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Part I The General Part, 5 External Context: Surrounding Circumstances, ‘Matrix’, and ‘Background’

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

Gerard McMeel

From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: null; date: 07 June 2023

Breach of contract — Validity of contract — Contract clauses and damages — Exclusion or limit of liability

(p. 177) External Context

Surrounding Circumstances, ‘Matrix’, and ‘Background’


5.01  One of the most controversial areas in the principles governing the interpretation of contracts is the question of what materials are admissible to assist the court in carrying out the task. With the commitment of English law to an objective approach it is clear that evidence of either party’s actual or subjective understanding of the contract is given no weight, and is deemed to be technically inadmissible. In contrast, it is long established that a document must be construed as a whole, so a particular word or phrase has to be construed set in the landscape of the remainder of the document. Traditionally the four corners of the instrument represented a boundary that judges were reluctant to cross. A rule developed that evidence outside the document—termed ‘extrinsic evidence’—was inadmissible to supplement, vary, or contradict the terms of the instrument. This restrictive approach was known as the parol evidence rule. Its original operation was to inhibit arguments that there were collateral terms, usually garnered from the oral negotiations. Its influence was soon extended into interpretation, and it was often suggested that extrinsic evidence was inadmissible as an aid to construction, unless the language was ambiguous. Such an approach is sometimes termed the ‘plain meaning rule’. However even in the nineteenth century judges considered the surrounding circumstances of assistance in interpreting contracts, and this permitted recourse to the parties’ dealings for the purposes of identifying background facts and the subject-matter of the contract. A broad approach to the relevance of context has been favoured by many great judges over the years. The context is seen as a source for understanding both the factual circumstances known to both parties and their purpose or object in agreeing to the provision under consideration. A prominent example is a well-known statement of Lord Blackburn in River Wear Commissioners v Adamson.1 Whilst concerned with a (p. 179) matter of statutory construction, his Lordship’s analysis was explicitly applicable to other legal documents:2

My Lords, it is of great importance that those principles should be ascertained; and I shall therefore state, as precisely as I can, what I understand from the decided cases to be the principles on which the Courts of Law act in construing instruments in writing; and a statute is an instrument in writing. In all cases the object is to see what is the intention expressed by the words used. But, from the imperfection of language, it is impossible to know what that intention is without inquiring farther, and seeing what the circumstances were with reference to which the words were used, and what was the object, appearing from those circumstances, which the person using them had in view; for the meaning of words varies according to the circumstances with respect to which they were used.3

5.02  During the course of the twentieth century the approach of the judges of the Commercial Court to the construction of commercial instruments came to predominate, where the emphasis was on business common sense and context. This approach was best encapsulated by Sir Robert Goff expressing the view that:

there is only one principle of construction: to make … 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.4

5.03  That identifies three sources of assistance in addition to the actual words under consideration: first, the rest of the instrument or the ‘internal context’, which was considered in Chapter 4; secondly, the nature of the transaction—presumably the particular species of contract may supply the usual default regime of implied obligations and legal incidents for that particular type of transaction; thirdly, the ‘legal and factual matrix’. The talismanic phrase ‘factual matrix’ derives from the speeches of Lord Wilberforce5 (who was himself a judge of the Chancery Division), but became the mantra of all commercial lawyers.6 Lord Goff glossed it by making explicit that the legal and regulatory background was often as important as the factual circumstances.

(p. 180) 5.04  According to Sir Thomas Bingham MR in Arbuthott v Fagan:

Courts will never construe words in a vacuum. To a greater or lesser extent, depending on the subject matter, they will wish to be informed of what may variously be described as the context, the background, the factual matrix or the mischief. To seek to construe any instrument in ignorance or disregard of the circumstances which gave rise to it or the situation in which it is expected to take effect is in my view pedantic, sterile and productive of error. But that is not to say that an initial judgment of what an instrument was or should reasonably have been intended to achieve should be permitted to override the clear language of the instrument, since what an author says is usually the surest guide to what he means. To my mind construction is a composite exercise, neither uncompromisingly literal nor unswervingly purposive: the instrument must speak for itself, but it must do so in situ and not be transported to the laboratory for microscopic analysis.7

5.05  The broad approach to external context is significantly qualified by the long-standing insistence that the exercise in construction is to be carried out as though it were contemporaneous with the date when the contract was concluded. 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.’8 Accordingly, the general rule is that declarations of subjective intent,9 the prior negotiations,10 and subsequent conduct11 of the parties are inadmissible. This rule is applicable to both elements of construction: interpretation of the express terms and the assessment of whether any terms or language should be implied.12

The tension between the positive and negative aspects of modern doctrine was encapsulated in 1992 by Staughton LJ in Youell v Bland Welch & Co Ltd:13

The modern approach of the House of Lords is that, on the positive side, evidence should be admitted of the background to the contract, the surrounding circumstances, the matrix, the genesis and aim. Almost every day in these Courts there (p. 181) is a contest as to what comes within that description[14] … The notion is what the parties had in mind, and the Court is entitled to know, what was going on around them at the time when they were making the contract. This applies to circumstances which were known to both parties, and to what each might reasonably have expected the other to know.

The negative aspect of the modern doctrine is that evidence of negotiations is not admissible as an aid to interpretation, at all events unless they show an agreed meaning for the language used.15

As Staughton LJ noted there, a central concern for practitioners is ascertaining 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 Society16 there was vigorous debate amongst lawyers and judges as to whether or not the traditional restrictions should be jettisoned. In 2009 this debate was resolved in favour of the conservative approach in relation to prior negotiations and subjective intent by the House of Lords in Chartbrook Ltd v Persimmon Homes Ltd.17

5.06  This chapter proceeds in four parts. First, the traditional rule that surrounding circumstances are taken into account is described. Secondly, we trace how that traditional rule evolved into the modern approach of having regard to the wider legal and factual matrix, through the seminal speeches of Lord Wilberforce to Lord Hoffmann’s restatement of the governing principles in Investors Compensation Scheme Ltd v West Bromwich Building Society.18 Thirdly, the scope of the exclusionary rules is examined in the light of the two leading cases of Investors Compensation Scheme Ltd v West Bromwich Building Society19 and Chartbrook Ltd v Persimmon Homes Ltd 20 and an attempt is made to identify which materials are legitimate aids to construction. Fourthly, consideration is given to arguments for further liberalization of the admissibility rules. This is currently precluded in English law as a result of Chartbrook v Persimmon Homes. Nevertheless the criticisms of the exclusionary rule and the position in other jurisdictions are discussed. Lastly, it should be noted that the approach of this text is that there is no ‘parol evidence rule’ or ‘plain meaning rule’ in English law which restricts the admissibility of extrinsic evidence for the purpose of construing a contract, as such a supposed rule cannot be reconciled with the modern statements of principle.

(p. 182) Key Points

5.07  In the nineteenth century it was established that it was permissible to prove by extrinsic evidence the ‘surrounding circumstances’ or objective background facts known to both parties as a legitimate aid to the construction of the contract. The ‘parol evidence rule’ which purported to restrict recourse to extrinsic evidence to prove additional terms which varied, supplemented, or contradicted a documentary contract did not limit such recourse for the purpose of construction. However, a related rule, sometimes called the ‘plain meaning rule’, was on occasion invoked to render extrinsic evidence inadmissible where the contract was considered to be clear and unambiguous. The tension between these two approaches was not fully resolved in the Victorian period.

5.08  In the twentieth century, the modern approach to contractual interpretation developed, building on the nineteenth century ‘surrounding circumstances’ principle, establishing that it was always legitimate to have regard to the wider background or matrix in all questions of construction. It was established that it is not a precondition that the contractual language should be ambiguous for such evidence to be adduced, and any supposed ‘plain meaning rule’ was repudiated; the background could even lead to the conclusion that the parties had used the wrong words or syntax in their contract.

5.09  On the modern approach the ‘matrix’ or the legal, regulatory, and factual background include: (1) factual circumstances known to both parties or which ought to have been appreciated by them, existing at the time of the contract; (2) evidence which tended to identify the subject-matter of the contract; and (3) the ‘legal matrix’, or legal and regulatory background known to both parties, or more usually their advisers, or which ought to have been appreciated by them, existing at the time of the contract.

5.10  This broad approach to context is nevertheless constrained both by the objective principle, and long-standing exclusionary rules which make the parties’ subjective understandings, their prior negotiations (including drafts), and the subsequent conduct of the parties irrelevant and inadmissible. It is therefore essential to consider whether a particular piece of evidence falls within the category of admissible legal and factual matrix or surrounding circumstances, or within the category of inadmissible subjective intentions, prior negotiations, or subsequent conduct.

5.11  The exclusionary rules do not apply where (1) the issue is one of characterization or categorization of a transaction, rather than pure construction of its terms; (2) where rectification of the document recording the agreement is sought; (3) where an estoppel—principally estoppel by convention—is relied upon.

(p. 183) The irrelevance of the ‘parol evidence rule’ to construction

5.12  The approach taken in this text is that, as a matter of English law, there is no parol evidence rule in either of the two traditional formulations: either to prevent the proof of a collateral term, or (in the guise of a supposed ‘plain meaning rule’) to restrict the evidence which is admissible for the purpose of construing a written contract.21

The different strands of the ‘parol evidence rule’

5.13  ‘Parol’ means any evidence outside a written instrument including both oral statements and other writing and documents. Three strands to the ‘parol evidence rule’ were identified by the Law Commission of England and Wales:

  1. [1]  The first rule excludes a particular means of proof, namely secondary evidence of a document: where the rule applies it prevents the contents of the document being proved by any means other than the production of the document. This is more usually known as the ‘best evidence rule’.

  2. [2]  By the second rule extrinsic evidence is inadmissible for the purpose of adding to, varying, contradicting or subtracting from the terms of the document: the writing is conclusive.

  3. [3]  The third rule deals with the admissibility of facts in aid of the interpretation or construction of documents.22

5.14  The first strand—that secondary evidence of a document was generally not admissible—can be put to one side as an aspect of the now defunct ‘best evidence rule’. It was formally excised from the common law by the Court of Appeal in 2001 in Masquerade Music Ltd v Springsteen.23 See further Chapter 28.

5.15  The second strand—a rule preventing proof of terms outside the written contract to vary, contradict, or supplement the document—was described by the Law Commission as ‘no more than a circular statement’24 and not a rule of law: ‘there is no rule of law that evidence is rendered inadmissible or is to be ignored solely because a document exists which looks like a complete contract. Whether or not it is a complete contract depends upon the intention of the parties, objectively judged, and not on any rule of law.’25 In Chartbrook Ltd v Persimmon Homes Ltd,26 Baroness Hale of Richmond referred with approval to the Law Commission’s conclusion that on a proper analysis the ‘parol evidence rule’ had ‘no real content’.27 That assessment is accepted here, but because it concerns proof of terms, (p. 184) rather than construction of the contract, the second strand of the rule is not further considered here, but is discussed in Chapter 15 on proof of terms and incorporation of terms.

5.16  The third supposed strand of the rule would suggest in its most extreme formulations that if it looks like the document contains all the terms, and the language of those terms considered in isolation is plain and unambiguous, then the judge is confined to the four corners of the document, and cannot consider extrinsic evidence by way of background for the purpose of construing the contract. No such rule, whether a strand of the ‘parol evidence rule’, or formulated as a supposed ‘plain meaning rule’, exists in modern English law.28

5.17  First, leading authorities from the nineteenth century make it clear that recourse to extrinsic evidence of the surrounding circumstances is permissible for the purpose of construing the contract. Secondly, that approach was developed over the course of the twentieth century, with the leading authorities accepting ready recourse, without a precondition of ambiguity, to the matrix or the reasonably available background. Thirdly, none of the leading texts accepts or defends the third supposed strand of the ‘parol evidence rule’ or ‘plain meaning rule’. The Law Commission’s diagnosis of the status of the parol evidence rule is accepted by Chitty29 and most other texts on contract. Sir Guenter Treitel, who defended the second strand of the rule, always accepted that recourse to the surrounding circumstances was permissible for the purpose of construing the contract, and constituted an exception to that rule.30 Professor Robert Stevens, whilst mounting a robust defence of the second strand,31 has accepted that the modern approach leaves no room for the supposed third strand:

[T[he rule against extrinsic evidence needs to be kept distinct from the question as to whether the parties can rely upon extrinsic evidence as an aid to interpretation of a contract. The extent to which the document is to be treated as conclusive of its terms is a question of degree. If all that has been agreed is that no terms other than those embodied in the written document have been agreed to, leading extrinsic evidence to interpret such a document is not inconsistent with the agreement. Indeed such contextual evidence might be indispensable. In recent times the courts have become much less restrictive in admitting such evidence. In principle, there is no tension between this development and the parol evidence rule.32

(p. 185) In the light of this consensus, no further purpose is served by referring to the ‘parol evidence rule’ in the context of construction of contracts.33

The Traditional Approach: The Surrounding Circumstances

What were the ‘surrounding circumstances’ in the nineteenth century?

5.18  In the nineteenth century the courts readily had regard to evidence outside the ‘four corners’ of the document, usually described as the ‘surrounding circumstances’, or sometimes described as ‘extrinsic evidence’, for the purpose of construing a contract.34 It is essential for a number of reasons to examine in some detail the nineteenth-century understanding of what constituted the surrounding circumstances, especially in the wake of the decision of the House of Lords to maintain the exclusionary rule for prior negotiations in Chartbrook Ltd v Persimmon Homes Ltd.35 First, the approach adopted in the nineteenth century is still the basis for the modern rule that the judge must examine the factual matrix (and in appropriate cases, the legal and regulatory background) in order to arrive at the true construction of a disputed contractual provision. Secondly, a thorough examination of the nineteenth-century statements of principle, and applications of those principles in practice, is necessary in order to state accurately the current law, and to describe the structure of the current law. It is submitted that it is not satisfactory to treat the admissibility of the factual background available to both parties as an exception to the exclusionary rule in relation to prior negotiations. Rather, the law as it developed in the nineteenth century required an examination of the parties’ pre-contractual dealings, negotiations, and the context or market in which they operated. Insofar as that examination yielded evidence of factual background known to both parties, or which ought to have been appreciated by them, such evidence was admissible. That is a positive principle, or an inclusionary rule. Insofar as the examination of prior dealings and negotiations yielded evidence as to subjective intentions or beliefs of the parties, it was inadmissible. That is the exclusionary rule. It is not necessary to accord primacy to either rule. However if it is considered desirable to do so, it is submitted that the inclusionary rule (which accords with the common-sense approach to language (p. 186) and communication) is the principal rule, and that the exclusionary rule operates by way of exception to it.36 Thirdly, when the application of the principles by our Victorian forebears are more carefully considered, certain recent decisions which have attracted criticism and surprise may appear to be more consistent with our legal tradition than has been commonly supposed.

Shore v Wilson

5.19  One of the leading nineteenth-century discussions of the evidence admissible for the purpose of construing written instruments (albeit not a contract case) is the decision of the House of Lords in Shore v Attorney-General ex rel Wilson.37 The case concerned the construction of Lady Hewley’s trust deeds executed in 1704 and 1709. The objects were various religious purposes connected with the Protestant religion. In the early eighteenth century all legally tolerated sects subscribed to the doctrine of the Trinity. By the mid-nineteenth century the majority of trustees were Unitarians who denied the divinity of Jesus Christ. Ultimately the House of Lords upheld the Court of Chancery’s decision that Unitarians, whose beliefs would not have been in the contemplation of the settlor, were not entitled under the deeds.

5.20  The traditional procedure for major decisions before the House of Lords was followed, whereby the judges assembled and presented their opinions to the members of the House. A particularly controversial question was addressed first: which evidence ought to be admitted? Despite concerning a unilateral instrument and trust principles, the case is often cited for pronouncements consistent with the parol evidence rule or the plain meaning rule. However, the case also illustrates the many qualifications to those rules. As Lord Cottenham noted in one of the two perfunctory speeches which followed the opinions of the judges, the question of admissible evidence was ‘subject of some difference in their opinions’.38 Lord Cottenham (agreeing with Gurney B) held that evidence of the surrounding circumstance that Lady Hewley was a member of a particular religious party was admissible. Lord Brougham concurred.39

5.21  An example of the various qualifications can be found in the opinion of Tindal LCJ, who stated that if a written instrument is unambiguous, and where the surrounding circumstances do not create any difficulty or doubt as to the effect or (p. 187) application of the words, then the ‘strict, plain, common meaning of the words’ is adopted. Note those two explicit preconditions. It is not sufficient that the language of the text is on its face unambiguous. The ‘surrounding circumstances’ are also important, and must be examined to see whether they are suggestive of ambiguity (which may be latent as well as patent) or otherwise lead to any difficulties in construing the text. If those two preconditions are met, and the text, in the light of its surrounding circumstances, is unambiguous, then the plain meaning rule applies and parol evidence is excluded. Tindal LCJ then continued:

[I]t has always been considered an exception, or perhaps, to speak more precisely, not so much an exception from, as a corollary to, the general rule above stated, that where any doubt arises upon the true sense and meaning of the words themselves, or any difficulty as to their application under the surrounding circumstances, the sense and meaning of the language may be investigated and ascertained dehors the instrument itself for both reason and common sense agree that by no other means can the language of the instrument be made to speak the real mind of the parties.40

Modern approaches have also found that ‘reason and common sense’ favour regard to the ‘surrounding circumstances’ to determine the meaning and effect of the language of an instrument. Tindal LCJ set the standard for admissibility low by his reference to ‘any doubt’ or ‘any difficulty’ for meaning of the language and the legal effect of the document respectively.

5.22  In offering his opinion, Parke B was emphatic that certain evidence was inadmissible:

[N]o extrinsic evidence of the intention of a party to the deed, from his declarations, whether at the time of his executing the instrument or before or after that time, is admissible, the duty of the court being to declare the meaning of what is written in the instrument, not what was intended to have been written.41

This is a robust statement of the objective principle. However it only entailed that evidence of subjective intentions, before or after the instrument, is inadmissible.

Lord Wensleydale on ‘surrounding circumstances’

5.23  In Grey v Pearson42 Lord Wensleydale (as Parke B had become), in the context of the construction of a will, observed that reference to intention was ambiguous in the legal context:

The expression that the rule of construction is to be the intention of the testator is apt to lend into error, because that word is capable of being understood in two senses, viz, as descriptive of that which the testator intended to do, and of that which is the meaning of the words he has used. The will must be in writing, and the (p. 188) only question is, what is the meaning of the words used in that writing. To ascertain which, every part of it must be considered with the help of those surrounding circumstances, which are admissible in evidence to explain the words, and put the Court as nearly as possible in the situation of the writer of the instrument.43

Lord Wensleydale accordingly again stressed the objective principle, but nevertheless favoured recourse to the surrounding circumstances as a matter of course. The court was entitled to stand in the author of the text’s shoes, but not to be inside his head.

Lord Blackburn’s statement of principle

5.24  Lord Blackburn’s influential statement in River Wear Commissioners v Adamson opened this chapter.44 In an earlier case in the Exchequer Chamber, his Lordship was more explicit as to what constituted the admissible ‘circumstances’ to which reference could be made. In Grant v Grant,45 which concerned the construction of a will, Blackburn J, during the course of argument, referred to the statement of principle in his own textbook on sale of goods:

The general rule seems to be, that all facts are admissible which tend to shew the sense the words bear with reference to the surrounding circumstances of and concerning which the words were used, but that such facts as only tend to shew that the writer intended to use words bearing a particular sense are to be rejected.46

This is a seminal statement of governing principles for the materials available to the court. It draws on the distinction with respect to prior dealings and negotiations of the parties, between evidence of the factual circumstances, which is admissible, and evidence of purely subjective intent, which is inadmissible. The surrounding circumstances were held to be admissible to resolve what the court recognized was a latent ambiguity. The issue was as to the construction of a will under which the testator devised considerable property to ‘my nephew Joseph Grant’. The Court of Exchequer Chamber unanimously admitted parol evidence (p. 189) to determine which, of either the testator’s brother’s son or the testator’s wife’s brother’s son, both of whom bore that name, should inherit. The highly material extrinsic evidence was that the testator knew neither the name, nor the existence, of the former. Furthermore, the testator had adopted the latter at a very early age, brought him up as his son, and had employed him in the management of his business. It was very properly conceded by counsel for the former, that if the evidence of surrounding circumstances were admitted there was no doubt that the testator intended that the latter gentleman should inherit. However his submission was based on a strict approach to construction, which required that the court should look to the meaning of the words used, and not for the actual intention of the testator.47 As a matter of strict interepretation, the former was the nephew. As Kelly CB noted ‘without doing any violence to the language of the will’, that whilst on ‘the more strict and accurate’ meaning of ‘nephew’, the former was the testator’s nephew, and the latter, his wife’s nephew, that ‘we all know that it is commonly used’ for both relations.48 The court accordingly made reference to the factual circumstances to identify that there was a problem of latent ambiguity to be resolved. This is an example of the ‘subject-matter principle’ in operation.

5.25  Blackburn J’s statement of principle has been relied on at the highest level in respect to the construction of contracts.49 Accordingly, leading nineteenth-century judges were prepared to receive evidence of factual matters known to both parties in order to identify latent ambiguities in written contracts which, without recourse to such evidence, would have been apparently clear and unambiguous.

Lewis v Great Western Railway Company

5.26  Another striking example is Lewis v Great Western Railway Company.50 The railway company in its general notices published two rates for the carriage of goods: an ordinary (and higher) rate under which it accepted the ordinary standard of care of a carrier; and a reduced rate, under which it exempted itself from liability, save for loss caused by the wilful misconduct of its servants. A quantity (p. 190) of Cheshire cheeses were improperly packed and thereby damaged. The plaintiff cargo-owner’s agent knew of the two-tier system when he signed the consignment note, which stated after identifying the goods, somewhat starkly, ‘Owner’s risk’. The Court of Appeal unanimously held that, in the light of the agent’s knowledge, these two words were sufficient to entail that the goods were carried on the railway’s reduced rate terms.

5.27  Bramwell LJ stated that it was not merely desirable, but necessary to consult the surrounding circumstances:

it is a rule of evidence or law that where words are used which would comprehend some other than one necessarily exclusive meaning upon which the judges are to put an interpretation, then, as Parke B said, all the surrounding circumstances, and the course of dealing between the parties, not only may, but must, be looked at to ascertain the meaning of those words when used in reference to those surrounding circumstances and that course of dealing; and therefore I cannot doubt that in this case there was a course of dealing between the consignor and the Great Western Railway Company, by which goods were sent and carried under two kinds of contract, and that, under the first kind, goods were carried at one rate by the company with an ordinary carrier’s liability: the liability of insurers: and that under the second, goods were carried at another rate with what was compendiously termed ‘Owner’s risk,’ which, when the course of business between the parties is regarded, means at the risk of the owner in consideration of the lower rate, plus the liability of the company for the ‘wilful misconduct’ of their servants. … On these considerations, I am of opinion that the course of dealing between these parties, not only may, but must, be regarded, and then there is abundant evidence to shew the meaning of ‘owner’s risk’ to be that the goods are carried at the lower rate in consideration of the condition, on the one side, that the company will be bound, under the circumstances, to take the lower rate, and cannot demand more, while, on the other side, the consignor sends the goods at the risk of the owner, plus the liability of the company for the wilful misconduct of their servants.51

5.28  To similar effect, Brett LJ reasoned:

Now I apprehend that, in order to construe a written document, the court is entitled to have all the facts relating to it and which were existing at the time the written contract was made, and which were known to both parties. Certain facts existing at a time when a written contract is made are sometimes customs of trade, or the ordinary usages of trade; sometimes the course of business between the parties; sometimes they consist of a knowledge of the matter about which the parties were negotiating; the Court is entitled to ask for those facts, to enable it to construe the written document; not simply because they are customs of trade, or the course of business between the parties, but because they are facts which were existing at the time, and which have a relation to the written contract, and which are things which must be taken to have been known by both parties to the contract. Here there were certain facts given in evidence which, I think, we are entitled to look at to enable us to construe the phrase ‘owner’s risk.’ The facts known to both parties, (p. 191) as I take it, upon the evidence, were that the Great Western Railway Company had two rates of charge, and that when persons elected to send goods at the one rate the senders and the company understood that the goods were to be taken with the common carrier’s risk, and that when they elected to send the goods at the other rate both parties knew that the company were taking them upon different terms; and more than that, it was proved here that the consignor and the Great Western Railway Company knew what those other terms were. They both knew that those terms were that the company should be absolved from all risk, except the wilful misconduct of their servants, and both parties knew that the phrase ‘owner’s risk’ was used commonly between them where one of those two liabilities was intended to be incurred. Those facts being known to both parties, we have to construe the phrase ‘owner’s risk.’ If the liability were inconsistent with either of those two contracts, we could not attribute it to that one with which it was inconsistent, notwithstanding any knowledge obtained as to the facts surrounding the transaction. But here ‘owner’s risk’ might be applied to the more limited liability of the company and to the form of contract under which, I say, both parties knew the company was in the habit of carrying; and, under those circumstances it seems to me that within the very terms of the document signed we should construe ‘owner’s risk’ as meaning, between these parties, that the company were to be absolved from all liability for damage in the carriage of these goods, unless that damage was caused by the wilful misconduct of their servants.52

5.29  Completing this trio of stellar Victorian judges, Cotton LJ concurred:

But in this, as in all other cases, we are entitled to look to the surrounding circumstances; we cannot look to the acts of the parties for the purpose of finding what their intention was, but we may look to the course of dealing of the parties to see whether they have given a conventional meaning to any terms used in the contract, and then the question becomes one simply of construction of the contract. From the evidence it appears that the plaintiff had sent goods to the railway company previously in exactly the same manner as in the present case, viz., under a consignment note, containing the words ‘owners’ risk,’ and that it had been acted upon by the railway company sending the goods at the lower rate, and, in fact, with the condition that they were not to be liable except for wilful misconduct of their servants. The plaintiff knew that, and that he and the company had treated the words as meaning the same thing. Therefore we are justified in arriving at the conclusion that, upon a proper construction of that written document, it was a contract as between the plaintiff and the railway company by which the plaintiff contracted to send his goods subject to that condition under which they agreed to take them.53

5.30  The approach in Lewis is entirely consistent with the first two principles of Lord Hoffmann’s restatement in Investors Compensation Scheme Ltd v West Bromwich Building Society.54 The decision of the Court of Appeal in Proforce Recruit Ltd v The Rugby Group Ltd 55 to order a trial to investigate the factual background (p. 192) which might shed light on the phrase ‘preferred supplier status’ is similarly consistent with the judgments of its nineteenth-century forebears. Likewise it is consistent with the decision of the Court of Session to have regard to pre-contractual memoranda in Bank of Scotland v Dunedin.56 More controversially it might be asked whether this permissive approach to surrounding circumstances would have extended to investigating the pre-contractual negotiations in order to try to eliminate the ambiguity in the word ‘after’ in the controversial Karen Oltmann57 case. All three modern cases are discussed further below.58

Macdonald v Longbottom

5.31  In Macdonald v Longbottom59 the plaintiffs were Scottish farmers and the defendant was a wool stapler in Liverpool. The latter’s agent in Scotland conducted oral negotiations with the farmers (father and son), and conducted correspondence with them concerning a proposed purchase of a consignment of wool, which concluded with an offer in writing to buy ‘your wool’, to be delivered in Liverpool, which was accepted by a letter referring to ‘the wool’. Subsequently, on a falling market, the defendant refused to accept delivery on the ostensible ground of late delivery. At the trial before Byles J at Liverpool Spring Assizes it was suggested that the wool tendered was not that contracted for. Byles J excluded the evidence of the conversations relating to the parcel of wool on the plaintiffs’ farm. On appeal the Court of King’s Bench unanimously held that evidence of this conversation was admissible. Lord Campbell CJ held that the correspondence satisfied the formality requirement for a ‘complete contract’ in writing60 and stated:

This was an offer made to the plaintiffs and accepted by them of 16s per stone for ‘your wool,’ to be delivered in Liverpool. The only question, therefore, is, What was the subject-matter of the contract described as ‘your wool’? I am of opinion that when there is a contract for the sale [of61] a specific subject-matter, oral evidence may be received for the purpose of shewing what that subject-matter was, of every fact within the knowledge of the parties before and at the time of the contract. Now Stewart, the defendant’s agent, had a conversation, before the contract, with one of the plaintiffs, who stated what wool he had on his own farm and what he had bought from other farms. The two together constituted ‘his wool’; and, with the knowledge of these facts, the defendant contracts to buy ‘your wool.’ There cannot be the slightest objection to the admission of evidence of this previous conversation, which neither alters nor adds to the written contract, but merely enables us to ascertain what was the subject-matter referred to therein.62

(p. 193) The Chief Justice concluded that the consignment was rejected because of the falling market. Erle J concurred: ‘The Judge, who has to construe the written document, cannot have judicial knowledge of the subject-matter; and evidence is invariably allowed to identify it.’63 Commenting on this case in Prenn v Simmonds64 Lord Wilberforce recorded: ‘Moreover, at any rate since 1859 … it has been clear enough that evidence of mutually known facts may be admitted to identify the meaning of a descriptive term.’ Those mutually known facts can be ascertained from direct evidence of conversations between the parties and their agents.

Bank of New Zealand v Simpson

5.32  In Bank of New Zealand v Simpson65 the respondent engineer was engaged to supervise the construction of a railway from Rosehill to Pennant Hills in Australia. The letter of engagement made reference to ‘the estimate of 35,000l.’ and entitled him to an additional commission in the event of his being able to ‘reduce the total costs for the work below 30,000l.’. If the cost was calculated exclusive of the acquisition costs for the land, this threshold was met; if inclusive, it was not. The trial judge admitted evidence of a conversation between the respondent and a manager of the appellant bank the day before the letter of engagement was sent, and of a circular prepared by the respondent, together with other correspondence which tended to support the bank’s case that land acquisition costs should be included. The Privy Council held that evidence was properly admissible to identify what items were included in the estimate. Lord Davey delivering the advice, stated:

The respondent admitted in his evidence (as indeed is plain without his admission) that what was proposed to be reduced was the 35,000l. to below 30,000l. or (in other words) that the two sums are coextensive. It is not, therefore, a mere question of the meaning of the words ‘the total cost of the works’ standing alone, but the meaning of ‘the estimate of 35,000ls.’ has also to be considered. These words point to something which was known to and in the contemplation of both parties to the contract, and with reference to which they contracted; and, in order to construe and apply the contract, you must ascertain what was included in ‘the estimate of 35,000ls.’ on the reduction of which the contract depended. Extrinsic evidence is always admissible, not to contradict or vary the contract, but to apply it to the facts which the parties had in their minds and were negotiating about.66

Lord Davey cited with approval Blackburn J’s statement of principle in Grant v Grant and applied it in this contractual context.67

(p. 194) Bank of Australasia v Palmer

5.33  Another Australian case, decided only a few years previously, is worth adverting to in this context, namely Bank of Australasia v Palmer,68 because it is frequently relied upon in support of the ‘parol evidence rule’. For example, Chitty recites Lord Morris’ statement that ‘[p]arol testimony cannot be received to contradict, vary, add to or subtract from the terms of a written contract, or the terms in which the parties have deliberately agreed to record any part of their contract’.69 However that was in the context of recording common ground between learned counsel, in a case which was replete with oral evidence of negotiations. Again it is worth considering what the courts actually did in that case. The case concerned a claim for damages for the dishonour of a cheque in which the plaintiff was successful in all courts. The plaintiff engineer, Mr Palmer, required a 2,000l overdraft for six months in order to complete a contract. The bank manager initially refused this, but subsequently agreed on the basis of (at least) the provision of a guarantee by Mr Palmer’s mother, together with the deposit of her title deeds as security. The main dispute was that the bank further contended that it was additional security by way of first charge over a company. All three individuals gave evidence of the oral discussions and circumstances: Mr Palmer, Mrs Palmer, and the bank manager. Mr Palmer was recalled to the witness box three times, and the bank manager twice. Mrs Palmer signed her guarantee, and then Mr Palmer completed a pro forma application for an overdraft which recorded the facility sought, repayable at the end of six months ‘or on demand at [the bank’s] discretion’. Mr Palmer was then allowed to draw down 880l without procuring the charge, but then a further cheque for 300l was dishonoured. The jury found that the overdraft was not terminable at will, and that the company charge was not a condition precedent to the facility. They awarded Mr Palmer 600l damages. Having recorded the agreement of counsel noted above, Lord Davey held there was no question of law before the Board, only a dispute of fact. Indeed it was common ground between the parties that the pro forma application for an overdraft did not contain the agreement, or ‘even purport to contain part of the agreement’.70 It was in the form of an application and did not touch upon the central dispute between the parties: ‘It was merely a memorandum of the transaction, not certainly altogether accurate.’71 The jury were entitled to find that the agreement was complete without reference to it. The Privy Council concluded with a salutary warning to the bank that if it should ‘in future contract to advance money for a definite period, and at the same time desire to have the power of recalling the advance at their discretion, thus making the agreement (p. 195) nugatory, it would not be amiss to state clearly what they do mean, and to take care that their meaning is understood by the persons with whom they are dealing’.72 It may have been better for our law had that last observation received more prominent attention, given that it requires an investigation into whether a particularly onerous term has been both clearly communicated, and understood, by the other party, which manifestly requires oral evidence.

Charrington v Wooder

5.34  The decision of the House of Lords in Charrington & Co Ltd v Wooder73 is an early example of a dispute between brewers as owners of tied pubs and their tied publicans. It also provides a striking example of recourse to the surrounding circumstances to attach a narrower meaning to contractual language than a common-sense reading would suggest, and therefore read down the words to the prejudice of one party. During the early part of the twentieth century breweries bought up large numbers of licensed premises so that about 93 per cent of the public houses in London were tied premises. Tied tenants were required by contract to buy their beer from their landlord brewer and received fixed discounts on the price of beer. Free tenants, who were not tied to the brewers, usually received far higher discounts. The defendant tied publican ran the Bay Malton pub in Great Portland Street. The obligation in the lease obliged him to buy beer, which the brewery undertook to supply at ‘the fair market price’. The defendant contended that this meant the ordinary price charged to non-tied publicans. The jury found there were, in effect, two market prices: one for tied houses and one for free houses. Accordingly Lord Alverstone CJ at trial found for the brewery. His judgment was affirmed by the House of Lords. The publican’s counsel submitted that ‘market price’ was an unambiguous expression, evidenced by the fact that it was employed in sections 50 and 51 of the Sale of Goods Act 1893 without further definition. Accordingly the surrounding circumstances found by the jury were inadmissible.74 This was unanimously rejected by the House of Lords. Evidence of the circumstances of the London brewing trade was admissible. Determination of market price required evidence of the market. That marketplace overwhelmingly comprised tied publicans.

5.35  Viscount Haldane LC stated:

[I]f the description of the subject-matter is susceptible of more than one interpretation, evidence is admissible to shew what were the facts to which the contract relates. If there are circumstances which the parties must be taken to have had in view when entering into the contract, it is necessary that the Court which construes the contract should have these circumstances before it.75

(p. 196) 5.36  Lord Kinnear opined:

Evidence is not admissible to put a peculiar meaning upon plain and unambiguous words. But it may be necessary to prove the relation of the document to facts; and I take it to be sound doctrine that for this purpose evidence may be given to prove any fact to which it refers, or may probably refer, or to identify any person or thing mentioned in it.76

5.37  Lord Dunedin cited with approval Lord Blackburn’s statement of principle (in Grant v Grant) and Bank of New Zealand v Simpson, and stated the principle as follows:

Now, in order to construe a contract the Court is always entitled to be so far instructed by evidence as to be able to place itself in thought in the same position as the parties to the contract were placed, in fact, when they made it—or, as it is sometimes phrased, to be informed as to the surrounding circumstances.77

5.38  Lord Atkinson also cited Lord Blackburn in Grant v Grant and Bank of New Zealand v Simpson, and stated:

The fact that so many judges have formed different opinions as to the meaning of these words ‘fair current market price’ and ‘fair market price,’ as used in this contract and contracts like it, should suffice in itself to shew that they are susceptible of either of two meanings. If that be so, as I think it is, the relations of the parties and all the surrounding circumstances may be taken into consideration, not to add to or alter their contract, but to interpret it, to shew the nature and quality of the subject-matter, or, in other words, to shew the meaning the parties themselves attached to the language they have used.78

5.39  These cases clearly demonstrate the scope of the principle, although the second limb of Lord Atkinson’s formulation goes the furthest, and perhaps too far. The speeches of Viscount Haldane LC, Lord Kinnear, and Lord Dunedin were all cited in Lord Wilberforce’s seminal speech in Reardon Smith Ltd v Yngvar Hansen-Tangen (The Diana Prosperity) as the basis for his famous observation that ‘what the court must do must be to place itself in thought in the same factual matrix as that in which the parties were’.79

The Modern Approach: ‘Matrix’ to ‘Background’

Lord Wilberforce’s contribution: ‘matrix’

5.40  Lord Wilberforce’s speeches on contractual interpretation in the 1970s in Prenn v Simmonds80 and Reardon Smith Ltd v Yngvar Hansen-Tangen (The Diana (p. 197) Prosperity)81 are regarded as seminal in the modern appellate authorities.82 His Lordship clearly built on the nineteenth-century foundations described above.

Prenn v Simmonds

5.41  In Prenn v Simmonds83 Lord Wilberforce insisted 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’.84 In contrast his Lordship rejected the arguments that evidence of the parties’ intentions should be admissible as a matter of authority.85

5.42  However Lord Wilberforce was clear that that evidence of mutually known facts was admissible to identify the meaning of a descriptive term.86 The surrounding circumstances included 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 agreement, or correspond with commercial good sense, nor is it, even linguistically, acceptable’.87

The Diana Prosperity

5.43  The dispute in Reardon Smith Ltd v Yngvar Hansen-Tangen (The Diana Prosperity)88 concerned a purported termination of a charterparty on the ground that the vessel which was the subject-matter of the charter, whilst described in all the (p. 198) 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, and in particular the significance of the usages and practices of Japanese shipbuilders. Lord Wilberforce held that Japanese shipbuilding industry practices (such as the sub-contracting of construction work) were not relevant to the interpretation of a charterparty contract between two foreign shipping companies, whether or not those practices were known to the parties. However Lord Wilberforce continued:

But it does not follow that, renouncing this evidence, one must be confined within the four corners of the document. No contracts made are 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 back ground, the context, the market in which the parties are operating …

It is often said that, in order to be admissible in any construction, these extrinsic facts must be within the knowledge of both parties of the contract, but this requirement should not be stated in too narrow a sense. When one speaks of the intention of parties to the contract, one is speaking objectively—the parties cannot themselves give direct evidence of what their intention was—and what must be ascertained is what is to be taken as the intention which reasonable people would have had if placed in the situation of the parties. Similarly when one is speaking of the aim, or object, or commercial purpose, one is speaking objectively of what reasonable persons would have in mind in the situation of the parties …

… what the court must do is to place itself as though in the same factual matrix as that in which the parties were. All of these opinions seem to me implicitly to recognise that, in the search for the relevant background, there may be facts which form part of the circumstances in which the parties contract in which one, or both, may take no particular interest, their minds being addressed to or concentrated on other facts so that if asked they would assert that they did not have these facts to the fore front of their mind, but that will not prevent those facts from forming the objective setting in which the contract would be construed.89

The modern restatement: ‘background’

5.44  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.’90 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 Society91 (which are repeated here for convenience):

(p. 199)

  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 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.92

Glossing the restatement

5.45  In Bank of Credit and Commerce International SA (in compulsory liquidation) v Ali 93 Lord Hoffmann, in apparent response to criticisms which had been voiced in the Court of Appeal, felt it necessary to gloss Investors Compensation Scheme, principle (2), in which his Lordship had stated 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.94

Accordingly all the reasonably available and relevant background information is now admissible for the purposes of construing private law documents. There remain a number of policy-based exclusionary rules, which are discussed below.

5.46  A further gloss was offered by Aikens J in his summary of the governing principles in Absalom v TRCU Ltd.95 Aikens J echoed Lord Hoffmann’s principle (2) that the available material ‘comprises anything that a reasonable man would have regarded as relevant in order to comprehend how the document should be (p. 200) understood, provided that the material was reasonably available to both parties at the time’. Aikens J made it explicit that ‘at the time’ meant ‘up to the time of the creation of the document’.96 It is submitted that this temporal restriction was (at least) implicit in Lord Hoffmann’s formulation, and that Aikens J’s analysis of ‘at the time’ is in accordance with principle.

The impact of the restatement

5.47  Despite the fears expressed in the initial reaction to the Investors Compensation Scheme case, judges do not appear overburdened by extraneous and irrelevant evidence. The case management powers of the judiciary introduced by the Civil Procedure Rules in 1998 can be deployed in managing the evidence before the courts. It is open to judges to use the broad discretion on costs to express disapproval of any time-wasting or unnecessary introduction of irrelevant background. In practice judges have not shown themselves averse to striking out (parts of) witness evidence containing inadmissible or irrelevant material or curbing cross-examination which strays into such fields. For example, in Wire TV Ltd v Cable Tel (UK) Ltd Lightman J complained:

A very large part of the flood of evidence in this case on the factual matrix in which the agreement was to be construed was legally inadmissible and the greater part of the remainder totally unhelpful. I had to spend over half a day hearing argument as a prelude to striking out the bulk of the witness statements before me as containing material … which should never have been or remained there.97

5.48  In Egan v Static Control Components (Europe) Ltd 98 Arden LJ suggested that the initial concerns were ill-founded:

When the principles in the ICS case were first enunciated, there were fears that the courts would on simple questions of construction of deeds and documents be inundated with background material … Speaking for myself, I am not aware that the fears expressed as to the opening of the floodgates have been realised. The powers of case management in the Civil Procedure Rules could obviously be used to keep evidence within proper bounds. The important point is that the principles in the ICS case lead to a more principled and fairer result by focussing on the meaning which the relevant background objectively assessed indicates the parties intended.99

To like effect in Chartbrook Ltd v Persimmon Homes Ltd,100 Lord Hoffmann noted that the Investors Compensation Scheme restatement ‘was viewed with alarm (p. 201) by some distinguished commercial lawyers as having greatly increased the quantity of background material which courts or arbitrators would be invited to consider’.101 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’.102 This assessment is not shared by all practitioners.103

Pleading and procedural controls

5.49  The suggestion above that judges can use case management powers to control the admission and extent of evidence as to the external context is now being implemented in specialist courts in England and Wales, and in other jurisdictions. The Admiralty and Commercial Courts Guide now explicitly provides that for statements of case (particulars of claim, defence and reply):

Where proceedings involve issues of construction of a document in relation to which a party wishes to contend that there is a relevant factual matrix that party should specifically set out in his pleading each feature of the matrix which is alleged to be of relevance. The ‘factual matrix’ means the background knowledge which would reasonably have been available to the parties in the situation in which they found themselves at the time of the contract/document.104

That requires a party to set out their stall on the extrinsic evidence at the commencement of the case, and presumably controls disclosure, submissions, and other matters. Similar steps have been adopted by judicial guidance in Scotland105 and Singapore.106

Jettisoning the ‘ambiguity’ threshold

5.50  It is clear from Lord Hoffmann’s restatement in the Investors Compensation Scheme case, and in particular principle (4), that ambiguity is no longer a threshold question for the admissibility of contextual material: ‘The background may not merely enable the reasonable man to choose between the possible meanings (p. 202) of words which are ambiguous …’107 This point was made more bluntly by Lord Steyn, writing extra-judicially: ‘It is sometimes argued by counsel, and even asserted by judges, that ambiguity is a precondition to admitting evidence of the setting of the contract. That is wrong.’108 Lord Steyn repeated his view in his speech in Westminster City Council v National Asylum Support Services where he stated that it was ‘crystal clear that an ambiguity need not be established before surrounding circumstances may be taken into account’.109 Accordingly the supposed third strand of the ‘parol evidence rule’ or the alleged ‘plain meaning rule’ do not form part of modern English law.

Reasonably available to both parties

5.51  A critical restriction is that background must be reasonably available to both parties. But that is also an objectively judged requirement. Actual knowledge or ignorance is irrelevant. It is critical that the information is reasonably available to both parties. As Brennan J opined in Codelfa Construction Prop Ltd v State Rail Authority of New South Wales:110 ‘an extrinsic fact known only to one of the contracting parties can shed no light upon the meaning with which that word or phrase was used by the other or others.’111 However that formulation needs to be qualified by making it clear that ‘reasonable availability’ is an objective test.

The legal context

5.52  The extension of the context to include explicitly ‘legal matrix’ or background was a major advance.112 Contracts are drafted against a legal and regulatory backdrop. In many cases it would be unrealistic to disregard that context, which might be more important than the background facts.

5.53  Lord Hoffmann’s speech in the Investors Compensation Scheme case is a model example. The assignment document was clearly drafted by legal representatives of the statutory compensation body. His Lordship immediately contextualized (p. 203) the document in the wider context of the primary and secondary legislation governing investment advice and constituting the Investors Compensation Scheme (the Financial Services Act 1986 and the Financial Services (Compensation of Investors) Rules 1990). His Lordship also credited the draftsperson with knowledge of the law of assignment, although he surmised that the draftsman had become ‘muddled’.113 In contrast, the investors were understood to be most likely to read principally the explanatory notes, which were a ‘model of clarity’ compared to the botched assignment document.114

5.54  The intention of the actual draftsperson remains inadmissible.115 If legal context is to be admitted the rhetorical question has been posed: ‘where does one stop with knowledge of the law?’116 The answer is: what was reasonably available to both parties, and (where relevant) their advisers. Whether or not they had access to legal advice, or were reasonably likely to have had such access, will be a relevant contextual factor.

5.55  In Phillips v Rafiq117 in the context of construing the Motor Insurers’ Bureau (Uninsured Drivers) Agreement 1999, the Court of Appeal examined previous versions of the well-known scheme and the legal background, including relevant European directives (which it implemented). Ward LJ was emphatic:

[I]t cannot be immaterial that this is not an agreement made between two legally unsophisticated parties who were using their best but incompetent endeavours to reduce to writing an oral understanding which they had reached. This, on the contrary, is an agreement between the Secretary of State on the one hand and the MIB on the other. And so, looked at objectively, the teams who drafted this agreement must be held to have a high level of knowledge of the working of the scheme in the past and of expertise over the subject matter of it.118

5.56  In The Ekha119 Moore-Bick LJ, in dealing with a standard form oil industry contract, offered the following guidance, and a note of caution, on the use of legal context:

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 (p. 204) 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.120

Legal or commercial draftsperson?

5.57  It will often be obvious whether a contract (or part of it) was drafted by commercial actors or by legal professionals. Over 50 years ago, in the context of the application of ejusdem generis to charterparties, it was suggested by Devlin J in Chandris v Isbrandtsen-Moller Co Inc121 that legal and commercial draftspersons may be credited with different degrees of knowledge:

Legal draftsmen are all familiar with the existence of the rule, and familiar too with the proper signals to hoist if they do not want it to apply. Phrases such as ‘whether or not similar to the foregoing’ and ‘without prejudice to the generality of the fore going’ are often employed in legal draftsmanship; and if the draftsman has read the report of Larsen v Sylvester & Co[122] he will know that the addition of ‘whatsoever’ generally serves the same purpose. Commercial draftsmen are not usually taught these rules … Draftsmen of charterparties—whether of the printed form or of the typewritten clause, but perhaps especially of the latter—are probably not consciously familiar even with the idea of ejusdem generis.123

5.58  In The Raphael 124 May LJ, in the context of the construction of exemption clauses, cautioned that both parties were adopting an ‘over-legalistic approach’: ‘When two commercial concerns contract with one another, they do not, neither should they be deemed to, concern themselves with the legal subtleties of the private law (p. 205) of nuisance or the like. They in fact approach the problem, and so also should the Courts, with a much broader brush.’125

Relevance of prior case law?

5.59  In appropriate cases the draftperson may be deemed to have knowledge of prior case law. Indeed where standard forms are adapted in the light of prior judicial decisions, such knowledge is readily imputed. In Beaufort Developments (NI) Ltd v Gilbert-Ash NI Ltd Lord Hoffmann commented:

It is also important to have regard to the course of earlier judicial authority and practice on the construction of similar contracts. The evolution of standard forms is often the result of interaction between the draftsmen and the courts and the efforts of the draftsman cannot be properly understood without reference to the meaning which the judges have given to the language used by his predecessors.126

In HIH Casualty and General Insurance Ltd v Chase Manhattan Bank127 the House of Lords assumed that most legal draftspersons were familiar with the example of the Canada Steamship guidelines128 on exempting liability for negligence. The role of prior case law as potentially relevant background appears to be established as a matter of English law.129 However, Professor Carter has suggested that whilst the general legal background may be admissible as legal matrix, specific case law or precedent is not.130 It is submitted that such a limitation (which would be difficult to apply in a common law jurisdiction) does not form part of English law, and that prior case law is sometimes considered, especially in the context of standard forms.

Cultural traditions

5.60  In Khan v Khan131 the court expressed the view that the cultural traditions of the parties might be relevant evidence against which the contract should be construed.132

(p. 206) The Exclusionary Rules

The restriction on prior negotiations and declarations of subjective intent

5.61  The broad contextual thrust of recent authorities is still constrained by well-established restrictions. First, both prior negotiations and declarations of subjective intention prior to the contract are not relevant or admissible.133 Secondly, the parties’ subsequent conduct is equally not relevant or admissible in carrying out the process of interpretation.134 The result is a requirement of ‘tunnel vision’ for a judge carrying out an exercise of interpretation. Whilst it is usually an unstated assumption of English contract law that there is a single moment in time at which offer and acceptance crystallize into a binding contract and that all the terms of the contract, express or implied, should be identifiable and ascertainable by the parties at that moment, in practice, many contracts may not live up to this elegant model.

5.62  A number of escape routes from these restrictive rules are provided by doctrine, including the well-known ‘safety nets’ of rectification and estoppel by convention.135 It should also be recalled that it is a question of fact whether or not an agreement has been reduced to writing. Where it is alleged that there are such non-documentary terms both the negotiations and the conduct of the parties may be a fertile source of additional terms which may modify the instrument or affect its construction.136

The classical statement of the ‘prior negotiations’ rule

5.63  A key difficulty with the ‘prior negotiations’ rule is that, described as such, it is too broadly stated. The hinterland to the contract (including the negotiations in a broad sense) must be examined to identify the clearly admissible objective factual and legal background, together with evidence tending to identify the parties or the subject-matter. The ‘prior negotiations’ rule obtained canonical force in the second half of the twentieth century, as two other supposed rules, the ‘parol evidence rule’ and the ‘plain meaning rule’, fell out of fashion. The rule states that for the purpose of construing a contract it is generally not legitimate to have recourse to the parties’ prior negotiations, or previous draft documents. It was enshrined as a fundamental rule by Lord Wilberforce, in Prenn v Simmonds in 1971 (see below), in a speech which proved seminal, albeit the rationale for the (p. 207) ‘prior negotiations rule’ and its scope and limits were left somewhat obscure. This was acknowledged by Lord Hoffmann in the third of his celebrated five principles in Investors Compensation Scheme Ltd v West Bromwich Building Society.137 Lord Hoffmann characterized the rule as an ‘exception’ (to the general admissibility of reasonably available ‘background’), and tantalilizing remarked: ‘The boundaries of this exception are in some respects unclear. But this is not the occasion on which to explore them.’138 Lord Hoffmann did revisit prior negotiations in his last speech before retirement in Chartbrook Ltd v Persimmon Homes Ltd.139 It has to be regretted that, whilst his Lordship did further articulate the ‘policy’ reasons for the rule, the boundaries of the exception were still left in some respects unclear. It was always probably too blunt to fashion a rule in terms of ‘prior negotiations’. It does not accurately reflect the formulations and decisions of great nineteenth-century judges recorded above, where it can be seen that the law does permit frequent recourse to the prior negotiations.

5.64  It is suggested that the better approach is to consider evidence of the facts and circumstances existing up to, and at the time of, the contract, in the light of the ‘objective principle’ of contractual construction. That entails that the parties’ subjective intentions and understandings, whether declared or undeclared at the time, and their developing stances and discussions during the negotiation and drafting of the text, will generally be of little or no weight in illuminating the contractual text. Nevertheless since the leading case of Prenn v Simmonds140 the English approach goes further, adopting an exclusionary approach to evidence under the not entirely accurate label of the ‘prior negotiations’ rule. Accordingly the law, as currently formulated, is that the parties’ subjective intentions and understandings, whether declared or undeclared at the time, and their developing stances, discussions, and draft documents, forming the background to the negotiation and drafting of the text, remain technically inadmissible.

Prenn v Simmonds

5.65  Prior negotiations were at the heart of the dispute in Prenn v Simmonds.141 The dispute concerned the construction of an option to purchase shares, and in particular whether a profit trigger which constituted a condition precedent of the option had been met. The dispute was whether ‘profits’ concerned simply the profits of the principal company, or whether it encompassed group profits, including those of subsidiary companies. The judgment of Pennycuick J utilized the technique of rectification to make the document apply to group profits. In contrast, both the (p. 208) Court of Appeal and the House of Lords resolved the dispute by construction, without resort to rectification. According to Lord Denning MR:

The judge put a literal construction on the word ‘profits’ holding that it meant the separate profits of the holding company: but then, finding that that literal construction was contrary to the intention of the parties, he had to resort to rectification to put it right. We think that he was wrong to give the word a literal construction: and that he should, in the circumstances have construed it as meaning ‘consolidated profits’. So there is no need to rectify the agreement …142

5.66  In the Court of Appeal Lord Denning MR had taken into account some of Dr Simmonds’ subjective concerns in construing the contract. Lord Wilberforce, in a single speech, could not see that such evidence was admissible, because it was unhelpful. The case is authority for the inadmissibility of both subjective intentions and prior negotiations, with Lord Wilberforce expressly treating the evidence of the parties’ intentions as being a fortiori inadmissible, given the well-established exclusion of prior negotiations. Lord Wilberforce insisted 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’.143 His Lordship rejected the arguments that evidence of the parties’ intentions should be admissible as a matter of authority.144 His Lordship then considered the argument as a matter of principle:

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 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. It may be said that previous documents may be looked to explain the aims of the parties. In a limited sense this is true: the commercial, or business object, of the transaction, objectively (p. 209) ascertained, may be a surrounding fact … and if it can be shown that one interpretation completely frustrates that object, to the extent of rendering the contract futile, that may be a strong argument for an alternative interpretation, if that can reasonably be found. But beyond that it may be difficult to go: it may be a matter of degree, or of judgment, how far one interpretation, or another, gives effect to a common intention: parties, indeed may be pursuing that intention with differing emphasis and hoping to achieve to an extent which may differ, and in different ways. The words used may, and often do, represent a formula which means different things to each side, yet may be accepted because that is the only way to get ‘agreement’ and in the hope that disputes will not arise. The only course can then be to try to ascertain the ‘natural’ meaning. Far more common, and indeed, totally dangerous is to admit evidence of one party’s objective—even if this is known to the other party.145

5.67  First, Lord Wilberforce in fact rejected as a justification for the exclusion of prior negotiations arguments (which are often advanced) based on time, tedium, and expense of admitting prior negotiations. Secondly, Lord Wilberforce’s only reason for refusing admissibility of prior negotiations, and by extension subjective intentions, is that such evidence is unhelpful. The English commitment to the view that there is a moment of responsibility when the intentions of the parties crystallize into a contract underlies such reasoning. Greater realism is shown when later in the same passage his Lordship admits that the parties may agree to a certain form of words, although each means different things by it. The latter observation is clearly correct, but only seems to go far enough to support the general objective approach and the still relatively uncontroversial desire to exclude subjective intention.

5.68  It is the middle section of the above passage which exposes the central tension in the reasoning of Lord Wilberforce. First, on the one hand Lord Wilberforce’s speech takes an extremely broad approach to the surrounding circumstances, and in particular to the circumstances which may supply the commercial purpose of the transaction. Secondly, on the other hand the speech insists on disregarding prior negotiations, even though the negotiations in common-sense terms form part of the surrounding circumstances. Where is the line to be drawn between prior negotiations and surrounding circumstances? Lord Wilberforce conceded that if there is evidence in the prior negotiations which may supply a commercial or business purpose for the agreement it will be admissible, especially if that purpose militates against a suggested interpretation of the contract. Lastly, this speech now needs to be read in the light of Chartbrook Ltd v Persimmon Homes Ltd 146 where the House of Lords accepted the rule laid down by Lord Wilberforce, but rejected his suggested rationale, preferring the policy-based reasons for excluding evidence which had not appealed to Lord Wilberforce.

(p. 210) Modern case law on prior negotiations

5.69  In the leading Australian case of Codelfa Construction Pty Ltd v State Rail Authority of New South Wales147 Mason CJ insisted both on the prior negotiations exclusionary rule, and the significant exceptions of ‘background facts’ and ‘subject-matter’:

Obviously the prior negotiations will tend to establish objective background facts which were known to both parties and the subject matter of the contract. To the extent to which they have this tendency they are admissible. But insofar as they consist of statements and actions of the parties which are reflective of their actual intentions and expectations they are not receivable.148

That passage needs qualifying to make clear that an objective test of ‘reasonable availability’ applies, and that legal matrix is also potentially admissible, but otherwise that is a relatively accurate statement of current English law.

Investors Compensation Scheme v West Bromwich

5.70  In Investors Compensation Scheme Ltd v West Bromwich Building Society149 the focus was not on the prior negotiations rule (albeit the reasoning did rely on ‘explanatory notes’ provided to the investors150). Nevertheless in his restatement of the governing principles Lord Hoffmann repeated the previous negotiations and subjective intention exclusionary rules. His Lordship went on to say: ‘The boundaries of this exception are in some respects unclear. But this is not the moment on which to explore them.’ According to Lord Hoffmann the exclusionary rule was the only respect in which ‘legal interpretation differs from the way we would interpret utterances in ordinary life’. The rule was based on considerations of legal policy.151

Bank of Scotland v Dunedin

5.71  Scots law traditionally also excludes consideration of what it terms ‘prior communings’152 and ‘subsequent actings’. However in Bank of Scotland v Dunedin Property Investment Co Ltd153 in the context of commercial lending the Scottish court permitted reference to evidence of what was said at a negotiation meeting, and one party’s notes of that meeting, in order to determine the parties’ knowledge of the surrounding circumstances. It was said not to be a case of glossing the express terms. Nevertheless admission of that evidence gave rise to a liability for one of the parties of nearly £1 million. In the light of the approving reference (p. 211) to Bank of Scotland v Dunedin in Chartbrook Ltd v Persimmon Homes Ltd 154 it may be predicted that this authority will be much relied upon, especially in the context of ‘objective fact’ exception.

5.72  The decision of the Scottish Court of Session concerned a £10-million, long-term, ten-year banking facility at a fixed interest rate of 12.5 per cent by way of a loan stock deed provided by the bank to a property company. A provision (condition 3) entitled the borrower to give six months’ notice to purchase the stock and redeem early, but ‘subject to the bank being fully reimbursed for all costs, charges and expenses incurred by it in connection with the stock’. The bank, in order to ‘hedge’ its position, entered into an interest rate swap with an American bank to protect it in respect of interest rate fluctuations. When the borrower redeemed early the bank sought to recover the breakage charge payable under the swap. The sum in question was £923,253. Did this fall within ‘costs, charges and expenses’? Lord Rodger, the Lord President, considered that the first instance judge, the Lord Ordinary, had construed these words too narrowly and had read them subject to a requirement of ‘direct’ connection. Lord Rodger was clear that ‘without the swap agreement, there would have been no loan stock agreement’.155 His Lordship took into account from the negotiations that the initiative for the long-term facility came from the property company and not the bank. Lord Rodger noted Prenn v Simmonds and other authorities on surrounding circumstances and continued:

As these authorities demonstrate, the rule which excludes evidence of prior communings as an aid to interpretation of a concluded contract is well-established and salutary. The rationale of the rule shows, however, that it has no application when the evidence of the parties’ discussions is being considered, not in order to provide a gloss on the terms of the contract, but rather to establish the parties’ knowledge of the circumstances with reference to which they used the words in the contract. For that reason I am satisfied that it was proper for the Lord Ordinary to take account of the evidence of what was said at the meeting on 8 June in order to establish the relevant circumstances in which the words of Condition 3 were used.156

5.73  Lord Rodger therefore examined a note of the 8 June meeting prepared by the bank which recorded discussion of the likely costs of early repayment. The first instance judge had heard uncontradicted evidence of the meeting at which the bank’s intention to hedge was explained and that it would look to the borrower for the cost of premature termination of that arrangement. Accordingly the hedging arrangement and the associated costs were part of the background facts known to both parties and relevant to a commercially sensible construction of condition 3. Lord Kirkwood reached the same conclusion based on the evidence (p. 212) that the borrower knew that the bank would hedge and that early termination would lead to a breakage charge for the hedge, but cautioned:

The limits to be placed on the evidence of the surrounding circumstances which will be admissible in any particular case may be difficult to define and in the present case it seems to me that certain of the evidence led by the Bank at the proof went rather beyond what was properly admissible as evidence of the surrounding circumstances.157

Lord Caplan was most explicit that, without the evidence of what was discussed in negotiations as part of the surrounding circumstances, he might have reached a different conclusion. Lord Caplan referred to both notes of a pre-contract meeting and ‘Outline Terms and Conditions’ which had been superseded by the agreement. These showed that the costs envisaged were not just administrative costs, but costs arising from the bank’s own funding arrangements. Nevertheless Lord Caplan still disclaimed the admissibility of pre-contract materials evidencing the parties’ intentions and aspirations. However these materials formed part of the factual matrix.

5.74  It is submitted that this case should be followed in English law. It illustrates that in respect of commercial agreements where there is evidence of pre-contractual discussions which illustrates an objectively ascertainable consensus on the scope of a particular provision such evidence should be admissible as an aid to construction. On these facts it was clear that the scope of the clause had been discussed and each party had knowledge of the circumstances in which it was intended to operate. In such circumstances agreed or uncontradicted notes of meetings and even earlier drafts or heads of terms may cast light on the eventual contract.

BCCI v Ali

5.75  In the dozen years which followed the landmark ruling in Investors Compensation Scheme Ltd v West Bromwich Building Society158 and prior to Chartbrook Ltd v Persimmon Homes Ltd 159 there was vigorous debate as to whether or not the traditional restrictions should be jettisoned.160 The debate was in part provoked by (p. 213) 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:161

In Investors Compensation Scheme Ltd v West Bromwich Building Society … my noble and learned friend Lord Hoffmann pointed out that the exclusion from evidence of the previous negotiations of the parties and their declarations of subjective intent is for reasons of practical policy. He added that the boundaries of this exception are in some respects unclear. Whether these reasons of practical policy still hold good today in all circumstances has become increasingly the subject of debate in recent years. The debate is still continuing: see the recent observations of Thomas J in the Court of Appeal of New Zealand in … his judgment in Yoshimoto v Canterbury Golf International Ltd [162] … This is not the moment to pursue this topic, important though it is, because the point does not arise on this appeal. I desire, however, to keep the point open for careful consideration on a future occasion.163

5.76  Subsequently, Lord Nicholls supported liberalization of the rule in an important extra-judicial lecture.164

Proforce Recruit v The Rugby Group

5.77  The decision of the Court of Appeal in Proforce Recruit Ltd v The Rugby Group Ltd 165 attracted considerable attention when it was decided—albeit of limited authority, in that it only determined an issue of arguability. Proforce operated an employment and recruitment agency and the defendant was a manufacturer of cement. From 1997 Proforce supplied temporary workers to the defendant and in 2001 a written agreement was entered into. It provided for a minimum two-year period, and that during that time Proforce would have ‘preferred supplier status’. This was not further defined.166 Proforce sought to rely on witness evidence from its chairman and managing director to elucidate that phrase, contending that it was well-understood by those negotiating the contract that it meant that Proforce would be given a reasonable opportunity of supplying personnel to the defendant before other suppliers were approached. At first instance, Field J refused to admit that evidence and struck out Proforce’s claim for breach of contract, which depended on what it contended was the agreed basis for the contract. Field J construed the clause as only applying if the defendant chose to operate a system of contracting only with preferred suppliers, in which case Proforce would (p. 214) be one of those preferred suppliers. In the Court of Appeal Proforce forcefully submitted that if the phrase did not give it a right of first refusal in meeting the defendant’s temporary workers requirements, and if the defendant’s construction was adopted, it would have no legal effect. Significantly Mummery LJ thought that the phrase under consideration had no ‘obvious natural and ordinary meaning’.167 Similarly Arden LJ considered ‘preferred supplier status’ to be ‘a very unusual combination of words’.168 Mummery LJ was reluctant to lay down any definitive ruling on admissibility or construction, given that the case was at an interlocutory stage. However on the basis that it was arguable that there had been negotiations on an agreed basis—based on The Karen Oltmann169 the matter should go to trial.170 Arden LJ agreed, but on the narrower basis that it was reasonably arguable that in the absence of contractual definition, the phrase should have the meaning the parties adopted in pre-contractual communications.171 Richards LJ considered Arden LJ’s reasons sufficient. This was a strike-out applicaton. Accordingly the court assumed that Proforce’s contentions were correct. On that basis the decision to send the matter to trial appears to be correct, even in the wake of Chartbrook Ltd v Persimmon Homes Ltd.172

5.78  At the resulting trial173 Proforce’s chairman and managing director was held to be an unsatisfactory witness and his account of pre-contractual exchanges was not accepted. Cresswell J construed the phrase against the background to mean that ‘preferred’ equated to ‘approved’, and not ‘sole’ or ‘exclusive’. Cresswell J considered the ‘private dictionary’ exception to necessarily be of limited scope:

The present case serves to illustrate some of the difficulties with this (the agreed dictionary) exception to the rule that the law excludes from the admissible background the previous negotiations of the parties and their declarations of subjective intent. It is in my opinion important that it should be recognised that this is an exception which will seldom arise in the interpretation of commercial contracts. If commercial parties wish to contract on the basis of their own dictionary meaning, they might be expected to include that dictionary meaning in the contract itself[174] … Where the parties have included their own dictionary meaning in the contract itself, the exception will not apply. Where the agreement is silent as to the meaning of the words in question, and those words have been used in a particular sense in correspondence preceding the agreement (which forms part of the factual matrix), it would be surprising if commercial parties intended to contract on the (p. 215) basis of some other meaning, without saying so in the contract. The exception under consideration should not be allowed to become a means, regularly adopted by litigants, of attempting to circumvent the fundamental principle that generally the law excludes from the admissible background the previous negotiations of the parties and their declarations of subjective intent.175

5.79  On the evidence ‘preferred supplier status’ did not have the agreed meaning during negotiations contended for by Proforce. Cresswell J observed:

It is important to distinguish between on the one hand evidence (which is exceptionally admitted) of what the parties said in negotiations, to show that the parties negotiated on an agreed basis that particular words used bore a particular meaning, and on the other hand declarations by the parties of subjective intent, the parties’ subjective states of mind or evidence to similar effect. Once evidence is admitted in connection with an alleged agreed meaning, experience in this case shows that there is a real danger that this distinction may be ignored or become blurred.176

Chartbrook Ltd v Persimmon Homes Ltd

5.80  In Chartbrook Ltd v Persimmon Homes Ltd 177 the House of Lords was afforded the opportunity to rule on the prior negotiations debate. It reached a conservative conclusion, based explicitly on pragmatic or policy grounds.

5.81  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 in particular the governing provision, the owner’s case was near unassailable. In (p. 216) the words of Lord Hoffmann: it was ‘certainly in accordance with conventional syntax’.178

5.82  The literal approach persuaded the trial judge, Briggs J,179 and the majority of the Court of Appeal, Tuckey and Rimer LJJ.180 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’.181 In contrast, it was ‘very difficult (and probably impossible) to discern the commercial sense behind [the owner’s] construction’.182 As a matter of construction, without recourse to prior negotiations the House of Lords preferred the developer’s construction and the conclusion of Lawrence Collins LJ.183 It is immediately obvious that in a jurisdiction which admitted prior negotiations this dispute would have been readily resolved, and would not have necessitated consideration in the appellate courts.

5.83  Despite Lawrence Collins LJ’s remarks about the significance of the prior documentation in the case, the House of Lords unanimously endorsed the rule in Prenn v Simmonds184 that both declarations of subjective intent and prior negotiations were inadmissible for the purpose of construing the contract. Lord Hoffmann, in the leading speech, 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’.185 These are three significant concessions which cumulatively undermine the supposed foundations of the prior negotiations rule. Accordingly Lord Hoffmann was in fact departing from Lord Wilberforce’s approach in Prenn v Simmonds by refusing to base the exclusionary rule on the ground of irrelevance, but rather on pragmatic grounds. The only remaining basis for the rule was to be found in public policy (as foreshadowed (p. 217) in Investors Compensation Scheme). The reasons for rejecting such evidence comprised the following:

The first is that the admission of pre-contractual negotiations would create greater uncertainty of outcome in disputes over interpretation and add to the cost of advice, litigation or arbitration. Everyone engaged in the exercise would have to read the correspondence and statements would have to be taken from those who took part in oral negotiations. Not only would this be time-consuming and expensive but the scope for disagreement over whether the material affected the construction of the agreement (as in the Yoshimoto case) would be considerably increased.186

5.84  Lord Hoffmann continued:

I rather doubt whether the ICS case produced a dramatic increase in the amount of material produced by way of background for the purposes of contractual interpretation. But pre-contractual negotiations seem to me capable of raising practical questions different from those created by other forms of background. Whereas the surrounding circumstances are, by definition, objective facts, which will usually be uncontroversial, statements in the course of pre-contractual negotiations will be drenched in subjectivity and may, if oral, be very much in dispute. It is often not easy to distinguish between those statements which (if they were made at all) merely reflect the aspirations of one or other of the parties and those which embody at least a provisional consensus which may throw light on the meaning of the contract which was eventually concluded. But the imprecision of the line between negotiation and provisional agreement is the very reason why in every case of dispute over interpretation, one or other of the parties is likely to require a court or arbitrator to take the course of negotiations into account.187

There was also a risk of self-serving evidence by parties to negotiations. Furthermore there was a theoretical risk of adverse effects on third parties.188 Accordingly it was inappropriate to depart from the previous decisions of the House of Lords on this point.

5.85  Lastly, there remained the ‘safety nets’ of rectification and estoppel by convention.189 Evidence of pre-contractual negotiations 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’;190 and (c) for the purposes of the ‘private dictionary’ principle, where a particular trade or community has its own unconventional or idiosyncratic linguistic usage.191 However The Karen (p. 218) Oltmann192 was an ‘illegitimate extension’ of that rule and was disapproved.

5.86  A similar conclusion was reached in Australia by the New South Wales Court of Appeal in Franklins Pty Ltd v Metcash Trading Ltd 193 at the end of 2009. Whilst the surrounding circumstances, including the commercial purpose, genesis, background, context, and market, were always admissible as an aid to construction, evidence of negotiations and declarations of subjective intent were not.194

5.87  Whilst disappointing to proponents of a more liberal approach to admissible evidence for the purpose of construing contracts, the obiter dicta of Lord Hoffmann in Chartbrook simplifies the debate by restating the rule as purely policy-based (rather than grounded in principle). It was conceded that such policies may not be as compelling as the House considered, or may need revisiting by the Law Commission.195 The case also legitimates and perpetuates the routine circumvention of the rule through the ‘safety nets’ of rectification and estoppel by convention (and thereby contributes to the artificiality of the law). As Lord Nicholls observed in another context in Sempra Metals v Commissioners for Inland Revenue: ‘legal rules which are not soundly based resemble proverbial bad pennies: they turn up again and again.’196 It is to be expected that the issue will continue to resurface.197

The rise and fall of The Karen Oltmann

5.88  The first instance decision of Kerr J in The Karen Oltmann198 was widely discussed in the context of prior negotiations as an example of what was sometimes called a ‘common assumption’ or ‘private dictionary’ exception to the exclusionary rule.199 However in 2009 in Chartbrook Ltd v Persimmon Homes Ltd,200 the House of Lords disapproved of the reasoning in the case. Nevertheless it is worth examining the approach of Kerr J, before turning to the criticisms of that decision.

(p. 219) 5.89  A two-year time charter of a vessel on the Baltime form included a clause that ‘Charterers to have the option to redeliver the vessel after 12 months trading subject to giving 3 months’ notice’. The charterers purported to exercise that option after nineteen months. The owners insisted that the option was available once only after the expiry of twelve months, whereas the charterers argued that they were entitled to give notice at any time after twelve months’ trading. Kerr J said that the issue was a ‘short but puzzling point of construction’.201 Both senses of ‘after’ were permissible dictionary meanings, and which one applied could only be determined by context. Kerr J’s instinct was that the owners’ construction was right. The words ‘at any time’ did not appear. Furthermore, such an open option to terminate was not one the judge had encountered before. This instinct was reinforced by certain pre-contractual telex exchanges which clearly showed that the word ‘after’ was used by the parties in the agreed sense of ‘on the expiry of’ rather than ‘at any time after the expiry of’. Despite Prenn v Simmonds, Kerr J held he was entitled to have regard to this evidence where it showed an agreed meaning:

I think that in such cases the principle can be stated as follows. If a contract contains words, which in their context, are fairly capable of bearing more than one meaning, and if it is alleged that the parties have in effect negotiated on an agreed basis that the words bore only one of two possible meanings, then it is permissible for the Court to examine the extrinsic evidence relied on to see whether the parties have in fact used the words in question in one sense only, so that they have in effect given their own dictionary meaning to the words as the result of their common intention. Such cases would not support a claim for rectification of the contract, because the choice of words in the contract would not result from any mistake. The words used in the contract would ex hypothesi reflect the meaning which both parties intended.202

5.90  Whilst pleaded as an estoppel, Kerr J did not think that it amounted to an ‘estoppel properly so-called … because there is nothing which amounts to a representation’.203 In similar vein, Mason J in the High Court of Australia in Codelfa Construction Prop Ltd v State Rail Authority of New South Wales204 had suggested that evidence of both parties’ actual intention may preclude (by way of an argument which resembles an estoppel) a party from advancing as an argument a construction which was rejected in negotiations ‘which the parties have united in rejecting’.205

5.91  Writing extra-judicially, Sir Johan Steyn suggested that the doctrine of estoppel could preclude a party from going back on a representation as to the meaning (p. 220) of a particular word or phrase, and went on to describe The Karen Oltmann as a ‘potentially more virile exception’ to the general rule precluding reliance on prior negotiations. Indeed, his Lordship presciently observed: ‘It is an exception which could easily swallow up the rule.’206

5.92  The decision in The Karen Oltmann was considered but not followed by the New Zealand Court of Appeal in Air New Zealand Ltd v Nippon Credit Bank Ltd 207 which concerned a sum payable under an aircraft lease ‘upon redelivery’ of the plane. The aircraft lease was governed by English law. Gault J, delivering the judgment of the court, said that Kerr J’s approach: ‘has the ring of estoppel by convention applied to contract construction … though that principle generally is applied to the correctness of underlying facts rather than to the construction of the terms of a written contract.’208 Gault J continued:

The circumstances of this case demonstrate the fine line there is between evidence showing that the parties proceeded on a common assumption as to the effect of their contract or the meaning of a word in it, which may be admitted, and evidence of their pre-contract negotiations (unless they otherwise evidence the common assumption just referred to) and subjective intentions, which may not.209

5.93  The court noted that this was a major commercial transaction, with skilled advisers on each side, and only strong and unequivocal evidence would demonstrate a shared common assumption which was not recorded in the final agreement. The extrinsic evidence was therefore disregarded. Considering the nature and substance of the deal the court concluded that ‘upon redelivery’ meant ‘at the time of redelivery’.

5.94  Despite attracting widespread discussion, the fate of The Karen Oltmann as a matter of English law was sealed by the House of Lords in Chartbrook Ltd v Persimmon Homes Ltd.210 Lord Hoffmann was prepared to accept the existence of a ‘private dictionary’ principle, where a particular trade or community has its own unconventional or idiosyncratic linguistic usage.211 However The Karen Oltmann was an ‘illegitimate extension’ of that rule and its reasoning was expressly disapproved.212 The key problem was that there was nothing idiosyncratic about (p. 221) either potential or perfectly conventional uses of the word ‘after’. Nevertheless Lord Hoffmann did not say that the case was wrongly decided. Indeed the telexes ‘merely confirmed the meaning which Kerr J, as an experienced commercial judge, would in any case have given to the clause’.213 Accordingly his Lordship appeared to be of the view that the result was defensible on ordinary principles of construction, or if necessary by recourse to rectification,214 or possibly estoppel by convention ‘which has been developed since the decision in The Karen Oltmann’.215 What is not legitimate was to have regard to the prior negotiations for the pure exercise of construction. The analysis by the appellate court of this relatively straightforward dispute both illustrates and perpetuates the artificiality of the English approach.

No direct evidence of the parties’ intentions

5.95  As Odgers records, a key feature of the legal approach to construction departs from everyday notions of the interpretation of utterances. What does a document mean?

To a layman, the easiest way to answer this question might seem to be to call the parties before the court and ask them what they meant. In that case, the parties would not only usurp the function of the court, but would probably hold entirely different opinions as to what was meant by the words used.216

5.96  The inadmissibility of direct testimony on questions of construction is entrenched in English law. This results from the commitment to objectivity. A clear statement of the rule is to be found in the speech of Lord Wensleydale in the House of Lords in Monypenny v Monypenny:

the question is not what the parties to a deed may have intended to do by entering into that deed, but what is the meaning of the words used in that deed; a most important distinction in all cases of construction and the disregard of which often leads to erroneous conclusions.217

5.97  It should be noted that a party’s state of mind may be highly relevant and admissible with respect to questions posed by the neighbouring techniques of rectification and estoppel, or if the validity of the instrument is challenged by reference to one or more of the vitiating factors (fraud, misrepresentation, mistake, duress). However, it is clearly established that declarations of subjective intent, whether made before or after the contract was formed, are irrelevant and inadmissible. (p. 222) A fortiori subjective understandings or concerns which were never made manifest or communicated to the other party during negotiations are irrelevant and inadmissible.

5.98  There appear to be a number of overlapping rationales for the exclusion of oral evidence from the parties on questions of construction. First and foremost, as a matter of grand theory English law is committed to an objective test of meaning in contracts. It is profoundly uninterested in what a party meant to say or write, if that departs from what he has actually said or written. Secondly, it is almost inevitable that evidence on this question is likely to be self-serving, or at least tainted by a long-standing sense of injustice or ill-use by the other party.218 Thirdly, the argument from futility—given that the parties have, by the time the dispute has reached a court or tribunal, entrenched themselves into opposed positions on the meaning and effect of the contractual words, it is perhaps unsurprising that the judiciary considers that it will be little assisted by two conflicting accounts of what was meant, perhaps years earlier. Treating construction as both an objective exercise and a question of law makes it more likely that the number and quality of the arguments advanced favouring rival constructions are kept within reasonable bounds. More succinctly, judges believe that direct testimony is highly likely not to be helpful in resolving the dispute.219

Prior negotiations admissible

5.99  There are five principal exceptions to the exclusionary rule, or, more properly, five situations in which the exclusionary rule does not apply: first, where a contract is oral, or partly oral; secondly, in order to establish facts which were reasonably known to both parties; thirdly, it may be possible to obtain evidence as to the genesis of the transaction; fourthly, what remains of the so-called ‘private dictionary’ exception; lastly, the prior negotiations rule has never applied to claims for the rectification of documents—indeed such materials are usually the basis upon which such a plea is advanced.

Exception (1): contracts partly oral

5.100  The construction of the written terms of a contract reduced to writing is a question of law. However the same is not true for contracts which are wholly or partly evidenced by oral statements or conduct. Here the content of the terms (p. 223) is a question of fact, and it appears that the exclusionary rules do not apply. The modern approach is illustrated by Carmichael v National Power plc.220 Tour guides were engaged by the utility company to act ‘on a casual … basis’. The House of Lords decided that the terms of the agreement had to be determined as a question of fact in order to determine whether the arrangements could be characterized as contracts of employment. It was appropriate to examine all documentary exchanges, oral statements, and conduct, including subsequent conduct, in order to resolve this issue of fact. Lord Hoffmann acknowledged the existence of the subsequent conduct rule which would have applied had this been a ‘purely written contract’, and recorded that even in such a case the rule would have been qualified by the rules on variation and estoppel.221

Exception (2): objective facts reasonably known to both parties

5.101  It is clear that it is permissible to have recourse to the negotiations and pre-contractual documentation in order to establish facts which were reasonably known to both parties. The nineteenth-century example of Lewis v Great Western Railway Company was considered above.222

5.102  In Youell v Bland Welch & Co Ltd 223 Staughton LJ attempted to elucidate further the phrases ‘surrounding circumstances’ and ‘factual matrix’:

The notion is what the parties had in mind, and the Court is entitled to know, what was going on around them at the time when they were making the contract. This applies to circumstances which were known to both parties, and to what each might reasonably have expected the other to know.224

A prominent modern consideration of this exception is the Scottish case of Bank of Scotland v Dunedin225 which was referred to with evident approval by the House of Lords in the leading English case of Chartbrook Ltd v Persimmon Homes Ltd.226 In Bank of Scotland v Dunedin Lord Rodger, whilst acknowledging that the prior negotiations rule did not permit reference to the negotiations (such as meetings) for the purpose of glossing the language of the contract, stated that this did not prevent the court from looking at the negotiations ‘to establish the parties’ knowledge of the circumstances with reference to which they used the words in the contract’.227

(p. 224) Exception (3): genesis and object

5.103  In Investec Bank (Channel Islands) Ltd v The Retail Group plc228 Sales J (in a judgment pre-dating Chartbrook) treated the ‘genesis’ of the contract as a distinct exception:

[I]n interpreting a contract, regard may be had to the content of the parties’ negotiations to establish ‘the genesis and object’ of a provision. This seems to me to be a relevant part of the factual matrix, since if the parties in the course of their negotiations are agreed on a general objective which is to be achieved by inclusion of a provision in their contract, that objective would naturally inform the way in which a reasonable person in the position of the parties would approach the task of interpreting the provision in question.229

5.104  Following the decision of the House of Lords in Chartbrook Flaux J in Excelsior Group Productions Ltd v Yorkshire Television Ltd 230 commented on this approach:

It seems to me that there is a very fine line between looking at the negotiations to see if the parties have agreed on the general objective of a provision as part of the task of interpreting the provision and looking at the negotiations to draw an inference about what the contract meant (which is not permissible), a line so fine it almost vanishes. However, I do not need to decide whether the approach adopted by Sales J survives the restatement of the exclusionary rule in Chartbrook.231

5.105  It is submitted that Sales J’s view is to be preferred and is consistent with the classical formulation of Lord Wilberforce in Prenn v Simmonds. It is permissible to have regard to ‘the genesis and object’ of a provision as a legitimate aid to construction, so long as any object identified satisfies the objective principle.232

Exception (4): rectification of documents

5.106  In Chartbrook Ltd v Persimmon Homes Ltd 233 the House of Lords confirmed the long-established practice of permitting recourse to all pre-contractual materials for the purpose of considering a plea of rectification. For further consideration see Chapter 17.234

Exception (5): the private dictionary

5.107  It is necessary to consider what remains of this exception in the wake of the disapproval of The Karen Oltmann in Chartbrook Ltd v Persimmon Homes Ltd.235 In (p. 225) the leading nineteenth-century case of Shore v Wilson Erskine J stated that the meaning of terms in a mercantile instrument could be ascertained according to their ‘acceptation amongst merchants’.236 In Chartbrook Ltd v Persimmon Homes Ltd Lord Hoffmann confirmed that:

It is true that evidence may always be adduced that the parties habitually used words in an unconventional sense in order to support an argument that words in a contract should bear a similar unconventional meaning. This is the ‘private dictionary’ principle, which is akin to the principle by which a linguistic usage in a trade or among a religious sect may be proved: compare Shore v Wilson … For this purpose it does not matter whether the evidence of usage by the parties was in the course of negotiations or on any other occasion. It is simply evidence of the linguistic usage which they had in common.237

However, outside of particular trade contexts, genuinely idiosyncratic use of language may be very difficult to prove.

Speculation about negotiations?

5.108  Whilst not strictly speaking an exception, on occasion, whilst not hearing evidence of the negotiations which in fact took place, the courts have on occasion speculated about the kinds of bargaining which may have taken place. For example, in The BOC Group v Centeon238 Evans LJ stated:

Although the court does not have evidence as to the actual progress of negotiations, it is entitled to speculate to a limited extent as to the course which the negotiations took, in so far as this might be relevant to understanding the meaning which the parties intended that their words should bear. For example the question may be asked: for whose benefit or at whose instance was this clause produced? What other terms might have been used? Both these questions might involve a measure of inquiry into what the negotiating process may be supposed to have been and both have been asked by counsel in the present case.

5.109  But the obvious perils of this process were identified in the Hong Kong Court of Final Appeal in Jumbo King Ltd v Faithful Properties Ltd 239 where Lord Hoffmann NPJ observed in a concurring judgment:

In my respectful opinion, the judge’s approach was far too narrow and literal. The construction of a document is not a game with words. It is an attempt to discover what a reasonable person would have understood the parties to mean. And this involves having regard, not merely to the individual words they have used, but to the agreement as a whole, the factual and legal background against which it was concluded and the practical objects which it was intended to achieve. Quite often this exercise will lead to the conclusion that although there is no reasonable doubt about what the parties meant, they have not expressed themselves very well. Their (p. 226) language may sometimes be careless and they may have said things which, if taken literally, mean something different from what they obviously intended. In ordinary life people often express themselves infelicitously without leaving any doubt about what they meant. Of course in serious utterances such as legal documents, in which people may be supposed to have chosen their words with care, one does not readily accept that they have used the wrong words. If the ordinary meaning of the words makes sense in relation to the rest of the document and the factual background, then the court will give effect to that language, even though the consequences may appear hard for one side or the other. The court is not privy to the negotiation of the agreement—evidence of such negotiations is inadmissible—and has no way of knowing whether a clause which appears to have an onerous effect was a quid pro quo for some other concession. Or one of the parties may simply have made a bad bargain. The only escape from the language is an action for rectification, in which the previous negotiations can be examined. But the overriding objective in construction is to give effect to what a reasonable person rather than a pedantic lawyer would have understood the parties to mean. Therefore, if in spite of linguistic problems the meaning is clear, it is that meaning which must prevail.240

If the court is not privy to negotiations there is always the risk of impermissible speculation, ignorant of the to’ing and fro’ing of the deal.

Particular examples of pre-contractual evidence

5.110  Given the uncertainty concerning the appropriate boundary between admissible context and inadmissible prior negotiations, it is necessary to examine some examples of the types of evidence that pose problems of classification.

Earlier drafts of the contract

5.111  The traditional rule is that the court is not permitted to examine earlier drafts of a contract in order to garner from any changes to the text evidence as to the meaning of the final contract.241 The leading cases of Prenn v Simmonds, Investors Compensation Scheme and Chartbrook v Persimmon confirm that this evidence is inadmissible in English law for the purpose of construing the contract. The question arose directly in Canterbury Golf International Ltd v Yoshimoto242 which confirmed the inadmissibility of draft versions of the final contract, despite an express invitation to revisit the law. The Judicial Committee of the Privy Council, which included Lords Hoffmann and Nicholls, concluded that the material put forward in that case was unhelpful. Conversely such documents are routine evidence where rectification is in issue. Contrast the necessarily different approach to formation disputes where the court examines all relevant draft documentation exchanged during negotiations: RTS Flexible Systems Ltd v Molkerei Alois Müller GmbH & Co KG (UK Production).243

(p. 227) Deletions from earlier drafts

5.112  The House of Lords case A & J Inglis v John Buttery & Co244 is emphatic authority that deletions from an earlier draft of a contract drafted by the parties are irrelevant and inadmissible, even though reference to the deleted (but legible) text would have enabled a more summary disposal of the issue between the parties.245 In Inglis v Buttery Lord Hatherley stated:

When I turn to the deleted words and find that in spite of a line being drawn through them I can read the words … it appears to me that, those words being deleted, and a marginal note affixed shewing that they were deleted before the contract was finally concluded, it is not in the power of any Court to look at words, for any purpose whatever connected with the construction of that contract of which they form no part whatsoever … It is to my mind perfectly immaterial whether the instrument was torn up and rewritten, written out again with those words no longer contained in it, or whether the course was taken of running through those words as they stood in writing.246

5.113  Lord O’Hagan and Lord Blackburn agreed. The citations with approval from Inglis v Buttery by the House of Lords in Chartbrook v Persimmon247 suggest that the case remains good authority.

Deletions or alterations to a standard form

5.114  The rule prohibiting reference to earlier drafts would also appear to extend to deletions or alterations to standard forms.248 Nevertheless in commercial cases the courts have often readily had regard to deleted words in familiar forms.249 Accordingly in Louis Dreyfus & Cie v Parnaso Diplock J, having noted ‘a pleasant diversity of authority on this subject’, pronounced emphatically:

Where there is a standard form of words familiar to commercial men and contained in a printed form in general use, such as the ‘Gencon’ charter, it seems unreal to suppose that when the contracting parties strike out a provision dealing with a specific matter, but retain other provisions, they intend to effect any alteration other than the exclusion of the provision struck out. I cannot, prima facie at any rate, ascribe to them any intention of altering the meaning of the words in the provisions which they have chosen to retain. I say ‘prima facie’ because there may be added or substituted words which drive one to the conclusion that they did intend to ascribe (p. 228) to the words retained a meaning modified by the added or substituted provisions; but, while I think that I must look first at the clause in its actual form without the deleted words, if I find the clause ambiguous, I think that I am entitled to look at the deleted words to see if any assistance can be derived from them in solving the ambiguity, bearing in mind the prima facie rule which I have indicated.250

5.115  In Mopani Cooper Mines plc v Millennium Underwriting Ltd 251 Christopher Clarke J carried out a comprehensive review of the authorities252 and concluded that it was permissible in that case to have regard to the deleted material:

The diversity of authority, of which Diplock J spoke, renders it difficult for a judge of first instance to recognise when recourse to deleted words may properly be made. The tenor of the authorities appears to be that in general such recourse is illegitimate, save that (a) deleted words in a printed form may resolve the ambiguity of a neighbouring paragraph that remains; and (b) the deletion of words in a contractual document may be taken into account, for what (if anything) it is worth, if the fact of deletion shows what it is the parties agreed that they did not agree and there is ambiguity in the words that remain. This is classically the case in relation to printed forms … or clauses derived from printed forms … but can also apply where no printed form is involved. …

Even if recourse is had to the deleted words, care must be taken as to what inferences, if any, can properly be drawn from them. The parties may have deleted the words because they thought they added nothing to, or were inconsistent with, what was already contained in the document; or because the words that were left were the only common denominator of agreement, or for unfathomable reasons or by mistake. They may have had different ideas as to what the words meant and whether or not the words that remained achieved their respective purposes.253

5.116  Christopher Clarke J’s analysis is a helpful account of the present law, but the uncertain state of the authorities requires appellate scrutiny. It is submitted that the only rational way forward (either as part of a wider reconsideration of prior negotiations, or more narrowly) is to permit the judge to consider deletions in every case, and for every type of contract, and to give such weight to the deleted material as is appropriate in the context of the particular dispute (including at least the factors identified by Christopher Clarke J). Inglis v Buttery (and its roundabout solution) and other authorities standing in the way of this sensible principle should be overruled.

Memorandum of negotiations

5.117  As discussed above the decision of the Scottish Court of Session in Bank of Scotland v Dunedin254 took account of the evidence (p. 229) of what was said at a crucial meeting in order to establish the relevant circumstances in which the words of the contested clause were used.255 It was clear that the scope of the clause had been discussed and each party had knowledge of the circumstances in which it was intended to operate. This suggests that agreed or uncontradicted notes of meetings which cast light on the eventual contract may in due course become admissible in English law. Support may also be garnered from the decision of the Court of Appeal in Commission for New Towns v Cooper (Great Britain) Ltd,256 where an agenda for a meeting appears to have been taken into account. Stuart-Smith LJ stated: ‘it is quite clear from the correspondence that the topics for discussion had indeed been limited and defined.’257 In contrast, Evans LJ acknowledged that the exchange of correspondence might have to be construed as a contract ‘without regard to what went before’, but would still reach the same conclusion.258

Related contracts

5.118  Traditionally, related instruments which were executed at the same time could be construed together.259 Nowadays, applying the contextual approach courts do generally have regard to related contracts and intertwining documents. In the context of the construction industry in Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd260 Lord Reid stated that ‘if any provision in the sub-contract is ambiguous in the sense that it is reasonably capable of having more than one meaning, one can go to the principal contract’.261 Nowadays the prerequisite of ambiguity is unlikely to be insisted on. For example, in Rainy Sky SA v Kookmin Bank262 which concerned six identical ‘on demand advance payment bonds’ used to provide security for the performance of six underlying shipbuilding contracts, the accepted matrix comprised the shipbuilding contract terms which provided the ‘genesis’ of the bond contracts.263

Previous contracts

5.119  Previous contracts do not fall within the mischief of the ‘prior negotiations’ rule. In the context of film finance reinsurance in HIH Casualty and General Insurance Ltd v New Hampshire Insurance Co264 Rix LJ (p. 230) reviewed the authorities suggesting that the original slip policy had been superseded,265 and provided guidance by way of obiter dicta:

… there is nothing in these citations which binds this court to rule that where a prior contract has been followed by a further contract, or where in an insurance context a slip contract has been followed by a policy, there is a rule of law which makes it inadmissible to consider the terms of the prior contract, or that the parol evidence rule has the same effect. … Where it is common ground that one contract has been intended to supersede an earlier contract, it must follow that the parties’ contract must be found exclusively in the later contract. Thus the earlier contract cannot be used to add to, or modify, the later contract.

But does it follow that the earlier contract cannot even be looked at for the purposes of construing the later contract?

In principle it would seem to me that it is always admissible to look at prior contracts as part of the matrix or surrounding circumstances of a later contract. I do not see how the parol evidence rule can exclude prior contracts, as distinct from mere negotiations. The difficulty of course is that, where the later contract is intended to supersede the prior contract, it may in the generality of cases simply be useless to try to construe the later contract by reference to the earlier one. Ex hypothesi, the later contract replaces the earlier one and it is likely to be impossible to say that the parties have not wished to alter the terms of their earlier bargain. The earlier contract is unlikely therefore to be of much, if any, assistance. Where the later contract is identical, its construction can stand on its own feet, and in any event its construction should be undertaken primarily by reference to its own overall terms. Where the later contract differs from the earlier contract, prima facie the difference is a deliberate decision to depart from the earlier wording, which again provides no assistance. Therefore a cautious and sceptical approach to finding any assistance in the earlier contract seems to me to be a sound principle. What I doubt, however, is that such a principle can be elevated into a conclusive rule of law.

Where, however, it is not even common ground that the later contract is intended to supersede the earlier contract, I do not see how it can ever be permissible to exclude reference to the earlier contract. I do not see how the relationship of the two contracts can be decided without considering both of them. In essence there are, it seems to me, three possibilities. Either the later contract is intended to supersede the earlier, in which case the above principles apply. Or, the later contract is intended to live together with the earlier contract, to the extent that that is possible, but where that is not possible it may well be proper to regard the later contract as superseding the earlier. Or the later contract is intended to be incorporated into the earlier contract, in which case it is prima facie the second contract which may have to give way to the first in the event of inconsistency. I doubt that it is in any event possible to be dogmatic about these matters.266

5.120  This was followed in Dunlop Haywards (DHL) Ltd v Barbon Insurance Group Ltd267 where Hamblen J noted Chartbrook in the House of Lords, and continued:

(p. 231)

The position therefore remains that evidence of such negotiations is not admissible for the purposes of construing the contract. This does not mean that prior contracts are necessarily excluded from the relevant background …268

Side-letters and accompanying letters

5.121  Contemporaneous documents or letters are often referred to in contract cases.269 Lord Denning MR in Amalgamated Investment & Property Co Ltd (in liq) v Texas Commerce International Bank Ltd insisted on construing a guarantee given by a parent company in respect of its subsidiary’s liabilities to a bank together with two accompanying letters in order to circumvent a problem caused by the bank’s use of its own subsidiary to channel the loan, so that on a strict reading the guarantee had nothing to bite on, because the debtor owed no money directly to the bank.270

‘Without prejudice’ communications

5.122  In Oceanbulk Shipping and Trading SA v TMT Asia Ltd 271 the Supreme Court held that ‘without prejudice’ communications, in addition to being admissible for the purpose of determining whether there was a concluded compromise agreement and what the terms of that agreement were, and for the purposes of claims based on rectification and estoppel, were also admissible for the purpose of determining how those terms were to be construed. Accordingly the Supreme Court recognized what it described as an ‘interpretation exception’ to the without prejudice rule. Lord Clarke, delivering the principal judgment, stated that the modern principles of construction applied:

In these circumstances, I see no reason why the ordinary principles governing the interpretation of a settlement agreement should be any different regardless of whether the negotiations which led to it were without prejudice. The language should be construed in the same way and the question posed by Lord Hoffmann should be the same, namely 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. That background knowledge may well include objective facts communicated by one party to the other in the course of the negotiations. As I see it, the process of interpretation should in principle be the same, whether the negotiations were without prejudice or not. In both cases the evidence is admitted in order to enable the court to make an objective assessment of the parties’ intentions.272

(p. 232) Explanatory notes

5.123  Many standard forms and contracts for use by consumers are accompanied by explanatory notes, which are an attempt to explain the meaning and implications of the document for the lay person in plainer English than the legal form. In the leading modern case of Investors Compensation Scheme Ltd v West Bromwich Building Society273 the guidance in the explanatory notes to a deed of assignment was critical in the determination of the House of Lords that the main instrument contained a botched clause.274 Similarly in Cameron v M & W Mack (ESOP) Trustee Ltd 275 Jonathan Gaunt QC, sitting as a deputy High Court judge, had recourse to explanatory notes to assist in construing an employee share-bonus scheme.

Use of dictionaries

5.124  The courts have long had regard to dictionaries in the interpretation of the meaning of particular words. In Holt & Co v Collyear276 Fry J used a common-sense approach to the construction of a particular word, but ‘not neglecting the use of dictionaries or any other means of information which may assist me in coming to a conclusion as to what is the ordinary meaning of the word’.277 In the context of the construction of technical language in patents Lord Denning observed that ‘reference may be made to a dictionary, which may be a general dictionary or even a technical one’.278

5.125  In Rowett Leakey & Co v Scottish Provident Institution279 Warrington LJ insisted that recourse to dictionaries and other extrinsic evidence was equally apt where a word was not used in its primary sense:

But I repudiate no less strongly the notion that when an English word occurs in a contract, the tribunal which has to ascertain the meaning of that word is not at liberty to make use for that purpose of any materials which it possesses. Especially is that the case when the word in question is obviously not used in its primary and literal sense. When it is used in some secondary or figurative sense it may be necessary to ascertain from external sources what that figurative or secondary sense is, and I am quite clear that the tribunal is entitled to rely either upon its own knowledge, derived from education or literature, of the meaning of the English language, or upon the knowledge of learned men who have compiled dictionaries of the language, or even upon knowledge derived from evidence given in the particular case.280

(p. 233) Recent scepticism about dictionaries

5.126  In contrast, in his restatement of the governing principles of contractual construction in Investors Compensation Scheme Ltd v West Bromwich Building Society, Lord Hoffmann’s principle (4) commenced with the warning:

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.281

5.127  Similarly Lord Steyn, writing extra-judicially, stated: ‘Language can never be understood divorced from its context. That is a dictionary can never solve a problem of interpretation.’282 His Lordship continued:

Dictionaries, a grammar book, and precepts of syntax, will not by themselves yield the contextual meaning of words and sentences. It is true that in a dictionary words are given a limited range of conventional meanings. But in a legal text a word forms part of a sentence and sentences are unlimited in their variety of the arrangement of words. Moreover, the sentence is embedded in a text which by virtue of its major purposes and the general effect of its provisions may add colour to words and sentences. A subtle interplay between word, sentence and text is involved. A problem of interpretation therefore requires an intense focus on particular language in its contextual setting.283

More recently Lord Sumption, writing extra-judicially has come to the defence of lexicographers:

I find the belittling of dictionaries and grammars as tools of interpretation to be rather extraordinary. Language is a mode of communication. Its efficacy depends on the acceptance of a number of conventions that enable people to understand each other. Dictionaries and grammars are simply reference books which record these conventions. If we abandon them as the basic tools of construction, we are no longer discovering how the parties understood each other.284

Nevertheless Lords Hoffmann and Steyn are correct that dictionary definitions can never provide the complete solution. As Justice Learned Hand warned: ‘Of course it is true that the words used, even in their literal sense, are the primary, and ordinarily the most reliable, source of interpreting the meaning of any writing. … But it is one of the surest indices of a mature and developed jurisprudence not to make a fortress out of the dictionary.’285

(p. 234) 5.128  In practice, the assistance rendered by dictionaries goes to the ‘meaning’ or available range of conventional meanings, rather than the ‘effect’ of contractual language. In practice dictionaries are still used, whilst they may not be a complete solution to a particular problem of interpretation. Often there is competition between the numerous different meanings which many ordinary English words have. For example, the Compact Oxford English Dictionary lists four meanings of the word ‘consideration’. Only the fourth is its business or legal sense of ‘payment or reward’. However in legal and commercial contexts that is likely to be a common usage. Overall dictionaries are an admissible aid to construction, but ultimately the general context may be determinative of which meaning is most apt, and it may not be one which is to be found in the dictionary.286

Context-driven and policy-based restrictions on admissible background

5.129  The context of a transaction, the type of transaction or some rule of legal policy may in appropriate cases restrict the admissible background which is considered as an aid to construction. This approach to the admissible background appears most explicitly in the speech of Lord Hoffmann in Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd: ‘There are documents in which the need for certainty is paramount and [in] which admissible background is restricted to avoid the possibility that the same document may have different meanings for different people according to their knowledge of the background.’287 Lord Hoffmann instanced bankers’ commercial credits which are employed in financing international trade. The banks which pay out against various shipping documents are not deemed to know trade usage. Accordingly banks are not deemed to know that the ‘Coromandel groundnuts’ referred to in the invoice is the same commodity as the ‘machine-shelled groundnut kernels’ described in the bill, albeit this was well known in the trade.288 In the words of Hugh Collins: ‘ “Text matters”, to be sure, but how much it matters, depends on context.’289 To which should be added, that context may yield good policy-based reasons why background should be limited. There appear to be a number of categories in which a more restrictive approach to the admissible background will be adopted.

Contracts which are transferable, likely to be assigned, or otherwise relied upon by third parties

5.130  Mercantile contracts such as bills of lading and other readily transferable documents may be a category where a restricted approach to background is appropriate. (p. 235) According to Lord Diplock in Miramar Martime Corp v Holborn Oil Trading Co Ltd:290

The words in the Exxonvoy bill of lading upon which this appeal turns are the same irrespective of whether it is issued in respect of a complete or part of a cargo, received on board at the first or any subsequent loading port for carriage to and discharge at the last or any previous discharging port. There must be ascribed to the words a meaning that would make good commercial sense if the Exxonvoy bill of lading were issued in any of these situations, and not some meaning that imposed upon a transferee to whom the bill of lading for goods afloat was negotiated, a financial liability of unknown extent that no business man in his senses would be willing to incur.291

Similarly, contracts which are relied upon by third parties, either pursuant to rights under the Contracts (Rights of Third Parties) Act 1999 or otherwise, may also be subject to a restrictive approach to admissible background. As Lord Devlin, writing extra-judicially, stated: ‘the common law has its eye fixed as closely on the third man as on the original parties; and the final document is the only thing that can speak to the third man.’292

5.131  In Zurich Insurance (Singapore) Pte Ltd v B-Gold Design & Construction Pte Ltd293 V K Rajah JA, delivering the judgment of the Singapore Court of Appeal, was emphatic:

There are many commercial contracts that will be relied on by persons who may have no more than a rudimentary understanding of the background to such contracts. These third parties must be able to enforce the plain words of such documents unless there is a reason to believe that the relevant contextual peculiarities were made known or made available to them before they entered into the contract in question. If the courts do not exercise restraint in interpreting such documents, this could engender commercial uncertainty and thereby encourage pointless litigation.294

5.132  In Chartbrook Ltd v Persimmon Homes Ltd 295 Lord Hoffmann repeated his preference for a restrictive approach in such cases, and accordingly did not appear to regard protecting the interests of third parties as a strong ground in itself for excluding prior negotiations.296 His Lordship suggested: ‘The law sometimes deals with the problem by restricting the admissible background to that which (p. 236) would be available not merely to the contracting parties but also to others to whom the document is treated as having been addressed.’297

A similar restrictive approach to background in relation to a security trust deed, which secured a variety of creditors at different times and in different circumstances, was advocated by Lord Collins in In re Sigma Finance Corporation (in administrative receivership).298

Standard form contracts

5.133  Where a standard form is used it is desirable that the same clause has the same meaning each time it is employed by the parties, who are likely to be professionals or regular participants on the marketplace in question. The particular circumstances of the individual deal may be less relevant to its construction, than in the case of ‘one-off’ or bespoke arrangements. This point was recently forcefully made by Lord Millett in AIB Group (UK) Ltd v Martin:

A standard form is designed for use in a wide variety of different circumstances. It is not context-specific. Its value would be much diminished if it could not be relied upon as having the same meaning on all occasions. Accordingly the relevance of the factual background of a particular case to its interpretation is necessarily limited. The danger, of course, is that a standard form may be employed in circumstances for which it was not designed. Unless the context in a particular case shows that this has happened, however, the interpretation of the form ought not to be affected by the factual background.299

Obviously such statements need to be treated with a certain degree of caution as the courts have, on occasion, had regard to the background circumstances even when a standard form is under consideration. Furthermore, Lord Millett did not advert to the clearly pertinent distinction between a standard form in use between commercial parties, of relatively equal bargaining power, and in the same field of trade, and the same form employed between a commercial concern and an individual consumer, or perhaps small business.

5.134  In the context of two commercial parties, in Zurich Insurance (Singapore) Pte Ltd v B-Gold Design & Construction Pte Ltd 300 V K Rajah JA, delivering the judgment of the Singapore Court of Appeal, pronounced:

The first and foremost consideration in approaching any written contract must be the essence and attributes of the document being examined. Different genres of documents may require different treatment by the court at various stages of (p. 237) the analytical process. For example, for standard form contracts and documents intended for commercial circulation (eg, negotiable instruments), the presumption that all the terms of the agreement between the parties are contained in the contract will be almost impossible to rebut. Such documents are examples par excellence of contracts that look complete to the parties … ; laymen are also more likely to attach greater importance to the written document in this particular context such that, on an objective view, it is difficult to say that the parties did not intend the agreement to be wholly contained in the written document. Furthermore, when interpreting such a contract, the court will usually be more restrained in its examination of the context of the contract.301

Contracts which are required to be in writing or evidenced in writing

5.135  Many contracts are required to be in writing or evidenced in writing. For example, the formalities prescribed by statute for sales of land are contained in section 2 of the Law of Property (Miscellaneous Provisions) Act 1989. In the view of Peter Gibson LJ in Firstpost Homes Ltd v Johnson, section 2 of the 1989 Act was ‘intended to simplify the law and to avoid disputes, the contract now being in a single document containing all the terms and signed by the parties. Thereby it has been sought to avoid the need to have extrinsic evidence as to that contract’.302 That would suggest a narrow approach to the admission of extrinsic evidence in such cases. The law may not be as restrictive where the statute merely requires the contract to be evidenced in writing, as opposed to in writing.

Public documents

5.136  The reasoning of Lord Hoffmann in Chartbrook Ltd v Persimmon Homes Ltd 303 favouring restricting the admissible background to that which would be available not merely to the contracting parties but also to others to whom the document is addressed has already been cited above.304 In Cherry Tree Ltd v Landmain Ltd 305 Lewison LJ explicitly extended this reasoning to public documents, such as statutorily registered charges:

Our courts have already drawn distinctions between the use of background material in the interpretation of what I might call “ordinary” commercial contracts on the one hand, and the interpretation of negotiable and registrable contracts or public documents on the other. It is true, as Arden LJ points out …[306], that in his speech in Chartbrook Lord Hoffmann did not expressly refer to documents in a public register. But he did refer to articles of association and to bills of lading; and made the point that the background relied on in Chartbrook would have been (p. 238) available to any prospective assignee or lender. The point about public documents did not arise for decision … The reasonable reader’s background knowledge would, of course, include the knowledge that the charge would be registered in a publicly accessible register upon which third parties might be expected to rely. In other words a publicly registered document is addressed to anyone who wishes to inspect it. His knowledge would include the knowledge that in so far as documents or copy documents were retained by the registrar they were to be taken as containing all material terms, and that a person inspecting the register could not call for originals. The reasonable reader would also understand that the parties had a choice about what they put into the public domain and what they kept private. He would conclude that matters which the parties chose to keep private should not influence the parts of the bargain that they chose to make public.307

The restriction on subsequent statements and conduct

5.137  A separate exclusionary rule prevents the court from taking into account statements and conduct of the parties subsequent to the date of formation for the purpose of construing the contract.308 As Arden LJ said in Full Metal Jacket Ltd v Gowlain Building Group Ltd:309

It is, I think, worth repeating that as the law stands today, evidence as to the conduct of the parties subsequent to making their contract in writing is not admissible to interpret that contract. Different rules apply where the contract is partly oral or partly written, or where the document to be interpreted is a title deed and the conduct in question represents acts of possession under the title or where estoppel is alleged or where it is alleged that the contract has been varied by conduct. …

When it comes to legal policy it is important that the law should not undermine the certainty of the meaning of contracts or lead to a position where the meaning of a contractual provision fluctuates according to the conduct which in fact occurs under the contract when it is performed by the time the meaning has to be ascertained. It is therefore worth repeating and emphasising that the courts in general should not have regard to subsequent conduct when interpreting written contracts.310

The rule to this effect was firmly established by the House of Lords in the 1970s. Previously, judicial opinion had not always been hostile to the admissibility of subsequent statements or conduct. In 1842 Sir Edward Sugden (later Lord St (p. 239) Leonards) pronounced: ‘tell me what you have done under such a deed, and I will tell you what that deed means.’311 However the cases were not consistent. In one nineteenth-century case a failure to claim payments for a period of 43 years was held not to affect the true construction of the contract. The payments were due on what was held to be the plain and unambiguous meaning of the contract.312

5.138  In the first half of the twentieth century there was Privy Council authority that subsequent conduct was relevant and admissible. In Watcham v Attorney-General of the East African Protectorate,313 in an opinion delivered by Lord Atkinson, his Lordship considered the much discussed ‘ancient documents’ exception and continued:

The principle of the above-mentioned decisions, so far as it is based on the probability of a change during the lapse of time in the meaning of the language used in an ancient document, cannot of course have any application to the construction of modern instruments, but even in these cases extrinsic evidence may be given to identify the subject-matter to which they refer, and where their language is ambiguous the circumstances surrounding their execution may be similarly proved to show the sense in which the parties used the language they have employed, and what was their intention as revealed by their language used in that sense.314

Lord Atkinson concluded that the principle in respect of modern instruments applied both in cases of latent ambiguity and of patent ambiguity. Accordingly Lord Denning MR in Amalgamated Investment & Property Co Ltd v Texas Commerce International Bank Ltd 315 recounted:

For many years I thought that when the meaning of a contract was uncertain you could look at the subsequent conduct of the parties so as to ascertain it. That seemed to me sensible enough. The parties themselves should know what they meant by their words better than anyone else.316

5.139  However in the 1970s the House of Lords was emphatic in two cases that such evidence was irrelevant to the process of construction: James Miller & Partners (p. 240) Ltd v Whitworth Street Estates (Manchester) Ltd 317 and L Schuler AG v Wickman Machine Tool Sales Ltd.318 This is the clear English rule,319 albeit such evidence is admissible for purposes other than construction, such as to prove a variation by conduct or to establish an estoppel by convention.

James Miller v Whitworth Street Estates

5.140  The case of James Miller & Partners Ltd v Whitworth Street Estates (Manchester) Ltd320 concerned a dispute about the proper law of a contract (whether English or Scottish law) for the purpose of arbitral proceedings. That issue is now superseded by the Rome I Regulation. Nevertheless it stands as authority for the proposition that a contract cannot be construed by reference to subsequent conduct of the parties. Such was the opinion of Lord Reid, Lord Hodson, Viscount Dilhorne, and Lord Wilberforce (albeit that Lord Reid and Lord Wilberforce were dissenting on the main question).321 The Court of Appeal was criticized for relying upon the subsequent conduct of the parties.322 Lord Reid stated:

I must say I had thought it was now well settled that it is not legitimate to use as an aid in the construction of the contract anything which the parties said or did after it was made. Otherwise one might have the result that a contract meant one thing the day it was signed, but by reason of subsequent events meant something different a month or a year later.323

5.141  Lord Wilberforce stated:

Reliance on subsequent conduct seems to have had considerable influence on the opinions expressed and, I would respectfully think, led the members of the court to attribute insufficient importance to the fact that the building site, and so the place of performance, was in Scotland. In my opinion, once it was seen that the parties had made no express choice of law, the correct course was to ascertain from all the relevant contemporary circumstances including, but not limited to, what the parties said or did at the time, what intention ought to be imputed to them on the formation of the contract. Unless it were found an estoppel or a subsequent agreement, I do not think that subsequent conduct can be relevant to this question.324

(p. 241) Schuler v Wickman Machine Tool Sales

5.142  The House of Lords rejected a second attempt to undermine the subsequent conduct rule in L Schuler AG v Wickman Machine Tool Sales Ltd.325 Reliance was placed on the fact that Watcham v Attorney-General of the East African Protectorate326 had not been cited in the Whitworth Street Estates case. Nevertheless, Lord Reid, of the majority, saw no reason to change his earlier view. Lord Wilberforce, albeit dissenting on the main point, concurred with the majority 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 the lay mind might at first sight seem proper to receive …327

5.143  Based on Prenn v Simmonds it may be deduced that such evidence is unhelpful. However in the wake of Chartbrook v Persimmon it is likely that the exclusionary rule would now be said to be grounded on considerations of policy. Lord Wilberforce repeated the new agreement and estoppel exceptions from Whitworth Street Estates and continued:

There are, of course, exceptions. I attempt no exhaustive list of them. In the case of ancient documents, contemporaneous or subsequent action may be addressed in order to explain words whose contemporary meaning may have become obscure. And evidence of the admitted surrounding circumstances or in order to explain technical expressions or to identify the subject matter of an agreement: or (an overlapping exception), to resolve a latent ambiguity. But 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.328

The New South Wales Court of Appeal confirmed the subsequent conduct rule in Franklins Pty Ltd v Metcash Trading Ltd,329 but qualified that by holding that subsequent evidence might be admissible to the extent that it was probative of surrounding circumstances at the time of the contract.330

The status of Watcham

5.144  The House of Lords in Schuler did not overrule Watcham v Attorney-General of the East African Protectorate331 and left its status (p. 242) somewhat uncertain. Lord Reid thought there may be ‘special reasons for construing a title to land in light of subsequent possession had under it’.332 Lord Morris concurred: ‘If on the true construction of a contract a right is given to a party, that right is not diminished because during some period either the existence of the right or its full extent was not appreciated.’333 However subsequent conduct could evidence a new agreement or an estoppel. Lord Wilberforce was perhaps the most scathing, describing Watcham as one which had ‘long been recognised to be nothing but the last refuge of the desperate’. His Lordship concluded: ‘in relation to the interpretation of contracts or written documents generally I must deprecate its future citation in English courts as an authority.’334 Nevertheless Lord Wilberforce left open the question as to whether in the field of real property it permitted reference to acts of subsequent possession, albeit that it had been powerfully criticized. Lord Simon thought that Watcham had been seriously weakened as a persuasive authority by judicial attacks.335 For Lord Kilbrandon Watcham did not ‘command universal confidence’, albeit he would not question its authority in the context of ambiguous grants of land. Accordingly Watcham remains as weakened authority permitting consideration of subsequent possession in construing an ambiguous grant of land.

Exceptions to the exclusionary rule

5.145  There appear to be four principal exceptions or situations in which the exclusionary rule in relation to subsequent statements and conduct does not apply. First, it does not in situations where what the court is engaged in is an exercise in characterization or categorization of the type of transaction or legal incident the parties have created. Secondly, it does not apply to contracts which are oral, or perhaps partly oral. Thirdly, it does not preclude the court from investigating whether the parties have manifested an intention to vary a term or terms of the contract, albeit the evidence is by way of conduct. Fourthly, it does not prevent a party relying on the separate doctrine or ‘escape route’ of estoppel by convention.

Exception (1): characterization or categorization

5.146  The process of characterization or categorization or classification of contracts is related to, but distinct from, construction. It is necessary to characterize or categorize the transaction or legal relationship which the parties have entered into for at least two purposes. First, at common law standard incidents or principles have developed for particular categories of contract or other private law concepts, often by law of terms implied by law. In order to determine whether these incidents or (p. 243) implied terms are applicable it is necessary to determine whether a contract falls within a particular category. Secondly, statutory law often either confers privileges, or conversely imposes obligation, in respect of transactions which fall into particular legal categories or concepts. 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. The most famous example, arising out of previous statutory attempts to control the rental housing sector, is the question whether an interest in a flat creates a lease or licence for the purposes of statutory rights of tenure or (when applicable) rent control. Therefore Street v Mountford 336 remains the leading case in 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.337 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. For example, in a sequel to Street v Mountford, the decision of the House of Lords in A G Securities v Vaughan, Lord Jauncey was clear that:

although the subsequent actings of the parties may not be looked at for the purpose of construing the agreements they may be looked at for the purposes of determining whether or not parts of the agreements are a sham in the sense that they were intended merely as ‘dressing up’ and not as provisions to which any effect would be given.338

5.147  The problem of categorization also surfaces in respect of retention of title clauses, where the characterization of a provision as a retention of title clause, rather than a floating charge, will ensure that registration as a security device is not required in order for the supplier to succeed in a claim to the goods in the event of the recipient’s insolvency.339 Another prominent example is the decision of the Privy Council in Agnew v Commissioner of Inland Revenue (‘Brumark’),340 which concerned the proper characterization of charges over (p. 244) the book debts of companies. The approach of Brumark was eventually adopted by the House of Lords in Re Spectrum Plus Ltd,341 save that the critical issue of the admissibility of subsequent conduct was not directly addressed in the latter case. It had been recognized in Siebbe Gorman & Co Ltd v Barclays Bank Ltd342 that it was conceptually possible to have a fixed charge over the book debts of a corporation provided there was sufficient control by the charge holder over the proceeds of the debt. The importance of control was stressed in authorities such as In Re Brightlife Ltd.343 However a controversial decision of the English Court of Appeal, In Re New Bullas Trading Ltd,344 had taken a liberal approach to a novel form of charge. The draftsman in New Bullas had created a fixed charge over the book debts whilst uncollected, but had released the book debts to a floating charge when collected. The Court of Appeal approached the question as one of freedom of contract, and having identified no public policy obstacles to such a charge, upheld this novel security. Brumark disapproved New Bullas Trading and restated the importance of control as emphasized in Brightlife. There are many fascinating commercial implications of the Brumark and Spectrum cases which are not our present concern.345 Brumark emphasizes a distinction between interpretation and characterization.346 In Brumark the Privy Council attacked the purely interpretative approach of the Court of Appeal in New Bullas. Lord Millett, delivering the advice of an exceptionally strong Privy Council, approached the process of construction in traditional holistic mode, focussed on the text embodying the charge, and its ancillary provisions.

5.148  However, towards the end of the advice his Lordship considered the relevance of how banks and other charge holders actually carried out the terms of the contract. Lord Millett gave guidance on what was required for a charge on book debts to be a fixed charge, and in particular the practice of some bank charge holders including contractual provisions creating a so-called ‘blocked account’ into which the proceeds of book debts are paid:

[I]t is not inconsistent with the fixed nature of a charge of book debts for the holder of the charge to appoint the company as its agent to collect the debts for its account or on its behalf … The proceeds of the debts collected by the company were no longer to be trust moneys but they were required to be paid into a blocked account with the charge holder. The commercial effect was the same: the proceeds were not at the company’s disposal. Such an arrangement is inconsistent with the charge being a floating charge, since the debts are not available to the company as (p. 245) a source of its cash flow. But their Lordships would wish to make it clear that it is not enough to provide in the debenture that the account is a blocked account if it is not operated as one in fact.347

5.149  This appears to admit the relevance of subsequent conduct in the interpretation of the debenture documents which create charges over book debts. The first thing to note is that according to the distinction introduced by Lord Millett the subsequent conduct appears to be relevant to the process of characterization, not the pure process of interpretation. This may be one way of explaining the apparent admissibility of subsequent conduct in such cases. The problem is that the admission of subsequent conduct may appear to change the proper characterization of an instrument. For example, an instrument drafted in the way suggested by the Privy Council would appear on its face at the time of formation to be capable of creating a fixed charge over book debts.

5.150  However, the suggested recourse to how the accounts operated in practice suggests that if the bank or other charge holder does not actually operate the provisions relating to control, the charge will be recharacterized as a floating charge. Is it the case that the operation in the process of characterization is not always complete at the time the contract is formed? Is this not a case where ‘a contract meant one thing the day it was signed but, by reason of subsequent events, meant something different a month or a year later’?348 If characterization is a linked process to interpretation this case may signal growing doubts about the wisdom of adhering to a strict subsequent conduct rule.

5.151  There appear to be a number of ways of explaining Lord Millett’s remarks in Brumark. First, it creates a special exception for subsequent conduct in the field of characterizing fixed or floating charges, and more generally, in the process of characterization of legal transactions. Subsequent conduct, it would seem, is now admissible in such cases. Secondly, it may be that the subsequent conduct generates an estoppel (albeit not an estoppel by convention, as it seems to depend upon the conduct of only one party) which prohibits the charge holder from enforcing what otherwise would be the strict legal entitlement based upon the instrument properly construed. Thirdly, it may be that subsequent conduct is relevant to the process of identifying whether an agreement is in fact a sham. This may be what Staughton LJ described as the ‘external route’ to discerning a sham in another context.349 Overall the Privy Council was not over-concerned about the juridical (p. 246) basis of its reference to subsequent conduct in what was otherwise a very thorough opinion.350

5.152  In the subsequent leading English case of Re Spectrum Plus Ltd the House of Lords, whilst approving of the reasoning in Agnew in general, was careful not to comment directly on the basis or correctness of Lord Millett’s view as to the relevance of subsequent conduct in this context.

5.153  Lord Walker came closest to addressing the issue:

It is also necessary to bear in mind Lord Millett’s warning in Agnew’s case,[351] that formal provision for a blocked account is not enough ‘if it is not operated as one in fact’. Lord Millett did not expand on this point, which may raise difficult questions as to what Staughton LJ, in Welsh Development Agency v Export Finance Co Ltd,[352] referred to as ‘external’ and ‘internal’ routes to the construction of commercial documents.353

It is submitted that where the issue is one of categorization or characterization, whilst the courts will usually attempt to resolve the issue by construing the contract or instrument against the admissible background, it is nevertheless open to them to investigate (in appropriate cases) whether the contractual language was in fact mere ‘window dressing’ to achieve some juridical advantage, by reference to how the contract or transaction was in fact carried out. For further consideration see the discussion in Chapter 27.354

Exception (2): oral contracts

5.154  The exclusionary rule has been held inapplicable to contracts which are not reduced to writing. This is consistent with the general principle that whilst construction of written contracts and terms is a question of law, determining the content, meaning, and effect of contracts which are oral, or at least partly oral, is a question of fact.355 This was made clear by the House of Lords in the leading, modern case of Carmichael v National Power plc.356

5.155  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.357 The industrial (p. 247) tribunal358 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:

[I]t 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.359

5.156  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.360

5.157  In contrast, Chadwick LJ in the Court of Appeal had insisted that: ‘The question is not what the parties thought their obligations were.’361 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.’362 Here the agreement was founded partly on oral exchanges and conduct. Evidence, even of uncommunicated subjective intentions of the parties, was admissible in determining what the agreement was between the parties, even though the ultimate test ascertaining the intention of the parties was the objective test:

The evidence of a party as to what terms he understood to have been agreed is some evidence tending to show that those terms, in an objective sense, were agreed. Of course the tribunal may reject such evidence and conclude that the party misunderstood the effect of what was being said and done.363

(p. 248) 5.158  In Maggs (trading as BM Builders) v Marsh364 a builder submitted an estimate of the costs of refurbishment of the appellant’s townhouse in Bath. Work commenced pursuant to an oral agreement, and during performance the appellant instructed the builder to carry out additional works. The judge refused to have regard to evidence subsequent to the formation of the contract to determine which works were within the scope of the contract. That finding was reversed by the Court of Appeal. Where a contract was partly written and partly oral, determining the scope of the contract was a question of fact and the judge had been wrong to disregard evidence of subsequent conduct. Smith LJ referred to James Miller & Partners Ltd v Whitworth Street Estates (Manchester) Ltd 365 and continued:

In my judgment it is clear that the principle set out in Miller’s case, does not apply to an oral contract. Determining the terms of an oral contract is a question of fact. Establishing the facts will usually, as here, depend upon the recollections of the parties and other witnesses. The accuracy of those recollections may be tested and elucidated by things said and done by the parties or witnesses after the agreement has been concluded. Receiving evidence of such words or actions does not mean that the judge is losing sight of his task of deciding what the parties agreed at the time of the contract. It is simply helping him to decide whose recollection is right. It is not surprising to me that the editor of Lewison should observe that there is nothing in the authorities to prevent the court from looking at post contract actions of the parties. As a matter of principle, I can see every reason why such evidence should be received.366

5.159  In Thorner v Major,367 in the context of a proprietary estoppel claim, Lord Neuberger cited Lord Hoffmann’s ‘illuminating analysis’ in Carmichael, and observed:

This shows that (a) the interpretation of a purely written contract is a matter of law, and depends on a relatively objective contextual assessment, which almost always excludes evidence of the parties’ subjective understanding of what they were agreeing, but (b) the interpretation of an oral contract is a matter of fact (I suggest inference from primary fact), rather than one of law, on which the parties’ subjective understanding of what they were agreeing is admissible.

The reason for this dichotomy is partly historical. Juries were often illiterate, and could therefore not interpret written contracts, whereas they could interpret oral ones. But it also has a good practical basis. If the contract is solely in writing, the parties rarely give evidence as to the terms of the contract, so it is cost-effective and practical to exclude evidence of their understanding as to its effect. On the other hand, if the contract was made orally, the parties will inevitably be giving evidence as to what was said and done at the relevant discussions or meetings, and it could (p. 249) be rather artificial to exclude evidence as to their contemporary understanding. Secondly, and perhaps more importantly, memory is often unreliable and self-serving, so it is better to exclude evidence of actual understanding when there is no doubt as to the terms of the contract, as when it is in writing. However, it is very often positively helpful to have such evidence to assist in the interpretation of an oral contract, as the parties will rarely, if ever, be able to recollect all the details and circumstances of the relevant conversations.368

Exception (3): variation by conduct

5.160  It was explicitly recognized that variation by conduct operated as an exception to the exclusionary rule in the leading cases. The governing principles are presumably analogous to those applicable to implied contracts and contracts concluded by conduct, which are considered further in Chapter 14.369

Exception (4): estoppel by convention

5.161  This is perhaps the principal exception in practice. For full consideration see Chapter 18.

The Future

5.162  In the wake of the decision of the House of Lords in Chartbrook Ltd v Persimmon Homes Ltd 370 it appears very unlikely that the exclusionary rules in relation to both prior negotiations and subsequent conduct will be revisited or abrogated by judicial decision in the immediate future. More likely, the limits of the exclusionary rules (for example, recourse to the negotiations to ascertain objective background facts) will be explored and tested in future cases. The rule will be circumvented in practice by parties pleading an appropriate exception, and the judge seeing the supposedly inadmissible evidence in any event. Some may be as direct as Baroness Hale of Richmond and confess that without sight of the material the conclusion would not be so easy.371 Any supposed time and costs savings will be negated, and usually outweighed by the need to plead cases in the alternative, and for solicitors and counsel to research the relevant law and principles not just of construction (perhaps embracing the scope of the subject-matter exception, or of the disputed ‘private dictionary’ and ‘genesis’ exceptions), but also of the most relevant escape route (rectification, estoppel by convention, or one or more of the others). Pre- and post-contractual documentation will remain disclosable if they tend to advance or detract from one side’s case under any of these doctrines and their exceptions. It may be that no other jurisdiction in the world (p. 250) invests so much time, effort, and money in considering the potential legal significance of prior negotiations, and other inadmissible materials. With the benefit of hindsight, Chartbrook v Persimmon may be seen as a turning point (perhaps like The Atlantic Star372 in the context of forum non conveniens) where the highest court, whilst explicitly rejecting a suggested development, in practice accepted it in the result, and set the law on a new course. Only time will tell.

5.163  Similarly, it would appear unlikely that this most characteristic example of ‘lawyers’ law’ would be high on the agenda for the Law Commission or other law reform bodies. English judges, with unparalleled experience in construing commercial contracts and other documentation, have clearly signalled (and occasionally celebrated) a preference for the exclusionary approach, with the text at the centre of consideration. It should be noticed that two members of the House of Lords did consider the possibility of statutory law reform. Lord Hoffmann eventually concluded that in the light of the consistent body of judicial authority favouring the exclusionary rule, it was not a matter capable of judicial resolution. Nevertheless, his Lordship accepted: ‘It is possible that empirical study (for example, by the Law Commission) may show that the alleged disadvantages of admissibility are not in practice very significant or that they are outweighed by the advantages of doing more precise justice in exceptional cases or falling into line with international conventions.’373 In contrast, Baroness Hale, a former Law Commissioner, said that her experience suggested that it was very difficult to achieve satisfactory legislative reform of such a common law rule: ‘The courts, on the other hand, are able to achieve step-by-step changes which can distinguish cases in which such evidence is “helpful” from cases in which it is not.’374 On that basis, it would seem unlikely that the task of reforming the exclusionary rule could be achieved other than by the judges, either acting independently, or following legislation which abolished one or more of the exclusionary rules and left to the judges to fashion what should take its place.

Reform of the exclusionary rules

5.164  It remains worthwhile summarizing the arguments for and against a liberalization of the admissibility of prior negotiations and subsequent conduct for the purpose of construing a contract. Academic commentators are near unanimous in their support for reform.375 The first point to note however is that while English contract law adheres to an objective theory of agreement any declarations (p. 251) of subjective intent and statements of one party’s position in the negotiation process will remain of little or no evidential value. It has now been accepted by the House of Lords that there is no necessary correlation between the objective theory and the exclusionary rules.376 Broadly speaking the arguments in favour of liberalization are as follows:

  1. (1)  Any legal text can only be understood in its context, which includes all the relevant surrounding circumstances. Accordingly as a matter of principle the liberal approach to admissible background in the Investors Compensation Scheme case should be pursued to its logical conclusion.

  2. (2)  The current prior negotiations rule is itself incoherent, or at least too subtle a distinction for practitioners to apply with any certainty, in that Lord Wilberforce in Prenn v Simmonds stated that whilst negotiations were generally inadmissible, they were admissible to identify the commercial purpose or aim of a transaction, or to establish facts known to both parties.

  3. (3)  The exclusionary rule may work injustice where credible evidence exists of a prior consensus between the parties which would render some questions of interpretation more straightforward. Accordingly the question should be one of the weight to be attached to the evidence, rather than its admissibility in the first place.

  4. (4)  The existence of escape routes from the current rules in the shape of rectification for prior negotiations and estoppel by convention for subsequent conduct (together with other less-clear exceptions) further demonstrates the incoherence of the current English position.

  5. (5)  The English rule of inadmissibility is out of step with most other legal systems, including civil law countries and the United States. Furthermore, international instruments and restatements of contract law, such as the Vienna Convention on International Sale of Goods (‘CISG’), the Principles of European Contract Law, the UNIDROIT Principles of International Commercial Contracts, and the Draft Common Frame of Reference, explicitly require that a judge does consider prior negotiations and subsequent conduct as matters material to the process of construction.

(p. 252) 5.165  The arguments against liberalization are as follows:

  1. (1)  English contract law is committed to an objective theory of contract. There are good pragmatic reasons for adhering to the objective view, not least because commercial parties (including many from overseas who choose to litigate or arbitrate in England and Wales) choose English law because it ascertains what the contract means, rather than seeking to discern the absolute truth about parties’ intentions.

  2. (2)  It follows that the restrictive rules promote certainty in the construction of contracts by focusing the exercise in construction on the principal document. The predictability of the outcomes of disputes, litigation, and arbitration is thereby enhanced.

  3. (3)  Admitting prior negotiations would increase the time and cost of advising on contracts, contractual disputes, litigation, and arbitration. It would open the floodgates on a great volume of evidence of little or no forensic value.377

  4. (4)  The impact on third parties who rely on a contract or acquire rights under it as assignees, transferees, or under the Contracts (Rights of Third Parties) Act 1999. Often many of the contracts depend upon a principal contract and are linked to it. For example, in international trade the international sales contract will be linked to carriage, insurance, banking, and stevedoring contracts. Such third parties can only rely upon the contract and its obvious commercial context, and may know nothing of prior negotiations or subsequent conduct of the immediate parties.

5.166  In the wake of Chartbrook the first of these counter-arguments has been abandoned. The second and third weighed heavily with Lord Hoffmann; the fourth less so. Most recently in Tartsinis v Navona Management Co Leggatt J instanced both the objective principle and the exclusion of prior negotiations and continued:

These rules have many advantages. Such advantages include: (i) enabling a party to predict with a reasonable degree of certainty when entering into a contract how its provisions will be interpreted, without having to probe or be concerned about whether the other party shares this understanding or with trying to lay a favourable paper trail in pre-contractual correspondence; (ii) enabling a lawyer advising a party, or a judge or arbitrator required to interpret the contract, to do so on the basis of relatively little information and without the need for an extensive and expensive factual inquiry; and (iii) respecting the autonomy of the contracting parties by treating them as rational agents who have chosen the words of their document to give appropriate expression to their bargain. There are some cases, however, in which the application of these rules would lead to injustice. In particular, that (p. 253) is potentially so in circumstances where the parties to the contract had a common intention or understanding when they made the contract as to what it meant which was different from the objective meaning of the contractual document as ascertained in accordance with the rules of interpretation.378

That rationalization favours retaining rectification as a safety valve, and only permitting full recourse to the evidence where that remedy is claimed. Nevertheless it is submitted that the balance of the argument still favours liberalization.

Reform of the exclusionary rules in other common law jurisdictions

5.167  It is also worth reviewing developments in New Zealand and Singapore where both the prior negotiations and the subsequent conduct rules have been revisited and found wanting by the highest courts.

Prior negotiations

Yoshimoto in the Court of Appeal of New Zealand

5.168  In Yoshimoto v Canterbury Golf International Ltd 379 a Japanese businessman owned all the shares in a company formed to develop an international golf course outside Christchurch. Canterbury Golf International Ltd (CGI) wished to acquire those shares. The two parties entered into a contract on 14 March 1996 whereby Mr Yoshimoto agreed to sell all his shares in return for NZ$3.4 million. An initial NZ$2 million was promptly paid. The question was whether the second instalment of NZ$1 million was due and owing. Clause 6.3 of the contract stated that it was a condition precedent of payment that the defendant had obtained all ‘necessary’ resource consents (for planning purposes) within 12 months. The contract provided first by recital D that the company had applied for such consents which were ‘necessary to enable the Development … to proceed’. In detail, clause 6.3 provided: ‘It shall be a condition precedent to the Vendor’s right to demand payment … of NZ$1 million … that [CGI] obtains all necessary … consents to the Development within twelve months of the date of this Agreement.’ There was also a contractual obligation on the part of CGI to take all reasonable and practical steps to obtain the consents (under clause 6.5).

Thomas J observed that the arrangement was a ‘recipe for disaster’.380 The NZ$1 million was payable only if planning approval was obtained within a tight timetable, but the responsibility for securing the necessary approvals was with the purchaser. In fact CGI did not obtain one of the consents, albeit one which had not been applied for at the time of the contract, until five months after the deadline. At first instance it was held that Mr Yoshimoto’s claim for the NZ$1million must fail on the facts. However on appeal the Court of Appeal of New Zealand (p. 254) disagreed with the first instance judge. It held that, whilst the resource consent was necessary to the development in the sense that it could not commence without it, it was not ‘necessary’ within the meaning of that term in the contract.381 Thomas J’s judgment drew support for his conclusions from four sources: (a) the rest of the contract; (b) the commercial objective; (c) the matrix; and (d) extrinsic evidence. We are concerned with the last category. In the opinion of Thomas J the planning issue in question was only a matter of tying up loose ends. The court could not ignore the fact that notwithstanding clause 6.5 CGI had a NZ$1 million incentive to prolong the process for more than a year.

5.169  Thomas J held that when the extrinsic evidence was considered there could be no real doubt as to the proper construction of the contract. Thomas J commented:

This Court is fully aware of the problems associated with evidence of the parties’ pre-contractual negotiations. Pre-contractual negotiations may not be unequivocal. They may simply indicate the changing thinking or position of the parties up to the time a final consent is reached and the contract is executed. I will therefore approach the evidence which was adduced by both parties relating to their conduct prior to 14 March 1996 with considerable caution. No evidence that can be said to be simply evidence of the parties’ subjective intention need be considered. For this reason, I confine my consideration to the earlier draft contracts, the changes made to cl. 6.3 and an earlier recital relevant to that clause.382

Accordingly Thomas J considered five travelling draft contracts and an earlier draft recital (limited to planning consents ‘presently applied for’) which was deleted only after the contract had been executed. Thomas J concluded that the NZ$1 million was intended to be paid as an additional premium of consideration of the development potential of the site. No change or development in the parties’ thinking was evidenced by the travelling drafts when compared to the final contract.

5.170  However the problem remained as to whether the evidence of prior negotiations was admissible under the law of New Zealand. Thomas J cited Lord Steyn’s extrajudicial view that if the rule against pre-contractual negotiations or subsequent conduct was absolute and unqualified it would sometimes defeat the reasonable expectations of honest men.383 What Thomas J described as ‘the landmark statement—or restatement—of the law relating to the construction of contracts’ in the Investors Compensation Scheme case had been adopted by the Court of Appeal in New Zealand in Boat Park Ltd v Hutchinson.384 In particular, Thomas J referred to Lord Hoffmann’s recognition that the boundaries of the rule rendering (p. 255) admissible prior negotiations and declarations of subjective intent are, in some respects, unclear.385 Thomas J concluded:

Lord Hoffmann’s speech in West Bromwich is welcome not only because of its clarity and attempt to rationalise and bring up-to-date the court’s approach to contractual interpretation, but also because it undoubtedly presages a common-sense approach to that task. The difficulties and analysis which I have traversed cannot be avoided but are, I would think, to be confronted with the same common-sense as is enjoined in that statement. If the language of cl 6.3 read in the context of the contract as a whole, in the light of its commercial objective, and having regard to the contractual matrix do not bring one to the conclusion that a resource consent under the Proposed Plan was effectively a foregone conclusion, it would seem sensible to have regard to the pre-contractual drafts referred to above. It is only by having regard to the evidence that the situation can be avoided whereby the Courts risk adopting a meaning which is not what the parties actually intended.

Yet, the rule of evidence of pre-contractual negotiations is not receivable is seemingly absolute. On the basis the evidence of the prior drafts must be excluded. The drafts are part of the negotiations of the parties using the term ‘negotiations’ in its ordinary sense. For reasons I will give shortly, I am not convinced that the rule is or should be absolute. Certainly, for present purposes, the rule could stand as the general rule, but it can surely enjoy sufficient flexibility to permit a departure where a departure will enable the Court to arrive at a meaning of the contract which accords with the ascertainable intention of the parties.386

Three factors warranted departure from the general rule in this case. First, nobody contended for a literal meaning of the clause. When the literal meaning was departed from the court would be assisted by admission of extrinsic evidence. Secondly, the predecessors of the contested clause were not in dispute. Thomas J would draw a distinction between negotiations which form part of the bargaining process and consequential changes seeking to give effect for the value reached. He proposed a less-absolute rule for the latter case. Finally, the draft contracts provided hard evidence of the types of planning consent which the parties had in mind when drafting the clause. Overall Thomas J was convinced that the meaning of a contract can never be clear except when it is placed in context. Thomas J’s conclusions were not intended to interfere with the objective basis of contractual interpretation. Furthermore, he considered that the court should still be cautious when treating such evidence and would have higher regard for documentary evidence over oral testimony.

Yoshimoto in the Privy Council

5.171  Despite Thomas J’s forceful judgment,387 when the case reached London the Privy Council allowed CGI’s appeal: Canterbury (p. 256) Golf International Ltd v Yoshimoto.388 The Judicial Committee (which included Lords Hoffmann and Nicholls) conducted a detailed review of the evidence, and ultimately preferred a stricter reading of the contract. Whilst clause 6.3 created an incentive for CGI to delay, Mr Yoshimoto was protected by the requirement in clause 6.5 that ‘all reasonable and practical steps’ were to be taken to obtain the consents, and there was no allegation of breach of that clause. The outstanding consent was necessary in planning law terms and therefore for the purposes of clause 6.3 it was four months too late. The effect of the construction of the New Zealand Court of Appeal was to construe ‘obtains’ as ‘is very likely to obtain’. Such a re-writing was not justified by anything in the background. With regard to the earlier drafts, the Privy Council, in an advice delivered by Lord Hoffmann, did not consider them helpful:

In a separate section of his judgment, Thomas J expressed the view that his construction was supported by two provisions in earlier drafts of the contract. He said that the normal rule which excludes evidence of pre-contractual negotiations, authoritatively stated by Lord Wilberforce in Prenn v Simmonds 389 … should be relaxed or departed from. Their Lordships do not think that this is a suitable occasion for re-examining the law because they consider that in this case the evidence is, as Lord Wilberforce predicted, unhelpful.390

5.172  The reference in the deleted recital to consents ‘presently applied for’ was not definitive and only signified that some consents would be necessary. It added nothing to recital D which had survived. Furthermore, there was no purpose in speculating over the changes made to clause 6.3 itself:

Their Lordships do not think that it is helpful to try to construe the earlier version of clause 6.3 because it was dropped and the present clause 6.3 substituted. It seems to them pointless to try to speculate upon why the change was made. No doubt each party had their reasons for proposing it on the one hand and accepting it on the other. All a court can do is to decide what the final contract means.391

5.173  On the evidence in this case the traditionally inadmissible evidence was not considered relevant and therefore did not persuade their Lordships that a development or restatement of the law was necessary. Given that the court only had access to documentary negotiations and not witness evidence, any opinions about changes in drafts would be necessarily speculative. Similarly in Chartbrook Ltd v Persimmon Homes Ltd 392 Lord Hoffmann referred to Thomas J as a critic of the rule, but noted that the Privy Council had found no ‘gold’ amidst ‘the dirt of aspirations, proposals and counterproposals’. Nevertheless this was the foundation for Lord Hoffmann’s important concession that as a matter of principle the prior (p. 257) negotiations may yield relevant evidence.393 In the modern leading English case was a purely pragmatic decision to disregard this potentially relevant evidence.

Vector Gas Ltd v Bay of Plenty Energy

5.174  The most recent consideration is the decision of the New Zealand Court of Appeal in Vector Gas Ltd v Bay of Plenty Energy Ltd.394

5.175  Two energy companies, both concerned in the New Zealand gas industry, entered into a gas supply agreement in 1995 whereby Vector Gas (then the Natural Gas Corporation of New Zealand Ltd (‘NGC’)) agreed to supply gas to Bay of Plenty Energy Ltd (‘BoPE’) (‘the Agreement’), which was then sold on to a milk-processing plant in Edgecumbe on the Bay of Plenty. In August 2004 NGC gave notice of termination of the Agreement to BoPE. The validity of this notice of termination was the original core of the parties’ dispute, but its legitimacy was upheld by the High Court and Court of Appeal, and no appeal was made in respect of that issue to the Supreme Court. The superficially straightforward issue before the New Zealand Supreme Court was whether a new agreement concluded on 15 October 2004 for NGC to continue to supply gas at a price of NZ$6.50 per gigajoule pending resolution of the termination dispute was inclusive or exclusive of transportation or delivery costs. The letter recording the Agreement did not explicitly address the issue, but referred back to the 1995 agreement, which was inclusive of transportation costs, which supported BoPE’s contention that the proper construction of the Agreement was for an inclusive price. Nevertheless the New Zealand Supreme Court unanimously preferred NGC’s contention that the price was exclusive of transportation costs. The difference between the two parties was worth some $3 million. The five judges reached the same destination by a variety of different routes, which each requires sensitive analysis.

5.176  In summary, two of the judges considered the meaning of the 15 October letter (and in particular the word ‘supplied’) to be plain and unambiguous (McGrath and Wilson JJ), agreeing with the Court of Appeal that it meant an inclusive price. Tipping J disagreed, and insisted that it was ambiguous, whether viewed in isolation or in context. The other two judges were more non-committal, with Blanchard J inclining to the view that it probably meant an inclusive price. Four of their Honours thought that regard could be had to background evidence, without a threshold of ambiguity having to be crossed. Wilson J seriously disagreed, reasserting traditional ‘plain meaning rule’ thinking and the need for an ambiguity threshold. Blanchard and Gault JJ thought that recourse could be had to the correspondence through the ‘subject matter rule or exception’. In doing so they disagreed with McGrath J, who defined the subject-matter rule (p. 258) more narrowly, and did not think that it could assist in determining the price here. Neither Tipping J nor Wilson J invoked this rule either way. For Wilson J, recourse was only possible to the correspondence via the estoppel-by-convention exception. Three of the judges employed estoppel by convention as an alternative ratio: Tipping, McGrath, and Wilson JJ. All the judges appeared to think that the inclusive price construction made no commercial sense.

5.177  On prior negotiations and subsequent conduct, the court split in three (or possibly four) directions. Blanchard and Gault JJ considered that it was not necessary to consider the issue on this occasion. McGrath J considered that the House of Lords had got it right in Chartbrook, and that the exclusionary rule should continue, subject to the legitimate safety valves of rectification and estoppel by convention. Both Tipping and Wilson JJ concluded that Prenn v Simmonds should be abandoned, and that all relevant evidence of prior negotiations and subsequent conduct should be admitted and weighed. Wilson J’s liberal stance on this has to be counterbalanced by his conservative restatement of the plain meaning rule. Tipping J revisited his Gibbons opinion, and his ‘shared or mutual’ restriction on evidence of subsequent conduct. His Honour abandoned it in favour of the objective principle. Wilson J took the same line.

5.178  It is necessary to set out the correspondence leading up to 15 October 2004 in a little more detail, although different judges had recourse to the correspondence on different legal bases. On 28 September 2004 NGC offered BoPE a range of options for the future supply of gas including an offer that gas could be purchased at NZ$6.50 per gigajoule. That letter was explicit that ‘transportation and metering rates’ were not included, and would need to be discussed taking into account historic usage and posted prices. On 5 October BoPE’s solicitors responded, rejecting the offer and intimating that proceedings were imminent on the termination issue. It noted that NGC had acknowledged that it had gas to supply at NZ$6.50 per gigajoule. The letter continued with a proposal that in lieu of BoPE ‘having to apply for injunctive relief’, NGC should agree to continue to supply gas ‘on the basis of the Agreement’ pending resolution of those proceedings. Correspondingly BoPE would undertake in the event that its proceedings were discontinued or were unsuccessful to pay for each gigajoule ‘the difference between the Agreement price and NZ$6.50 (or the current market price, whichever is lower), plus interest’. This became the basis of the Agreement recorded in correspondence on 15 October that BoPE agreed in the event that its proceedings were discontinued or were unsuccessful to pay ‘for each GJ supplied, the difference between the price set out in the Agreement and $6.50 per GJ’, plus interest as per the Agreement.

5.179  In the most important judgment, Tipping J insightfully observed that: ‘Some of the difficulties in this area may derive from the concept of “prior negotiations” being employed in a more or less expansive way.’ His Honour continued:

(p. 259)

It is necessary, however, to distinguish between the subjective content of negotiations; that is, how the parties were thinking, their individual intentions and the stance they were taking at different stages of the negotiating process on the one hand, and, on the other, evidence derived from the negotiations which shows objectively the meaning the parties intended their words to convey. Such evidence includes the circumstances in which the contract was entered into, and any objectively apparent consensus as to meaning operating between the parties.395

5.180  It is submitted that that is far more consistent with the classical authorities than many more recent authorities, and properly deploys the objective principle to determine which pre-contractual material is available. Tipping J was clear:

There is no problem with objective evidence directed to the context, factual or linguistic, in which the negotiations were taking place. That kind of evidence can properly inform an objective approach to meaning. Whereas evidence of the subjective content of negotiations is inadmissible on account of its irrelevance, evidence of facts, circumstances and conduct attending the negotiations is admissible if it is capable of shedding objective light on meaning. It is often said in contract interpretation cases that evidence of surrounding circumstances is admissible. Circumstances which surround the making of the contract can operate both before and after its formation. In either case irrelevance should be the touchstone for the exclusion of evidence. I do not consider there are any sufficiently persuasive pragmatic grounds on which to exclude evidence that is relevant.396

The recent English conversion to pragmatic or policy-based reasons for excluding otherwise relevant evidence was thus rejected.

5.181  Critically Tipping J explicitly retreated from his earlier judgment in Gibbons Holdings Ltd v Wholesale Distributors Ltd 397 (which is considered further below) which had insisted on a ‘shared or mutual’ intention precondition to admitting evidence. Accordingly evidence which did not cross the line between the parties, or otherwise demonstrated mutuality, was not relevant. However Tipping J’s second thoughts were that the governing criterion was to be straightforwardly the objective principle:

There is no logical reason why the same approach should not be taken to both post-contract and pre-contract evidence. The key point is that extrinsic evidence is admissible if it tends to establish a fact or circumstance capable of demonstrating objectively what meaning both or all parties intended their words to bear. Extrinsic evidence is also admissible if it tends to establish an estoppel or an agreement as to meaning.398

Tipping J reviewed the earlier correspondence and concluded:

(p. 260)

It is clearly apparent, on an objective basis, that the parties had reached an agreement during the negotiations as to what meaning the expression $6.50 per GJ should bear for the purposes of the contract they ultimately entered into. That agreement was still operating when the final agreement was reached.399

5.182  Wilson J, whilst puzzlingly attempting to reassert the ambiguity threshold, also accepted the nineteenth-century approach that if ambiguity was established all the evidence becomes available, including declarations of subjective intent (but not ‘undeclared intent’).400 Having commenced with a conservative, nay reactionary, stance, the tone of Wilson J’s judgment then turned more radical:

Prior negotiations may well be relevant; the time has come to remove in this country the barrier imposed by Prenn v Simmonds to looking at those negotiations in a situation where they illuminate, in advance of consensus being achieved, what the parties were intending to achieve in their contract. Their conduct subsequent to the contract may also be a helpful guide to what was intended in the contract.401

5.183  If His Honour had been in the court in Gibbons Holdings Ltd v Wholesale Distributors Ltd 402 (he was successful counsel) he would have joined the majority on the question of principle, and would not have imposed a ‘shared or mutual’ intention restriction. Whether the evidence crossed the line or was mutual went to weight, not admissibility. Wilson J would have admitted the evidence here on the basis of his estoppel exception. It is submitted that the approach of both Tipping and Wilson JJ now approximates to that adopted by Thomas J in Gibbons.

5.184  Blanchard J, with whom Gault J agreed, delivered a succinct judgment. First, His Honour considered the ordinary meaning of ‘supplied’, and suggested that it was perhaps more likely to be indicative of an inclusive price. Secondly, the context of the agreement was the proposed interim order application to ensure that supply continued. The quid pro quo of the court granting that order would have been BoPE’s undertaking in damages to NGC for the loss it would suffer if its argument that it was entitled to refuse to supply eventually succeeded. Such loss would be measured by prevailing market rates which in October 2004 were on average $6.68 plus transmission costs.403 Thirdly, recourse to that background (which is always possible without the need to prove ambiguity) demonstrated that the agreement was ambiguous, and furthermore that in the context of ‘an interim settlement of an aspect of larger dispute about supply under the 1995 Agreement’404 BoPE’s suggested inclusive price construction was ‘exposed as commercially absurd’.405

(p. 261) 5.185  Moving beyond the immediate context to the parties’ negotiations recorded in the correspondence, Blanchard J noted the confirmation of the exclusionary rule in Chartbrook Ltd v Persimmon Homes Ltd406 and that it appeared to continue to hold sway in Australia,407 but insisted that the rule was not without exception. These included the recourse to the negotiations ‘not in order to provide a gloss on the terms of the contract, but rather to establish the parties’ knowledge of the circumstances with reference to which they use the words in the contract’.408 In addition, it embraced the genesis, the background, and the market. Critically it included the ‘subject-matter exception’, which also in part defined the commercial object of the transaction. Here Blanchard J (with Gault J agreeing), expressly differed from the narrower approach to the ‘subject-matter exception’ adopted by McGrath J. In Blanchard J’s view:

I see no reason why it can be called in aid, if necessary, for the purpose of ascertaining that the contract was concerned with a gas supply but not to learn that it dealt with gas only. If there is, as I think, a subject matter exception, there cannot sensibly be degrees of subject matter. There is of course an important qualification that any material which is simply declarative of the subjective intentions of one party must be disregarded. But there is no reason in principle why the Court should not have regard to communications between the parties for the light they may throw upon the objective commercial purpose and, in particular, what ground the contract was to cover.409

5.186  On the basis of that broad approach to subject-matter there was no need to examine the broader issue of principle: ‘The question of how much further the courts of this country should go towards admitting evidence of negotiations for the light they may shed on the objective intention of the parties can be left for another day.’410

Accordingly, Blanchard and Gault JJ appear to have decided that the immediate context, genesis, or purpose of the agreement (obviating the need for an injunction hearing) were sufficient to demonstrate that the inclusive price construction was commercially absurd. Furthermore, that conclusion was ‘reinforced’ if reference were made to the correspondence leading up to the agreement, which was admissible on the basis of the subject-matter exception: it demonstrated what the supply of gas consisted of.

5.187  Of the five judges, only McGrath J endorsed the conservative English rejection of any liberalization in Chartbrook:

I am satisfied that the House of Lords judgments in Investors Compensation Scheme and Chartbrook set sound limits for the common law principles (p. 262) concerning admission of extrinsic material so that considerations of purpose will bear to an appropriate degree in deciding the meaning of a commercial agreement. The current English position is the outcome of decades of close consideration of the conflicting arguments reflected in the views of judges, legal academics and practising lawyers. It has recently been reaffirmed by the House of Lords. It also appears to reflect the current position of the High Court of Australia. I see no point in New Zealand courts at this stage attempting to put a gloss on the general approach so recently stated by the House of Lords. It is better that the common law of New Zealand in this important field of commerce march in step with settled approaches overseas unless and until very good reasons for departure emerge.411

5.188  Furthermore, McGrath J took a very restrictive view of the ‘subject-matter rule’. The earlier correspondence was inadmissible because McGrath J considered the meaning of the final letter to be unambiguous. No relevant exception applied:

Insofar as it bears on price, this material is not part of the factual background that might throw light on what the parties meant when they agreed on terms expressed in [the] letter of 15 October. Nor is it evidence going to the subject matter of the contract. The subject matter was the supply of gas which does not need more precise identification. What is in issue is the price payable under the agreement. The subject matter exception does not permit the admission of pre-contractual material to clarify such a term.412

This is far too limited an account of subject-matter, as Blanchard and Gault JJ made clear. It can be contrasted with the nineteenth-century authorities we have discussed. Evidence should have been admitted to see whether the subject-matter was ‘gas without delivery’ or ‘gas with delivery’. However McGrath J was consistent with the conservative position, and reached the same result via the legitimate safety device of estoppel. The pre-contractual material was inadmissible for the purpose of construction, but was admissible for the purposes of estoppel, and on that basis BoPE was estopped from denying that it had agreed to a price exclusive of transmission costs.413

Zurich Insurance (Singapore) v B-Gold

5.189  Singapore has decisively embraced the modern contextual approach. The leading Singaporean case on contractual construction is Zurich Insurance (Singapore) Pte Ltd v B-Gold Design & Construction Pte Ltd.414 It was common ground that the commercial insurance policy in that case represented the complete agreement of insurer and insured.415 Accordingly reference to the extrinsic evidence was firmly (p. 263) constrained. Here the judge had disapplied an entire exclusion clause, not merely ‘read down’ a clause, by giving it a narrower interpretation. The judge had ‘strayed far into the realm of varying a contract’.416 This was a relatively straightforward exercise in construction of a standard form, commercial insurance policy, which was accepted to the entire agreement of the parties. Nevertheless, in the light of inconsistencies in prior Singaporean case law the Court of Appeal took the opportunity to ‘clarify and consolidate’417 the governing principles of the law of evidence and of contractual interpretation.

5.190  The court stressed both the need for loyalty to the test of the contract as the principal (and often only) source of meaning and effect. It also stressed the importance of certainty: ‘The Singapore courts have always been mindful of the need for contractual certainty, especially in commercial agreements.’418 That policy might often necessitate restraint in admitting background circumstances, particularly for standard forms:

A court should take into account the essence and attributes of the document being examined. The court’s treatment of extrinsic evidence at various stages of the analytical process may differ depending on the nature of the document. In general, the court ought to be more reluctant to allow extrinsic evidence to affect standard form contracts and commercial documents.419

Nevertheless the Court of Appeal embraced the modern approach to contractual construction:

The traditional approach does not accord with ordinary commerce. Under that approach, the courts, faced with a wealth of text but a dearth of context, have often attributed to contracting parties artificial objective intentions that are divorced from reality. For the reasons given above, the contextual approach is here to stay in Singapore.420

This extended to a decisive rejection of the ‘plain meaning rule’ or ‘ambiguity threshold’.

5.191  The court was emphatic: ‘Crucially, ambiguity is not a prerequisite for the admissibility of extrinsic evidence.’421 However there remained two overriding constraints: first, the objective principle;422 secondly, the importance of contractual (p. 264) certainty.423 In order to give effect to the need for certainty the court helpfully spelt out three conditions424 before extrinsic evidence, of whatever provenance, should be usefully admitted:

  1. (1)  the extrinsic evidence must be relevant (‘it would affect the way in which the language of the document would have been understood by a reasonable man’);

  2. (2)  the extrinsic evidence must have been reasonably available to all the contracting parties; and

  3. (3)  the context of the contract must be clear and obvious.

5.192  By way of contrast the prior negotiations issue was only touched upon briefly in Zurich Insurance but nevertheless the Singapore Court of Appeal indicated a more liberal approach, expressly accepting the arguments put forward in two Law Quarterly Review articles.425 V K Rajah JA expressly stated that ‘there should be no absolute or rigid prohibition against evidence of previous negotiations’.426 Its reception was likely to be on rare occasions. Controlling factors would obviously include the character of the transaction and the objective principle. Furthermore, such evidence would need to satisfy the court’s threefold test for admissibility of extrinsic evidence in general: that it should be:

  1. (1)  relevant;

  2. (2)  reasonably available to all the contracting parties;

  3. (3)  clear and obvious.

Subsequently in Sembcorp Marine v PPL Holdings427 Sundaresh Menon CJ (delivering the judgment of the Singapore Court of Appeal) revisited these issues and confirmed that the court had been right in Zurich Insurance to adopt the modern contextual approach.428 However in the wake of a review of case law and scholarly material across several jurisdictions it modified the practice of the courts in extrinsic evidence cases by requiring parties to plead the elements of the factual matrix which they contend are relevant and to set out the contended effect of those facts in their statements of case. The pleading process would then control the exercise of disclosure.429 These judge-made developments reflect the changes outlined above in the Commercial and Admiralty Courts Guide.430

(p. 265) 5.193  Lastly, the Court addressed prior negotiations, but left the question open for a future case:

Asst Prof Goh has, after a comprehensive survey of the historical literature on the law governing the admissibility of prior negotiations, argued that the seemingly blanket exclusionary rule against the admissibility of prior negotiations was a product of a historical misstep by the courts … [431] We prefer to leave for another occasion the consideration of whether this argument is to be accepted in principle; and if so, whether evidence of prior negotiations should nonetheless be excluded as irrelevant or unhelpful for the policy reasons set out by Lord Hoffmann in Chartbrook at [34]–[38] … Whichever way that may eventually be resolved, any future attempt to rely on such material should be made with full consciousness of the concerns already expressed and in compliance with the pleading requirements we have just prescribed.432

It is submitted that the development of the civil justice techniques in Sembcorp reinforce the argument that properly controlled it is preferable to admit all pre-contractual material as a matter of principle and permit the judge to determine its relevance and weight.433 It will be for parties to justify reference to all factual materials outside the four corners of the contract.434

Subsequent conduct

5.194  The two significant cases to have addressed this issue are Zurich Insurance (Singapore) Pte Ltd v B-Gold Design & Construction Pte Ltd435 and Gibbons Holdings Ltd v Wholesale Distributors Ltd.436

5.195  However to set the scene it is worthwhile going further back to 1996, when the New Zealand Court of Appeal in Attorney-General v Dreux Holdings Ltd 437 had signalled a preference for a flexible approach to evidence of subsequent conduct, rejecting the House of Lords’ blanket exclusion of such evidence. The case concerned an option in relation to large parcels of railway property, and whether or (p. 266) not both vendor and purchaser had options under the agreement, which contained inconsistent provisions on the latter’s rights.

5.196  In the joint judgment of Richardson P, Keith and Blanchard JJ, delivered by Blanchard J, reliance was placed on New Zealand’s adoption of the Vienna Convention on the International Sale of Goods 1980 (‘CISG’), with its permissive rule in Article 8(3)438 and ‘the idea that New Zealand domestic contract law should be generally consistent with the best international practice’. However the subsequent conduct in that case was thought to be of little probative value by the majority because of changes in personnel at the relevant entity.

5.197  Thomas J’s judgment, concurring in the result, was emphatic that as a matter of principle, subsequent conduct should be admitted:

I am of the view that, as a matter of principle, the Courts should be able to have regard to the subsequent conduct of the parties when construing the meaning of an ambiguously written contract. The evidence would be admissible as an aid to the interpretation of the agreement. To be accepted as being of assistance it must necessarily support the construction for which the party contends. This support will be present if the mutual conduct of the parties or, possibly, the conduct of the party denying the interpretation contended for only, points to the proposed meaning. In other words, the consistency of the parties’ conduct provides a relevant and reliable basis for the inference that the contract had that particular meaning.439

On the evidence itself, Thomas J did consider it probative: ‘I consider that, in itself, the subsequent conduct is patently unequivocal. For a full year after Dreux had exercised its option the parties proceeded on the basis that the option had been validly exercised.’ Whilst noting the change in personnel, Thomas J considered that this was counter-balanced by the fact that the same firm of solicitors had been retained by the vendor throughout.

Gibbons Holdings v Wholesale Distributors

5.198  Gibbons Holdings Ltd v Wholesale Distributors Ltd 440 concerned a dispute as to the scope of an express covenant in an assignment of a lease of warehouse premises to pay the rent ‘during the remainder of the term of the lease’. The head lease of the premises to Gibbons as tenant commenced in 1982 and, following renewals, was to determine in 2023. Gibbons sub-let to GUS in 1991, which was to determine in 2002, but the parties to the sub-lease expressly agreed to enter into a new lease, expiring in 2010. It was obvious from the terms of the sub-lease that this was a deliberate structuring into two leases, clearly intended to avoid the (p. 267) sub-lease operating as an assignment of the head lease on the expiry of its then current term.441

5.199  The 1997 deed of assignment between GUS and Wholesale Distributors Ltd (WDL) expressly provided in the first schedule that the ‘Expiry Date of Lease’ was ‘31 October 2002 with a New Lease being granted for a term expiring 31 October 2010’. Under the second schedule WDL covenanted with Gibbons in return for Gibbons’s consent to the assignment (as required under the 1991 sub-lease) that ‘from the Date of Assignment and during the remainder of the term of the lease the Assignee will pay the rent provided for in the Lease and keep and perform all the covenants in the Lease’.

Gibbons claimed to enforce that covenant up to the end of 2010. WDL insisted that its covenant was limited to the term of the lease then subsisting, and expired in 2002. It was clear that on a literal reading of the provision the construction urged by WDL must prevail.442 Nevertheless the New Zealand Supreme Court unanimously accepted Gibbons’ construction that the covenant must be understood as referring to the expiry of the anticipated new lease in 2010.443 This could be explained by emphasizing the contractual plane of the parties’ relationship. This was emphasized by Elias CJ: ‘the assigned sublease therefore set up a contractual regime which lasted until 2010.’444 Alternatively it could be explained by reference to the property plane of the parties’ relationship In the words of Blanchard J: ‘The assignment of GUS’s interest to WDL encompassed both the legal interest in the existing lease and the equitable interest contingent on the creation of the new head lease.’445

5.200  Subsequent to the 1997 assignment, in 1999 WDL, with Gibbons’ consent, subleased by deed part of the premises to another company, TNL.446 The 1999 sub-lease was deliberately structured around the 2002 renewal of the original 1991 sub-lease, and with rights of renewal, potentially extended to 2008. This obviously invited the argument that WDL considered itself bound until 2010 under its 1997 assignment.

5.201  Accordingly the New Zealand Supreme Court also revisited the question of the admissibility of subsequent conduct as an aid to construction, previously (p. 268) considered by the New Zealand Court of Appeal in Attorney-General v Dreux Holdings Ltd.447 The Supreme Court reached a curiously balanced outcome. Four members of the court were in favour of permitting recourse to subsequent conduct, but they were evenly divided on the application of the principles.

5.202  Elias CJ and Thomas J held that evidence of both shared intention and unilateral intention (which undermined a suggested construction by that party) was admissible, and that the evidence here was so probative, even though it did not cross the line between the parties.

5.203  Elias CJ accepted the argument of principle: ‘I do not think it necessary to have regard to the subsequent conduct of the parties in reaching this conclusion, but I accept that how the parties subsequently treated their contractual obligations may be helpful evidence as to the meaning of the contract.’448 Further Elias CJ agreed with Thomas J that ‘the meaning I prefer based on the terms of the documents and their commercial context is also consistent with the subsequent conduct of WDL in entering into subsequent assignments of the lease for terms extending beyond October 2002’.449

5.204  Thomas J had already delivered a seminal judgment in Attorney-General v Dreux Holdings Ltd450 on the admissibility of subsequent conduct, and His Honour did not feel that it was necessary to repeat himself.451

5.205  Thomas J spent some considerable time responding to Alan Berg’s widely read case note in the Law Quarterly Review,452 where Berg had argued that lawyers in practice would be over-burdened by the task of proferring appropriate advice by the admission of pre-contractual documentation, save where transactions were recent ones of which they had personal experience. Where issues arose years later, or where a subsequent party came on the scene, it would be impossible to know of oral statements made at the time. Berg concluded that the ‘fiction’ that contracts are addressed to the immediate parties should be abandoned.

5.206  Thomas J acknowledged the force of Berg’s arguments, and accepted that it was ‘intuitively unaceptable’ for lawyers to have to trawl through extensive correspondence and drafts, or for subsequent parties to have to carry out ‘due diligence’ into the background to contracts. However His Honour considered Berg’s arguments over-stated in three respects. First, despite the denials, Berg’s call was really for a ‘retreat to “literalism”’. Secondly, conscientious lawyers already amass all relevant background documentation. Thirdly, it was not a ‘fiction’ that most (p. 269) contracts speak to the immediate parties who have entered into deals to advance and protect their own interests. Most contracts are not assigned or transferred.453

5.207  Thomas J’s analysis of the evidence in this case repays study. The terms of WDL’s subsequent sub-lease to TNL in 1999, renewable until 2008, contradicted any assertion that it did not consider itself bound until 2010. Even stronger evidence was provided of its subsequent sale of its whole grocery business to Infogate in 2000 including all its ‘estate and interest in the Lease for the remainder of the term of years created by the lease’. At that point the actual lease only had less than a year to run. Internal memoranda, demonstrating the same understanding, reinforced that conclusion. It was commercially unrealistic to consider that WDL did not consider itself bound up to 2010 on the occasion of both these transfers.454

5.208  Thomas J rejected Tipping J’s suggested restriction of evidence to cases where it evidenced ‘shared’ or ‘mutual’ intention. Even evidence which did not cross the line between the parties was probative where it contradicted an argument subsequently raised:

That party has acted inconsistently with the meaning it seeks to persuade the court to place upon the contract. The value of the evidence stems from the inconsistency … It would be unfortunate if the principle that evidence of subsequent conduct is admissible as an aid to interpretation becomes hedged with qualifications which undermine the objective of the principle. Providing that the evidence is relevant to the question of interpretation before the court, it should be sufficient that, following the completion of the contract, the party concerned has acted inconsistently with the meaning it now asserts in court.455

It is submitted that this is the correct approach. It should not be a precondition that evidence has crossed the line between the parties to the dispute.

5.209  Tipping and Anderson JJ agreed with the broad proposition that subsequent conduct was admissible, but limited it to evidence of the shared intention of the parties. Accordingly the evidence here of subsequent transactions with third parties and internal memoranda were inadmissible or not probative.

5.210  However Tipping J allowed that ‘it is desirable for there to be clarity as to whether subsequent conduct can be examined as an aid to interpretation, if only for confirmatory or supporting purposes’.456 His Honour noted the exceptions in relation to (1) rectification, (2) formation, and (3) estoppel.

5.211  Tipping J ws highly critical of Lord Reid’s influential speech in Whitworth Street Estates (Manchester) Ltd v James Miller & Partners Ltd 457 where his Lordship had stated:

I must say that I had thought that it is now well settled that it is not legitimate to use as an aid in the construction of the contract anything which the parties said or (p. 270) did after it was made. Otherwise one might have the result that a contract meant one thing the day it was signed, but by reason of subsequent events meant something different a month or a year later.458

In Tipping J’s view: ‘The subsequent course of English law was shackled by this rare case of even Homer nodding’. Tipping J retorted:

Evidence of subsequent conduct does not invite a subsequent meaning. It is directed to the original meaning; that is, the meaning of the contract when it was signed. It is a distraction to suggest that post-contract evidence is capable of changing the contract date meaning, when its sole purpose is to elucidate that meaning.459

5.212  Tipping J’s statement of principle would have restricted admissible evidence to matters which ‘shed light on the shared intention of the parties’.460 That now needs to be qualified in the light of Tipping J’s second thoughts in Bay of Plenty.

5.213  Anderson J thought that the point of construction was straightforward. His Honour also favoured admission of such evidence, but thought it ‘of limited practical significance’.461 His reasoning followed Tipping J’s original view that evidence of a ‘shared’ meaning was required. Most interestingly Anderson J thought that a more liberal rule might reduce, rather than increase, litigation: ‘the possibility of recourse to such evidence of actual mutual understanding of contractual terms might forestall litigation about seemingly ambiguous terms.’462

5.214  Blanchard J reserved his position463 as he had done in Attorney-General v Dreux Holdings Ltd.464 However His Honour intriguingly added: ‘I do not read Lord Hoffmann’s remarks in Investors Compensation Scheme Ltd v West Bromwich Building Society465 as being directed to this point. If His Lordship had intended to rule out use of subsequent conduct it would have been easy for him to say so.’466 Accordingly, it is suggested that nothing in the seminal statement of principles ruled out a more liberal approach here.

Zurich Insurance (Singapore) v B-Gold

5.215  The issue was only touched upon in the Singaporean case of Zurich Insurance (Singapore) Pte Ltd v B-Gold Design & Construction Pte Ltd,467 but (p. 271) nevertheless the Court of Appeal indicated a more liberal approach, expressly accepting the arguments put forward in two Law Quarterly Review articles.468 V K Rajah JA expressly stated that ‘there should be no absolute or rigid prohibition against evidence of … subsequent conduct’.469 Its reception was likely to be on rare occasions. Controlling factors would obviously include the character of the transaction and the objective principle. Furthermore, such evidence would need to satisfy the court’s threefold test for admissibility: that it should be:

  1. (1)  relevant;

  2. (2)  reasonably available to all the contracting parties;

  3. (3)  clear and obvious.

The Court of Appeal stated parenthetically: ‘We should add that the relevance of subsequent conduct remains a controversial and evolving topic that will require more extensive scrutiny by this court at a more appropriate juncture.’470

Franklins v Metcash

5.216  By way of contrast, the New South Wales Court of Appeal recently confirmed the subsequent conduct rule in Franklins Pty Ltd v Metcash Trading Ltd,471 but qualified that by holding that subsequent evidence might be admissible to the extent that it was probative of surrounding circumstances at the time of the contract.472

Comparison: Draft Common Frame of Reference (‘DCFR’)