case was near unassailable. In the words of Lord Hoffmann, it was ‘certainly in accordance with conventional syntax’.486

1.167  The literal approach persuaded the trial judge, Briggs J,487 and the majority of the Court of Appeal, Tuckey and Rimer LJJ.488 In contrast, the impressive dissenting judgment of Lawrence Collins LJ and a unanimous House of Lords preferred a more purposive reading and upheld the construction of the developers. Curiously, this was a case in which there was no disparity between any of the drafts and the final agreement, so that any error in drafting was embedded from the start. However, in the view of Lawrence Collins LJ, ‘every piece of paper which throws light on the commercial purpose of the provision, supports [the developer’s] case’.489 In contrast, it was ‘very difficult (and probably) impossible to discern the commercial sense behind [the owner’s] construction’.490

1.168  Lord Hoffmann stated that this was a case which was ultimately to be resolved by the application of the principles which were set out authoritatively in Investors Compensation Scheme Ltd v West Bromwich Building Society491 a dozen years earlier:

It clearly requires a strong case to persuade the court that something must have gone wrong with the language. … It is, I am afraid, not unusual that an interpretation which does not strike one person as sufficiently irrational to justify a conclusion that there has been a linguistic mistake will seem commercially absurd to another. … The subtleties of language are such that no judicial guidelines or statements of principle can prevent it from sometimes happening. It is fortunately rare because most drafts-men of formal documents think about what they are saying and use language with care. But this appears to be an exceptional case in which the drafting was careless and no one noticed.492

Lord Hoffmann agreed with the dissenting opinion of Lawrence Collins LJ on the basis that to construe the clause ‘in accordance with “ordinary rules of syntax” makes no commercial sense’.493 Linguistic factors which counter-balanced the ordinary syntactical reading of the clause included the need to give effect to the words ‘minimum’ and ‘guaranteed’ in the defined expression MGRUV, and the fact that a neighbouring provision qualified the additional payment with the words ‘if any’. Only if the property market had fallen by a (p. 94) devastating 66 per cent would that qualification have any content if the owner’s construction was preferred. Similarly Lord Walker stated: ‘The definition is obviously defective as a piece of drafting.’494

1.169  Lord Hoffmann rejected the notion that ‘correction of mistake by construction’ was ‘a separate branch of the law, a summary version of an action for rectification’.495 There is a single exercise in construction, and in determining whether a mistake has been made the background is admissible. Furthermore, it was not necessary for the court to reformulate or rearrange the language of the clause to coincide with its ascertained meaning:

What is clear from these cases is that there is not, so to speak, a limit to the amount of red ink or verbal rearrangement or correction which the court is allowed. All that is required is that it should be clear that something has gone wrong with the language and that it should be clear what a reasonable person would have understood the parties to have meant. In my opinion, both of these requirements are satisfied.496

Turning to the second question, the House of Lords unanimously endorsed the traditional approach of Prenn v Simmonds497 that both declarations of subjective intent and prior negotiations were inadmissible for the purpose of construing the contract. Lord Hoffmann was prepared to accept three propositions. First, admission of prior negotiations would not be inconsistent with the objective principle of contract interpretation. Secondly, as a matter of principle on some occasions prior negotiations would be relevant. Thirdly, ‘there are no conceptual limits to what can properly be regarded as background’.498 Accordingly Lord Hoffmann was in fact departing from Lord Wilberforce’s approach in Prenn v Simmonds by refusing to base the exclusionary rule on irrelevance, but rather on pragmatic grounds. The reasons for rejecting such evidence comprised (1) the risk of greater uncertainty of outcome in disputes; (2) the increased cost of advice, litigation, or arbitration, which would be both time-consuming and expensive; (3) the reality that ‘statements in the course of pre-contractual negotiations will be drenched in subjectivity and may, if oral, be very much in dispute’; (4) the risk of self-serving evidence by parties to negotiations; and (5) the risk of adverse effects on third parties.499 Accordingly there was no ground for departing from the previous decisions of the House of Lords on this point.

(p. 95) There remained the ‘safety nets’ of rectification and estoppel by convention.500 Evidence of pre-contractual negotiatons remains admissible for the purposes of (a) rectification when pleaded; (b) ‘to establish a fact which may be relevant as background known to the parties’;501 and (c) for the purposes of the ‘private dictionary’ principle, where a particular trade or community has its own unconventional or idiosyncratic linguistic usage.502 However The Karen Oltmann503 was an ‘illegitimate extension’ of that rule and was disapproved.504

1.170  On the third issue of rectification, which was advanced for the first time in the House of Lords on the basis of ‘common mistake’ rectification, it was held that in the alternative the document would have been rectified as suggested by the developers. It was held that what was required was a mistake as to whether the document correctly reflected the prior consensus. In accordance with the objective principle, the terms of the prior consensus were what a reasonable observer would have understood them to be and not what one or even both of the parties believed them to be. This more objective approach to rectification has proved controversial.505

Rainy Sky v Kookmin Bank

1.171  In Rainy Sky SA v Kookmin Bank506 the claimant buyers entered into six contracts with a shipbuilder, who agreed to build and supply six vessels. The purchase price of US$33.3 million for each vessel was payable in five, equal, staged instalments, the last payable on delivery. The provision of a refund guarantee on behalf of the shipbuilders was a condition precedent to payment of the first instalment. In due course the defendant bank issued each claimant with an advance payment bond in the same terms. After each claimant had paid at least the first instalment of US$6.66 million the shipbuilder got into financial difficulties, and entered a process under South Korean corporate restructuring law, but it refused to refund the instalments paid, and the dispute between the buyers and the builder was referred to arbitration. The buyers made a demand on the bank, which refused to pay, initially on the basis that it was not obliged to do so pending resolution of the dispute between the buyers and the shipbuilder.

(p. 96) 1.172  The second paragraph of the bonds referring to the shipbuilding contract stated that pursuant to it ‘you are entitled, upon your rejection of the vessel in accordance with the terms of the contract … or upon a total loss of the vessel, to repayment of the pre-delivery instalments of the contract price paid by you prior to such termination or a total loss of the vessel …’. This only identified two of the grounds upon which the buyers were entitled to a refund under the shipbuilding contracts. The third paragraph of the bonds stated: ‘In consideration of your agreement to make the pre-delivery instalments under the contract … we hereby, as primary obligor, irrevocably and unconditionally undertake to pay to you … on your first written demand, all such sums due to you under the contract …’ (emphasis added). The question arose whether ‘such sums’ referred back to the ‘pre-delivery instalments’ in the first line of the third paragraph, or to the more limited reference to instalments as described in the second paragraph, and critically not including express reference to insolvency events. The former construction was favoured by Simon J (at first instance)507 and Sir Simon Tuckey (dissenting in the Court of Appeal). The latter found favour with the majority of the Court of Appeal.508 The Supreme Court unanimously allowed an appeal, favouring the buyers’ construction.509

1.173  The importance of the case lies in its discussion of the role of business common sense in contractual construction. Lord Clarke (with Lord Phillips, Mance, Kerr, and Wilson agreeing) stated:

The language used by the parties will often have more than one potential meaning. I would accept the submission made on behalf of the appellants that the exercise of construction is essentially one unitary exercise in which the court must consider the language used and ascertain what a reasonable person, that is a person who has all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract, would have understood the parties to have meant. In doing so, the court must have regard to all the relevant surrounding circumstances. 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.510

Accordingly business common sense can act as a tie-breaker between two tenable readings of the contract. Lord Clarke qualified his approach by stating: ‘Where the parties have used unambiguous language, the court must apply it.’511 This, perhaps unguarded, remark is sometimes seized upon as evidence (p. 97) that English law has adopted or re-adopted a ‘plain meaning rule’.512 However it needs to be set in the context of the judgment as a whole, and the wider dispute. Simon J had considered that the bank’s construction led to the surprising and uncommercial result that the refund guarantee would not be available in the event of the shipbuilder’s insolvency.513 In the Court of Appeal Patten LJ did not regard it as legitimate to take into account that factor, and suggested a more stringent test: ‘Unless the most natural meaning of the words produces a result which is so extreme as to suggest that it was unintended, the court has no alternative but to give effect to its terms.’514 Whilst accepting Patten LJ’s caveats about the court not being privy to the give and take of negotiations, the Supreme Court expressly rejected the test proposed by him. Patten LJ’s formulation was tantamount to a ‘plain meaning rule’. It was rejected by the Supreme Court and accordingly Lord Clarke’s dictum cannot mean that there is such a rule in English law. Rather the court favoured the classic formulation of Lord Reid in Wickman v Schuler, and subsequent cases identifying the tie-breaker role of commercial common sense.515 The bank had conceded in the Court of Appeal that each side’s construction was arguable, then sought to resile from that in the Supreme Court. Lord Clarke considered both positions possible.516 The natural language of the third paragraph read alone favoured the buyers’ argument. His Lordship also noted en passant that the bank’s construction was ‘something of an afterthought’.517 Whilst the buyers’ formulation made the second paragraph arguably redundant (or at best a preamble) this was a case where commercial common sense did resolve what a reasonable person would have understood the instrument to mean. The refusal (or inability) of the bank to formulate a credible commercial reason why insolvency (p. 98) risk was excluded also told against the bank’s construction.518 Overall Rainy Sky gave appropriate prominence to the concept of business common sense. However subsequent cases have tried to resist too ready recourse to the concept,519 and the Supreme Court has subsequently changed the emphasis in the last case in our sequence.

Arnold v Britton

1.174  In 2015 the Supreme Court re-visited the topic of the interpretation in Arnold v Britton,520 stressing the importance of loyalty to the actual language of the document. However the facts illustrate that manifest unfairness may result when a legal system gives absolute priority to the actual language of the contract, where there is no statutory or regulatory override on grounds, such as reasonableness, of the substantive terms.521 It concerned a holiday park on the picturesque Gower peninsular in South Wales, owned by the landlord, comprising ninety-one chalets let on very similar terms for ninety-nine years, with one significant discrepancy between two classes of tenants. Each lease asserted in a recital that all chalets were let on similar terms, and by clause 3 the tenants entered into various covenants with the landlord ‘and with and for the benefit of the owners and lessees from time to time …’. Clause 4(8) provided that leases of other chalets would contain covenants with ‘like obligations … or obligations as similar thereto as circumstances permit’. The disputed clause 3(2) was a covenant to pay an annual service charge. In respect of seventy of the leases dating from the early 1970s clause 3(2) provided:

To pay to the lessors without any deduction in addition to the said rent a proportionate part of the expenses and outgoings incurred by the lessors in the repair maintenance renewal and the provision of services hereafter set out the yearly sum of £90 and VAT (if any) for the first three years of the term hereby granted increasing thereafter by ten pounds per hundred for every subsequent three year period or part thereof.

(p. 99) In respect of the other twenty-one leases522 granted between 1977 and 1991 clause 3(2) provided:

To pay to the lessors without any deductions in addition to the said rent as a proportionate part of the expenses and outgoings incurred by the lessors in the repair maintenance renewal and renewal of the facilities of the estate and the provision of services hereafter set out the yearly sum of £90 and VAT (if any) for the first year of the term hereby granted increasing thereafter by ten pounds per hundred for every subsequent year or part thereof.523

1.175  The case illustrates the exponential effect of compound interest. On the language of the provision the landlord’s contention that the twenty-one tenants were required to pay £90 in the first year, increasing in each subsequent year by 10 per cent on a compound basis, whereas the other lessees only covenanted to a 10 per cent increase on a triennial basis. Assuming an annual interest increase lease commencing in 1980, by the time of the Supreme Court judgment in 2015 the annual service charge for the minority tenants had grown to over £2,500 per annum, and would reach the dizzying sum of over £550,000 by 2072.524

1.176  It was therefore unsurprising that the twenty-one lessees argued that the words ‘up to’ should be read into clause 3(2) prior to ‘the yearly sum of £90’. That is, the numerical figure was a cap and the rate should be set with regard to the actual expenses and outgoings of the lessor. In the alternative the tenants contended that the recital, introductory words of clause 3 and clause 4.8 meant that the lessor could not discriminate between the service charge claimed from the other seventy lessees and themselves. The lessees stressed the astronomical numbers as illustrating the extreme unlikelihood of their having agreed to automatic, compounded increases. These arguments were rejected by a 4:1 majority of the Supreme Court, with Lord Carnwath the sole dissentient.

1.177  In the leading judgment Lord Neuberger P (with whom Lords Sumption and Hughes agreed) identified forty-five years of pronouncements on the interpretation or construction of contracts from Prenn v Simmonds,525 through Chartbrook Ltd v Persimmon Homes Ltd,526 to Rainy Sky SA v Kookmin Bank.527 Drawing the threads together his Lordship stated:

(p. 100)

When interpreting a written contract, the court is concerned to identify the intention of the parties by reference to ‘what a reasonable person having all the background knowledge which would have been available to the parties would have understood them to be using the language in the contract to mean’, to quote Lord Hoffmann in Chartbrook Ltd v Persimmon Homes Ltd [528]. And it does so by focussing on the meaning of the relevant words, in this case cl 3(2) of each of the 25 leases, in their documentary, factual and commercial context. That meaning has to be assessed in the light of

  1. (i)  the natural and ordinary meaning of the clause,

  2. (ii)  any other relevant provisions of the [contract],

  3. (iii)  the overall purpose of the clause and the [contract],

  4. (iv)  the facts and circumstances known or assumed by the parties at the time that the document was executed, and

  5. (v)  commercial common sense, but

  6. (vi)  disregarding subjective evidence of any party’s intentions. …529

Lord Neuberger went on to highlight a number of other factors, of which the first four are of general importance:

First, the reliance placed in some cases on commercial common sense and surrounding circumstances (e g in Chartbrook … ) should not be invoked to undervalue the importance of the language of the provision which is to be construed. The exercise of interpreting a provision involves identifying what the parties meant through the eyes of a reasonable reader, and, save perhaps in a very unusual case, that meaning is most obviously to be gleaned from the language of the provision. Unlike commercial common sense and the surrounding circumstances, the parties have control over the language they use in a contract. And, again save perhaps in a very unusual case, the parties must have been specifically focusing on the issue covered by the provision when agreeing the wording of that provision.

Secondly, when it comes to considering the centrally relevant words to be interpreted, I accept that the less clear they are, or, to put it another way, the worse their drafting, the more ready the court can properly be to depart from their natural meaning. That is simply the obverse of the sensible proposition that the clearer the natural meaning the more difficult it is to justify departing from it. However, that does not justify the court embarking on an exercise of searching for, let alone constructing, drafting infelicities in order to facilitate a departure from the natural meaning. If there is a specific error in the drafting, it may often have no relevance to the issue of interpretation which the court has to resolve.

(p. 101) The third point I should mention is that commercial common sense is not to be invoked retrospectively. The mere fact that a contractual arrangement, if interpreted according to its natural language, has worked out badly, or even disastrously, for one of the parties is not a reason for departing from the natural language. Commercial common sense is only relevant to the extent of how matters would or could have been perceived by the parties, or by reasonable people in the position of the parties, as at the date that the contract was made. Judicial observations such as those of Lord Reid in Wickman Machine Tools Sales Ltd v L Schuler AG … and Lord Diplock in Antaios Cia Naviera SA v Salen Rederierna AB (The Antaios) … , have to be read and applied bearing that important point in mind.

Fourthly, while commercial common sense is a very important factor to take into account when interpreting a contract, 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, even ignoring the benefit of wisdom of hindsight. The purpose of interpretation is to identify what the parties have agreed, not what the court thinks that they should have agreed. Experience shows that it is by no means unknown for people to enter into arrangements which are ill-advised, even ignoring the benefit of wisdom of hindsight, and it is not the function of a court when interpreting an agreement to relieve a party from the consequences of his imprudence or poor advice. Accordingly, 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.530

1.178  Three points clearly emerge. First, the re-emergence of the phrase ‘natural meaning’ in the highest court, despite Lord Hoffmann’s scepticism about the phrase. Secondly, this fed into what was clearly intended to be emphatic endorsement of the principle of the loyalty to the text. Thirdly, whilst still relevant and admissible, the subordination of both the contractual context and commercial common sense to the principle of loyalty to the text. Indeed the only evidence considered by each court was the various iterations of the leases and the Retail Price Index for 1970 to 2010.531 The majority, whilst acknowledging some drafting errors, did not consider that anything had gone significantly wrong with the language.532

1.179  That conclusion can be immediately contrasted with the sensible and careful dissenting judgment of Lord Carnwath, to which it is impossible to do justice in a summary. Lord Carnwath considered the factual matrix to include the knowledge of the landlords as parties to the leases of not just the ‘extraordinary’ increases which would be faced by the minority lessees, but also of the ‘dramatically increasing, and ultimately grotesque, differences between the amounts payable by the two different groups of lessees on the same estate’.533 So too, the individual lessees would have viewed the chalets as a long-term investment for their families, and (p. 102) would not have risked undue financial burdens.534 The reasonable expectation of each lessee in the same development that all other leases would be granted on the same terms found expression here in the actual language of the preamble and clause 4(8).535 If it provided for a fixed increase service charge the clause would side-step the protections of the Landlord and Tenant Act 1985. Lord Carnwath, unusually but compellingly, invoked public policy as evidenced by statutory interventions as a legitimate source of guidance in areas analogous to those where the legislature had intervened.536 Lord Carnwath observed:

Even where the legislature has not intervened, the courts have a responsibility in my view to ensure that such clauses are interpreted so far as possible not only to give effect to their intended purpose, but also to guard against unfair and unintended burdens being placed on the lessees.537

Lord Carnwath unhesitatingly concluded that something had gone wrong with the drafting. The clause contained two mutually inconsistent formulations—a proportionate share and a fixed amount—leaving an ambiguity to be resolved.538 He concluded that the modest implication making the fixed sum an upper limit was warranted, and that the alternative construction could only be achieved by the clearest words. The implication of ‘up to’ avoided a result which was a commercial nonsense.539

1.180  Despite the majority’s commitment to a more strict approach to language its members nevertheless expressed ‘considerable sympathy’ with Lord Carnwath’s dissenting judgment, and acknowledged parenthetically that ‘it is a much more satisfactory outcome in common sense terms, particularly viewed as at today’.540 Furthermore, because this case fell within a statutory lacuna the majority thought there was a ‘strong case’ for legislative reform.541 None of this availed the minority tenants, who were left to depend on the future goodwill of the landlord in not enforcing the leases on their strict terms.

(p. 103) 1.181  Lord Neuberger clearly intends Arnold v Britton as the last word for now on contractual construction in the Supreme Court.542 It obviously places the principle of the primacy of the text at the heart of the technique.543 It also appears to signal an apparent downgrading of the role of commercial or business common sense from its prominent role in Rainy Sky v Kookmin Bank.544 Obviously this represents an important change of emphasis,545 but nevertheless does not undo the central tenets modern restatement of contractual construction brought about by the preceding forty-five years of case law in the House of Lords and Supreme Court.546 No doubt was cast on the general principles enunciated in the sequence of decisions from from Prenn v Simmonds547 to Rainy Sky SA v Kookmin Bank.548 Nevertheless whilst unexceptionable in its statement of the applicable principles of construction, the application of those principles to the facts of the instant case demonstrates that something has clearly gone wrong with the reasoning of the majority, representing a marked departure from the common sense approach that has characterized this topic over the last five decades. Ordinarily little is to be gained from criticizing the results in construction cases involving one-off disputes. However given its prominence, Arnold v Britton represents an exception. The majority of the Supreme Court simply got the balancing exercise wrong. (p. 104) Most importantly, there was over-concentration on the latter half of the disputed clause, rendering the preceding words mere surplusage. Insufficient weight was given to the remainder of the instrument, the relevant background and common sense. Lord Carnwath’s sensible and holistic reading of the leases is more consistent with the common law approach to interpretation over the centuries, and not just the preceding fifty years, and foregoing eleven authorities.

Concluding Observations

Where are we now?

1.182  It may be that the excessive literalism, strictness of the rhetoric, and the actual results in the Supreme Court decisions in Arnold v Britton (on interpretation) and Marks & Spencer (on implication), both in 2015, represent an aberration or an over-correction.549 None of the modern principles of interpretation have been scorned and no leading authorities held to be wrongly decided. The continued relevance of modern principles of contractual construction is best demonstrated by two subsequent decisions of the Court of Appeal, the first of which has been upheld by the Supreme Court. First, in December 2015 BNY Mellon Corporate Trustee Services Ltd v LBG Capital No 1 plc (‘the Lloyds Bank Bonds case’), which was upheld by the majority of the Supreme Court in June 2016.550 Secondly, Globe Motors, Inc v TRW Lucas Varity Electric Steering Ltd decided in April 2016.551

The Lloyds Bank Bonds case

1.183  This case featured the capital raising efforts of one of the UK’s leading banking groups in the wake of the Global Financial Crisis of 2007–08. Amongst the prudential measures required of banks are minimum capital requirements based on international standard setting measures (at the time of the crisis, known as Basel II), implemented in turn by EU and UK measures. In order to test their resilience to economic shocks central banks and regulators subjected banks to ‘stress tests’ based on negative economic conditions. In March 2009 the then UK regulator, the Financial Services Authority (FSA) conducted such a test on Lloyds Bank and concluded that it had failed to meet the core regulatory capital requirement of 4 (p. 105) per cent of risk-weighted assets under Basel II. At a time when it was difficult for the bank to raise sufficient new capital purely through equity issues it launched a bond-raising issue of over £8 billion by way of Enhanced Capital Notes (‘the Bonds’), offering attractive coupon interest averaging over 10 per cent, and in some cases not redeemable until 2032. However under their terms the Bonds would be converted into bank shares if there were a ‘Capital Disqualification Event’ such as where the Bonds ‘ceased to be taken into account’ for the purpose of any FSA stress test. The terms were somewhat unsatisfactorily drafted in utilizing the language of the Basel II capital requirements regime. In the wake of the crisis the FSA was superseded from April 2013 by a new dedicated prudential regulator, which was in effect the Bank of England, and the international measures for regulatory capital were enhanced under a new regime, using different terminology (‘Basel III’), implemented in the EU and UK with effect from the end of 2013. In June 2013 the regulator announced that Lloyd’s Bank needed to raise another £8 billion to meet the new capital requirement of 7 per cent of risk-weighted assets. At a further stress test in December 2014 the regulator did not take into account the Bonds, so Lloyds bank claimed a ‘Capital Disqualification Event’ had occurred.

1.184  That contention was upheld by the Court of Appeal and by a majority of the Supreme Court,552 applying the modern principles of contractual construction. In some respects the reasoning of the Court of Appeal is wider, especially in relation to the admissible materials. However both courts to some extent were correcting a badly drafted contract, and had regard to some pretty recondite regulatory and other background material by way of admissible background to justify their conclusions.

1.185  So just as Lord Hoffmann had in Investors Compensation Scheme, in the Lloyds Bank Bonds case both Gloster LJ in the Court of Appeal and Lord Neuberger delivering the judgment of the majority of the Supreme Court set out in considerable detail the legal, regulatory, and factual matrix, before even quoting the disputed clauses.553 Indeed the background was the Global Financial Crisis and the near-collapse of several of the UK’s high street banks. The nine judges who heard the case unanimously rejected the bondholders’ explicitly literal argument554 based on the ‘embedded definition’ by reference to superseded regulatory language which it was argued meant that the 2014 exercise was not a relevant stress test for the purposes of determining a Capital Disqualification Event. In respect of the construction issues both Gloster LJ and Lord Neuberger invoked (p. 106) the commercial purpose of the Bonds and the relevant clause, common sense and concluded that something had gone wrong with the language.555

The Globe Motors summary: changes of emphasis

1.186  In Globe Motors556 Beatson LJ drew the threads of recent developments together:

The professed object of a common law court in interpreting or construing a written contract is to discover the mutual intention of the parties. It is now generally accepted that this is not to be done by a purely literal approach. The formulations by appellate judges have differed, but the differences have primarily been ones of emphasis rather than of principle. They relate to the extent to which the approach to construction should be contextual, the role of background material, and the relationship between the approach to construction and the approach to the implication of a term …

Since 1997, the starting point has generally been the five principles distilled from the authorities by Lord Hoffmann in his seminal judgment in Investors Compensation Scheme v West Bromwich Building Society (‘the ICS case’). Those principles were refined by him in later decisions, in particular BCCI v Ali, Chartbrook Ltd v Persimmon Homes Ltd, and Attorney General of Belize v Belize Telecom Ltd. In the last of these he reappraised the process of implying terms and its relationship to the exercise of interpreting the express terms.

The most recent adjustments of emphasis occurred in 2015 when, in Arnold v Britton and Marks and Spencer plc v BNP Paribas Securities Services Trust Co. (Jersey) Ltd, the Supreme Court revisited Lord Hoffmann’s statements of the principles. Both those cases involved leases. In the first, the change of emphasis was to give greater weight to the words used in the document. In the second it concerned the relationship between interpretation and implication. A majority of the Supreme Court stated (see [25], [26] and [76]) that, while interpreting the words which the parties have used and implying words into the contract both involve determining the scope and meaning of the contract in the broad sense, ‘construing the words used and implying additional words are different processes governed by different rules’.557

Therefore Arnold v Britton emphasized the importance of loyalty to the contractual language and Marks & Spencer—whilst accepting that interpretation an implication are neighbouring techniques—insisted they were governed by different rules. Nevertheless as subsequent cases, including the Lloyds Bank Bonds case,558 have shown the commercial or contextual approach to construction and (p. 107) implication is entrenched. The modern approach was pithily summarized by Briggs LJ in the Court of Appeal in 2016 in Nobahar-Cookson v The Hut Group Ltd 559 where his Lordship stated: ‘The court must still use all of its tools of linguistic, contextual, purposive and common-sense analysis to discern what the clause really means.’560

Wood v Capita: the Supreme Court stresses continuity

1.187  Most recently in 2017 in Wood v Capita Insurance Services Ltd561 the Supreme Court went so far as to refuse to hear argument based on the proposition that Arnold v Britton562 had ‘rowed back’ from the guidance in Rainy Sky SA v Kookmin Bank,563 stating that ‘the legal profession has sufficient judicial statements’ on contractual interpretation.564

1.188  The case concerned the takeover of a regulated insurance broker. The share purchase agreement contained an indemnity clause embracing ‘all fines, compensation or remedial action or payments imposed on … the company … arising out of claims or complaints registered with’ regulators and ombudsmen, including the then Financial Services Authority (‘FSA’) in the period prior to the completion of the sale of the company. Shortly after the takeover some of the company’s employees raised concerns about its sales processes. The company carried out a review which revealed that in many cases its telesales staff had misled customers. The buyer was obliged under a fundamental regulatory rule (FSA Principle 11) to self-report to the FSA. It was agreed with the FSA that the business would conduct a scheme for compensation to be paid to customers affected by the mis-selling. The buyer made a claim against the seller under the indemnity clause alleging that the company and its subsidiaries had suffered loss resulting from mis-selling insurance products in the period prior to the sale of the company. The judge construed the indemnity clause as requiring the seller to indemnify the buyer, even though there had been no claim or complaint by a customer, and accordingly gave judgment for the buyer. The Court of Appeal construed the indemnity clause as being confined to losses arising out of customers’ claims or complaints and accordingly allowed the appeal.565

(p. 108) 1.189  The Supreme Court rejected the contention that any disagreement between the judge and Court of Appeal arose from applying different principles. Despite the surfeit of judicial observations, Lord Hodge went on to summarize the modern approach, stressing the continuities in the authorities and stating that:

The court’s task is to ascertain the objective meaning of the language which the parties have chosen to express their agreement. It has long been accepted that this is not a literalist exercise focused solely on a parsing of the wording of the particular clause but that the court must consider the contract as a whole and, depending on the nature, formality and quality of drafting of the contract, give more or less weight to elements of the wider context in reaching its view as to that objective meaning. In Prenn v Simmonds … and in Reardon Smith Line Ltd v Yngvar Hansen-Tangen … , Lord Wilberforce affirmed the potential relevance to the task of interpreting the parties’ contract of the factual background known to the parties at or before the date of the contract, excluding evidence of the prior negotiations. When in his celebrated judgment in Investors Compensation Scheme Ltd v West Bromwich Building Society Lord Hoffmann reformulated the principles of contractual interpretation, some saw his second principle, which allowed consideration of the whole relevant factual background available to the parties at the time of the contract, as signalling a break with the past. But Lord Bingham in an extra-judicial writing, A new thing under the sun? The interpretation of contracts and the ICS decision[566], persuasively demonstrated that the idea of the court putting itself in the shoes of the contracting parties had a long pedigree.

Lord Clarke elegantly summarised the approach to construction in Rainy Sky … In Arnold all of the judgments confirmed the approach in Rainy Sky[567]… Interpretation is, as Lord Clarke stated in Rainy Sky, a unitary exercise; where there are rival meanings, the court can give weight to the implications of rival constructions by reaching a view as to which construction is more consistent with business common sense. But, in striking a balance between the indications given by the language and the implications of the competing constructions the court must consider the quality of drafting of the clause[568] … ; and it must also be alive to the possibility that one side may have agreed to something which with hindsight did not serve his interest[569]. Similarly, the court must not lose sight of the possibility that a provision may be a negotiated compromise or that the negotiators were not able to agree more precise terms.

This unitary exercise involves an iterative process by which each suggested interpretation is checked against the provisions of the contract and its commercial consequences are investigated[570]… To my mind once one has read the language in dispute and the relevant parts of the contract that provide its context, it does not matter whether the more detailed analysis commences with the factual (p. 109) background and the implications of rival constructions or a close examination of the relevant language in the contract, so long as the court balances the indications given by each.

Textualism and contextualism are not conflicting paradigms in a battle for exclusive occupation of the field of contractual interpretation. Rather, the lawyer and the judge, when interpreting any contract, can use them as tools to ascertain the objective meaning of the language which the parties have chosen to express their agreement. The extent to which each tool will assist the court in its task will vary according to the circumstances of the particular agreement or agreements. Some agreements may be successfully interpreted principally by textual analysis, for example because of their sophistication and complexity and because they have been negotiated and prepared with the assistance of skilled professionals. The correct interpretation of other contracts may be achieved by a greater emphasis on the factual matrix, for example because of their informality, brevity or the absence of skilled professional assistance. But negotiators of complex formal contracts may often not achieve a logical and coherent text because of, for example, the conflicting aims of the parties, failures of communication, differing drafting practices, or deadlines which require the parties to compromise in order to reach agreement. There may often therefore be provisions in a detailed professionally drawn contract which lack clarity and the lawyer or judge in interpreting such provisions may be particularly helped by considering the factual matrix and the purpose of similar provisions in contracts of the same type …

On the approach to contractual interpretation, Rainy Sky and Arnold were saying the same thing.

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.571

Were it not for the highly regrettable misapplication of the governing principles to the leases in Arnold that conclusion might be defensible. Similarly on its particular facts the holding of the Court in Wood would strike most lawyers familiar with financial services regulation as acontextual and unbusiness-like.572 The Supreme Court upheld the Court of Appeal’s somewhat strict reading that the indemnity clause did not embrace self-reporting to the regulator. Overall Lord Hodge emphasized continuity in the authorities which have been discussed above. Nevertheless most observers would consider that in the most recent authorities, at least in terms of the results of cases, rather than the principles available to the courts, the pendulum can be said to be swinging towards literalism (of which the contractual estoppel line of cases is the extreme example),573 or, more kindly, textualism.

(p. 110) Summary of leading principles and policies574

The aim of construction

1.190  First, the aim of the exercise of construction of a contract or other document is to ascertain the meaning which it would convey to a reasonable business person.

The objective principle

1.191  Secondly, the objective principle is therefore critical in defining the approach the courts will take. The courts are concerned usually with the expressed intentions of a person, not his actual intentions. The standpoint adopted is that of a reasonable reader.

The holistic or ‘whole contract’ approach

1.192  Thirdly, the exercise is one based on the whole contract or an holistic approach. Courts are not excessively focused upon a particular word, phrase, sentence, or clause. Rather the emphasis is on the document or utterance as a whole.

The contextual dimension

1.193  Fourthly, the exercise in construction is informed by the surrounding circumstances or external context. Modern judges are prepared to look beyond the four corners of a document, or the bare words of an utterance. It is permissible to have regard to the legal, regulatory, and factual matrix which constitutes the background in which the document was drafted or the utterance was made.

Business purpose

1.194  Fifthly, within this framework, due consideration is given to the commercial purpose of the transaction or provision. The courts have regard to the overall purpose of the parties with respect to a particular transaction, or more narrowly the reason why a particular obligation was undertaken.

Lawful effect

1.195  Sixthly, a construction which entails that the contract and its performance are lawful and effective is to be preferred.

(p. 111) Contra proferentem

1.196  Seventh, where a particular species of transaction, contract, or provision is one-sided or onerous it will be construed strictly against the party seeking to rely on it.

Avoiding unreasonable results

1.197  Eighth, a construction which leads to very unreasonable results is to be avoided unless it is required by clear words and there is no other tenable construction.

Specially negotiated terms

1.198  Ninth, a specially agreed provision should override an inconsistent standard provision which has not been individually negotiated.

General provisions versus precise provisions

1.199  Tenth, a more precise or detailed provision should override an inconsistent general or widely expressed provision.


1  River Wear Commissioners v Adamson (1877) 2 App Cas 743, 763, HL. See also Seaford Court Estates Ltd v Asher [1949] 2 KB 481, 499, CA: ‘The English language is not an instrument of mathematical precision. Our literature would be much the poorer if it were’ (Denning LJ).

2  See generally S Pinker, The Language Instinct—The New Science of Language and Mind (1994).

3  See E McKendrick (ed), Goode on Commercial Law (5th edn, 2016), paras 1.44–1.48 on the problem of language in contracts and statutes. For a defence of lawyers and the importance of ‘legal jargon’ to the maintenance of the rule of law see Diplock LJ in Sydall v Castings Ltd [1967] 1 QB 302, 313–14 (discussed more fully at 13.04).

4  A suspicion that either the other party or the judge might approach the text, at best pedantically, at worst in bad faith, has exercised a powerful discipline over draftpersons of legal texts over the centuries. For an example of this concern, see Stephen J (Sir James Fitzjames Stephen) in Re Castioni [1891] 1 QB 149, 167–8: ‘I published some years ago a book which has been considerably quoted to-day, and in the passage in which I stated my views upon this subject. I gave what appeared to me to be the true interpretation of the expression “political character.” It is very easy to give it too wide an explanation. I think that my late friend Mr Mill [John Stuart Mill] made a mistake upon the subject, probably because he was not accustomed to use language with that degree of precision which is essential to everyone who has ever had, as I have had on many occasions, to draft Acts of Parliament, which, although they may be easy to understand, people continually try to misunderstand, and in which therefore it is not enough to attain to a degree of precision which a person reading in good faith can understand. It is necessary to attain, if possible, to a degree of precision which a person reading in bad faith cannot misunderstand. It is all the better if he cannot pretend to misunderstand it.’

5  Lloyds TSB Foundation for Scotland v Lloyds Banking Group plc [2013] UKSC 3, [2013] 1 WLR 366, [2013] 2 All ER 103, para [23] (Lord Mance). See also Lord Hope at para [43].

6  K Zweigert and H Kotz, An Introduction to Comparative Law (3rd edn, 1998; trans by T Weir), 400.

7  For discussion of ‘ambiguity’ see Hon J J Spigelman AC, ‘From text to context: Contemporary contractual interpretation’ (2007) 81 ALJ 322, 325–6. Contrast D W McLauchlan, ‘Plain Meaning and Commercial Construction: Has Australia Adopted the ICS Principles?’ (2009) 25 JCL 7, 16–17. See also W Allen and G Levy, ‘The Uses of Ambiguity in Commercial Contracts: on Facilitating Re-Bargaining’ in S Worthington (ed), Commercial Law and Commercial Practice (2003), 163.

8  Compare Tipping J, in the New Zealand Supreme Court in Vector Gas Ltd v Bay of Plenty Energy Ltd [2010] NZSC 5, para [33], who includes ‘special meaning’ as a source of disputes: ‘generally speaking, issues of contractual interpretation arise in three circumstances: mistake; ambiguity; and special meaning.’

9  As evidenced by three leading cases in the House of Lords: Prenn v Simmonds [1971] 1 WLR 1381; Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896; and Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38, [2009] 1 AC 1101.

10  E A Farnsworth, ‘ “Meaning” in the Law of Contract’ (1967) 76 Yale LJ 939, 954.

11  In the context of ‘letters of comfort’: Chemco Leasing SpA v Redifussion plc (unreported) 19 July 1985; also cited by Hirst J in Kleinwort Benson Ltd v Malaysia Mining Corporation Berhad [1988] 1 WLR 799, 806; revsd [1989] 1 WLR 379, CA.

12  A W B Simpson, ‘The ratio decidendi of a case and the doctrine of binding precedent’ in A Guest (ed), Oxford Essays in Jurisprudence (First Series, 1961), 158; also quoted in B Bix, Law, Language and Legal Determinancy (1993), 5.

13  ‘The expression “construction,” as applied to a document, at all events as used by English lawyers, includes two things: first, the meaning of the words; and, secondly, their legal effect, or the effect which is to be given to them.’: Chatenay v Brazilian Submarine Telegraph Co Ltd [1892] 1 QB 79, 85 (Lindley LJ). Contrast J W Carter and E Peden, ‘The “Natural Meaning” of Contracts’ (2005) 21 JCL 277 (a three-stage approach). Subsequently Professor Carter reverted to a two-stage process of ‘linguistic meaning’ and ‘legal effect’: J W Carter, ‘Commercial Construction and Contract Doctrine’ (2009) 25 JCL 83.

14  Sir Robert Goff, ‘Commercial contracts and the Commercial Court’ [1984] LMCLQ 382, 389.

15  In re Golden Key Ltd [2009] EWCA Civ 636 at para [28]; and see paras [26]–[29] and [42] (Arden LJ).

16  [2001] 2 All ER (Comm) 299, [2002] Lloyd’s Rep IR 612, para [16] (Mance LJ).

17  The origin of this terminology in the context of contractual construction appears to be the judgment of Lord Neuberger MR in In re Sigma Finance Corporation (in administrative receivership) [2008] EWCA Civ 1303, para [98]. The Compact Oxford English Dictionary gives as the second meaning of ‘iterate’ (and its adjectival form): ‘make repeated use of a mathematical or computational procedure, applying it each time to the result of the previous application’. See Lord Grabiner, ‘The Iterative Process of Contractual Interpretation’ (2012) 128 LQR 41.

18  In re Sigma Finance Corporation (in administrative receivership) [2009] UKSC 2, [2010] 1 All ER 571, para [12] (Lords Hope, Scott, and Collins concurring), echoing [2008] EWCA Civ 1303, para [98] (Lord Neuberger MR dissenting). See also Rainy Sky SA v Kookmin Bank [2011] UKSC 50, [2011] 1 WLR 2900, para [28] (Lord Clarke); Arnold v Britton [2015] UKSC 36; [2015] AC 1619, para [77] (Lord Hodge); and Wood v Capita Insurance Services Ltd [2017] UKSC 24, [2017] 2 WLR 1095, para [12] (Lord Hodge).

19  See Sir Johan Steyn, ‘Written Contracts: To What Extent May Evidence Control Language?’ [1988] CLP 23, 23–4 discussing the contrasting approach of common law and civil law systems.

20  Macbeath v Haldimond (1786) 1 Term Rep 172, 180; 99 ER 1036 (Lord Mansfield); Bowes v Shand (1877) 2 App Cas 455, 462 (Lord Cairns LC). Contrast Lindley LJ in Chatenay v Brazilian Submarine Telegraph Co Ltd [1892] 1 QB 79, 85: ‘The meaning of the words I take to be a question of fact in all cases, whether we are dealing with a poem or a legal document. The effect of the words is a question of law.’ It is submitted that it does not aid analysis to characterize the meaning of individual words as a question of fact. The modern approach is to ask what the words of the document mean either individually or collectively in context, and that is treated as a question of law. Furthermore, as Lewison notes, it is curious that if they are facts, no evidence is admissible to prove them: Sir Kim Lewison, The Interpretation of Contracts (6th edn, 2015), para 4.01.

21  Pioneer Shipping Ltd v BTP Tioxide Ltd (The Nema) [1982] AC 724, HL: a case on leave to appeal under s 1 of the Arbitration Act 1979. Or indeed whatever the common sense of the matter, as was reinforced by the House of Lords in Antaios Compania Naviera SA v Salen Rederierna AB (The Antaios) [1985] AC 191, 199, where Lord Diplock was scathing of ‘that insistence upon meticulous semantic and syntactical analysis of the words in which business men happen to have chosen to express the bargain made between them, the meaning of which is technically, though hardly commonsensically, classified in English jurisprudence as a pure question of law’. See also Bahamas International Trust Co Ltd v Threadgold [1974] 1 WLR 1514, 1525, PC (Lord Diplock).

22  [1982] AC 724, 736. The other members of the House of Lords agreed. See also Sirius International Insurance Co (Publ) v FAI General Insurance Ltd [2004] UKHL 54, [2004] 1 WLR 3251, para [3] (Lord Steyn); Braes of Doune Wind Farm (Scotland) Ltd v Alfred McAlpine Business Services Ltd [2008] EWHC 426 (TCC), [2008] 1 Lloyd’s Rep 608, para [26] (Akenhead J). Contrast the civil law system of France where interpretation is a matter of fact (and therefore generally outside the control of the Cour de Cassation): B Nicholas, The French Law of Contract (2nd edn, 1992), 47.

23  Compare (more stridently) P Devlin, Trial by Jury (1956), 61: ‘there are questions of fact that judges can answer better then juries.’ Cited by Lord Hoffmann in Carmichael v National Power plc [1999] 1 WLR 2042, 2048, HL.

24  Carmichael v National Power plc [1999] 1 WLR 2042, 2048–9, HL (Lord Hoffmann). See also Thorner v Major [2009] UKHL 18, [2009] 1 WLR 776, paras [82]–[83] (Lord Neuberger).

25  Yap Son On v Ding Pei Zhen [2016] SGCA 68, para [64] (Sundaresh Menon CJ). Compare Redrow Regeneration (Barking) Ltd v Edwards [2012] UKUT 373 (LC), para [18].

26  Sattva Capital Corp v Creston Mining Corp 2014 SCC 53; [2014] 2 SCR 633, (2013) DLR (4th) 393, paras [42]–[55] (Rothstein J); noted S Waddams (2015) 131 LQR 48.

27  Ledcor Construction Ltd v Northbridge Indemnity Insurance Co [2016] SCC 37.

28  Contrast E McKendrick (ed), Goode on Commercial Law (5th edn, 2016), para 3.62, n 187.

29  Torbett v Faulkner [1952] 2 TLR 659, 661, CA (Romer LJ); Sir Christopher Staughton, ‘How Do the Courts Interpret Commercial Contracts?’ [1999] CLJ 303.

30  Maggs (trading as BM Builders) v Marsh [2006] EWCA Civ 1058. See also Blue v Ashley [2017] EWHC 1928 (Comm), paras [49–64] (Leggatt J).

31  Smith v Hughes (1871) LR 6 QB 597, 607 (Blackburn J). See 3.18.

32  A Burrows (assisted by an Advisory Group of Academics, Judges and Practitioners), A Restatement of the English Law of Contract (2016), §13(1) and see Commentary at 80.

33  The English courts tend to speak of ‘reduction to writing’. In contrast, ‘integration’ is traditionally the language of American law. See J H Wigmore, Wigmore on Evidence (3rd edn, 1981; revised by J H Chadbourn), vol 9, para 2425, describing ‘integration’ as ‘the process of embodying the terms of a jural act in a single memorial’. See also E Peden and J Carter, ‘Entire Agreement—and Similar— Clauses’ (2006) 22 JCL 1, 4–5.

34  Moore v Garwood (1849) 4 Ex 681, 689–90, 154 ER 1388, Exch Ch; Yani Haryanto v E D & F Man (Sugar) Ltd [1986] 2 Lloyd’s Rep 44, 46 (Staughton J). See for a more recent discussion: Maggs (trading as BM Builders) v Marsh [2006] EWCA Civ 1058.

35  [1999] 1 WLR 2042, HL. See also Inntrepreneur Pub Co v East Crown Ltd [2000] 2 Lloyd’s Rep 611, para [10] (Lightman J: principles for determining existence of collateral warranty); see further 20.32.

36  Employment Protection (Consolidation) Act 1978, s 1.

37  Subsequently re-named Employment Tribunals by the Employment Rights (Dispute Resolution) Act 1998.

38  [1999] 1 WLR 2042, 2047. The other members of the House agreed.

39  [1999] 1 WLR 2042, 2050. Lords Goff and Jauncey agreed.

40  [1998] ICR 1167, 1194.

41  [1999] 1 WLR 2042, 2050.

42  In Inntrepreneur Pub Co (CPC) v Sweeney [2000] EWHC 1060 (Ch), para [46], Park J recorded that ‘The report reads “threshing”, but Lightman J has confirmed to me that this is a transcribing error for “thrashing” ’.

43  Inntrepreneur Pub Co v East Crown Ltd [2000] 2 Lloyd’s Rep 611, para [7] (Lightman J). See also A Berg, ‘Thrashing through the Undergrowth’ (2006) 122 LQR 354.

44  See Peekay Intermark Ltd v Australia and New Zealand Bank Group Ltd [2006] EWCA Civ 386, [2006] 2 Lloyd’s Rep 511 and Springwell Navigation Corporation v J P Morgan Chase Bank [2008] EWHC 1186 (Comm) (Gloster J); [2010] EWCA Civ 1221. For detailed consideration of entire agreement, non-reliance, and restriction of variation clauses see Chap 26.

45  Contrast A Burrows (assisted by an Advisory Group of Academics, Judges and Practitioners), A Restatement of the English Law of Contract (2016), §13(2) (wider presumption for all contracts in writing) and see Commentary at 81.

46  Globe Motors, Inc v TRW Lucas Varity Electric Steering Ltd [2016] EWCA Civ 396, (2016) 168 Con LR 59; and MWB Business Exchange Centres Ltd v Rock Advertising Ltd [2016] EWCA Civ 553, [2016] 3 WLR 1519, [2016] 2 Lloyd’s Rep 391, paras [1