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From: Principles of Contractual Interpretation (2nd Edition)

Richard Calnan

From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: null; date: 06 June 2023


(p. 1) Prologue

A.  The Nature of the Interpretative Process

Pr.01  ‘How difficult can it be, Boss?’ An expression used by one of my colleagues when we were about to embark upon a transaction seems particularly apposite to the question of contractual interpretation. We may hesitate to offer an opinion on a point of law, but we are all prepared to express a view on what a document means. Surely we can all read English. So what is the problem?

Pr.02  The problem is that interpretation of contracts is an art, not a science. So said Johan Steyn in the John Lehane Memorial Lecture 2002.1 It is his fourth general proposition of interpretation. Robert Walker LJ made the same point in John v PricewaterhouseCoopers:2

The process of construction often … involves the assessment of disparate (and therefore incommensurable) factors to reach what is ultimately an intuitive (but not irrational) conclusion.

Pr.03  The reason why it is an art, not a science, is because we are ultimately trying to work out what the parties wanted to achieve from what they have said and done. The interpreter puts himself or herself in the position of a reasonable person with all the relevant background information available to the parties at the time the contract was entered into with a view to establishing what the contract means. And that is ultimately a matter of judgement on which two perfectly reasonable people can have quite different views. In the words of Lord Steyn: ‘[interpretation] is an exercise involving the making of choices between feasible interpretations’.3 And as Lord Hoffmann said in Chartbrook v Persimmon Homes:4(p. 2)

It is, I am afraid, not unusual that an interpretation which does not strike one person as sufficiently irrational to justify a conclusion that there has been a linguistic mistake will seem commercially absurd to another …

Pr.04  The result is that, however far we try to create a body of law which explains how to interpret contracts, the interpretation of any particular contract will ultimately involve a question of judgement. You can get a long way with principled reasoning, but the final step is a leap of faith. It is important to understand the limits of logic, and where intuition takes over.

Pr.05  We therefore have to recognize that books on interpretation can only carry the putative interpreter so far. Ultimately, we are on our own.

B.  The Purpose of This Book

Pr.06  The purpose of this book is, therefore, to try to state the principles which guide anyone who has to interpret contracts.5

Pr.07  They are principles, rather than rules, both because they need to be stated at a relatively high level of generality and also because they are by their nature general approaches to the problem, rather than specific answers to it.

Pr.08  There are also related concepts, such as implied terms, rectification, and estoppel by convention, which play a part in the overall question of how contracts are read; and these also need explanation.

Pr.09  And finally, the Epilogue contains a brief discussion of the effect of all this on the way in which contracts should be drafted. This is, after all, the other side of the coin.

C.  Why is it Important?

Pr.10  The law of contract is about the voluntary assumption of obligations. Although there are plenty of rules concerned with matters such as the formation and discharge of contracts, in practice much of contract law is about the interpretation of the promises which the parties have made to each other, rather than about particular rules of law.

Pr.11  This point was made by Professor Patrick Atiyah in his Essays on Contract6 when he said:(p. 3)

[i]t hardly seems open to doubt that construction has become by far the most popular technique for the solution of practically all problems in the law of contract which do not depend on unyielding rules of positive law, such as incapacity, illegality and the requirements of consideration.

Pr.12  The reason for this is straightforward. Because contractual obligations are assumed voluntarily, rather than imposed by law, the extent of one person’s contractual claim against another depends on what the contract says, rather than on what the law says. Issues do arise in relation to whether or not a contract has been created (for instance, whether the promisee has provided consideration) or whether it is affected by illegality or mistake, but the vast majority of questions in relation to contracts are concerned with what they mean.7

Pr.13  In practice, courts are also often able to avoid dealing with difficult legal issues by interpreting the contract in a particular way. Two examples can illustrate how this is done—The Didymi8 and Associated Japanese Bank v Credit du Nord.9

Pr.14  The Didymi10 concerned a time charterparty. The contract provided for the charterer to pay a particular daily rate of hire, and there was also provision for that rate of hire to be increased if the vessel out-performed certain criteria, and to be reduced if it under-performed. The contract provided for the hire to be ‘equitably [increased/decreased] by an amount to be mutually agreed between owners and charterers’. The owners claimed an increase in hire under this provision, and the charterers denied liability on the basis that it was an agreement to agree, and therefore not binding.

Pr.15  If it had been an agreement to agree, it would not have been binding.11 But the Court of Appeal managed to avoid the conclusion that this provision had no effect by interpreting it in such a way that it did not amount to an agreement to agree. The court decided that there was a binding obligation to adjust the charter hire ‘equitably’, and that the required agreement of the parties was simply a mechanism to give effect to that essential term. If the mechanism did not work, because the parties did not agree, then the court could establish what was equitable.

Pr.16  The interesting thing about this case (and, indeed, many others) is that the court gets round a difficult legal issue (in this case, that an agreement to agree is not binding) by interpreting the contract in such a way that the difficult issue does not arise on the facts (in this case, by deciding that the agreement was not an agreement to (p. 4) agree). A clause which appears to require the parties to reach an agreement is interpreted as being an agreement to do something objective, with the agreement of the parties being merely a mechanism to give effect to it.

Pr.17  Whether that was an appropriate thing to do in the circumstances is beside the point in this context. What is important is that the court was able to avoid having to deal with a difficult legal issue concerning agreements to agree by interpreting the contract in a particular way. This is not uncommon. A few years earlier, the House of Lords had done the same thing in a dispute concerning a lease.12

Pr.18  The other example is Associated Japanese Bank v Credit du Nord.13 A bank purchased some machines and then leased them back. The lessee’s obligations under the lease were guaranteed by another bank. It subsequently transpired that the machines did not exist and that a fraud had been committed on both banks. The lessor bank sued the guarantor bank under the guarantee.

Pr.19  Steyn J decided that the guarantor was not liable to the lessor. He gave three reasons. The first was that, under the terms of the guarantee, the existence of the machines was an express condition precedent to the guarantor’s liability. The second was that, even if there was no express condition precedent, the existence of the machines was an implied condition precedent to the guarantor’s obligations. A reasonable man, faced with the suggested term, would, without hesitation, have said that it must be implied: it was so obvious that it went without saying.14 The third reason was that, if the first two reasons were wrong, the contract was void for mistake in any event.

Pr.20  Steyn J did in fact deal with the difficult question of whether the contract was void for mistake. But he did not strictly need to do so because of the way in which he interpreted the contract—by deciding that the existence of the machines was a condition precedent to the guarantor’s liability. Questions of mistake are frequently really about the express or implied allocation of risk between the parties to the contract. What is important is not so much abstract rules of law but the express or implied intention of the parties.

Pr.21  These cases are illustrations of a broad tendency for common law courts to deal with problems that arise in a contractual case by looking more to questions of interpretation than to matters of law. Since contracts involve the voluntary assumption of liability, this is hardly surprising.

(p. 5) D.  The Principles

Pr.22  Most of this book consists of the elucidation of ten Principles which, it is suggested, underlie all aspects of contractual interpretation. Like any writing, the Principles need to be read as a whole, and that is why this book is relatively brief.

Pr.23  The Principles are divided into five Parts. Part I describes the Guiding Principle—that interpretation is concerned with the objective common intention of the parties to the contract. Part II is concerned with the materials available to the person interpreting the contract. Parts III to V are concerned with the words used: Part III with what the words mean, Part IV with adding words, and Part V with changing words.

Pr.24  The book is primarily concerned with commercial transactions, rather than consumer ones and, generally, with written contracts, because these are ubiquitous in commercial transactions. But the principles are relevant to the interpretation of all contracts and also to unilateral documents, such as wills, subject to any statutory provisions to the contrary.15

E.  Principles, Rules, and Precedent

Pr.25  One of the reasons for stating the law concerning contractual interpretation by reference to principles, rather than rules, is that it is necessary to state the law at a level of generality sufficient to take account of the fact that interpretation is an art, rather than a science. As Sir Anthony Clarke MR has said:16 ‘It is to my mind possible to over-elaborate the relevant principles [of contractual interpretation]. Indeed there was a tendency to do so during the argument in this appeal.’

Pr.26  Case law can be authority for the general approach to interpretation, but it cannot lay down what particular words mean, except in the most general way. Words take their meaning from the contract in which they appear and the background facts at the time the contract was entered into. What particular words mean in one contract at one time in one context cannot bind a judge deciding what the same words mean in a different contract at a different time and in a different context.17 Cases should be cited for their guidance on matters of principle, not for what they actually decided.18

(p. 6) Pr.27  Although the interpretation of an oral contract is a question of fact, the interpretation of a written contract is a question of law.19 The reason is purely historical—it comes from a time when civil cases were tried by a judge with a (frequently illiterate) jury, and it was therefore necessary for the interpretation of the writing to be left to the judge.

Pr.28  An important practical effect of this rule is that cases concerning interpretation frequently end up in the Court of Appeal and, quite often, in the Supreme Court.20 Paul Davies has argued21 that the person best equipped to interpret the words of a contract in light of the documents as a whole and in the context of the surrounding facts is the judge who tries the case. An appeal court may take a different view of interpretation (and very frequently does) but, on a cost-benefit analysis, it is not at all clear that having so many appeals on questions of interpretation is of any real commercial benefit. ‘It would be preferable for the meaning of the contract to be resolved quickly and more efficiently by a first instance judge applying clear principles.’22

Pr.29  This point was recognized by the Supreme Court of Canada in Sattva Capital v Creston Moly.23 They decided that, in Canada, the interpretation of a written contract should no longer be regarded as a question of law, but as a mixed question of law and fact. The reason why it is a question of law is purely historical; and, because interpretation is now seen as being contextual, deference should be given to the first instance judge on points of contractual interpretation. There is much to be said for this approach, and it remains to be seen whether other common law jurisdictions will follow suit.

F.  Recent Developments

Pr.30  Over the past twenty years, there has been an unprecedentedly large number of cases at the highest level concerned with the principles of the interpretation of contracts. Much of the credit for this must go to Lord Hoffmann who, in a series of cases, has elaborated what have been described as modern principles for the interpretation of contracts.24 Some commentators see these cases as having changed the landscape of (p. 7) contractual interpretation; others see them more as changing the emphasis. Some accept it with enthusiasm; others approach it with caution, sometimes bordering on hostility.

Pr.31  In Investors Compensation Scheme v West Bromwich Building Society,25 Lord Hoffmann set out five principles of contractual interpretation, which have generally been followed in subsequent cases. He prefaced these principles with a comment that the process of interpreting legal documents has largely been assimilated with ‘the common sense principles by which any serious utterance would be interpreted in ordinary life’.26 Much of the ‘old intellectual baggage of “legal” interpretation has been discarded’.27 The formalistic ‘canons of construction’ now have a much smaller part to play in what is recognized as being essentially an intuitive exercise.

Pr.32  This is a welcome development. Lawyers should not be allowed to make up their own rules of interpretation which preclude others. It should be possible for any intelligent business person to have a reasonable stab at understanding what a contract means. Lord Hoffmann put this point very clearly in an article written shortly before the Investors Compensation Scheme case.28 He referred to:

something which laymen find puzzling, and even slightly repellent, about lawyers, namely their claim to use language in a special way which only other lawyers can understand. Contracts are made by businessmen … Why, therefore, should any special techniques be required for their interpretation? … It is these rules which give rise to public unease about what lawyers are up to.

Pr.33  But the analogy between legal documents and other utterances cannot be carried too far.29 The process of creating a commercial contract is far removed from everyday utterances—even serious ones. We have different expectations of the former than the latter. Novelists aspire to ambiguity;30 lawyers eschew it. This creates a tension in the interpretation process, as can be seen when the Principles are discussed.

Pr.34  There is a temptation to see what Lord Hoffmann said in Investors Compensation Scheme v West Bromwich Building Society31 almost as if it were a statutory provision, to be followed to the letter without question. This would be a mistake. As Munby J said, in this context, in Beazer Homes v Stroude:32 ‘Utterances, even of the demi-gods, are not to be approached as if they were speaking the language of statute.’ (p. 8) Lord Hoffmann would be the first to recognize that what he said has to be read in context—against the background of the cases which preceded it, and in the light of the facts of the case in question.33

Pr.35  Indeed, there is a tendency in the more recent decisions of the Supreme Court to temper the approach in the Investors Compensation Scheme case with an acceptance of the fact that parties enter into legal documents because they want a clear record of the terms of their contractual relationship and that a great deal of effort will have gone into the creation of a text which is intended to do just that.34

G.  The Two Opposing Views

Pr.36  For practically every statement about how to interpret contracts, you will find a contradictory one. There is authority for just about every approach to interpretation.

Pr.37  The law of the interpretation of contracts can be seen, in large part, as an eternal conflict between two different approaches, which are sometimes described as the literal approach and the purposive approach. The way in which contracts are in fact interpreted cannot be understood without an understanding of this conflict.

Pr.38  A book on substantive legal topics can tell you what the answers are, or at least have a good stab at it. That cannot be done with interpretation. It is ultimately a matter of judgement, which will depend on the approach of the judge concerned.

Pr.39  It should therefore come as no surprise that, as David McLauchlan has pointed out,35 the outcome of cases concerning interpretation of contracts is difficult to predict. Decisions on interpretation by one tribunal are frequently overruled on appeal; and there are very often dissenting judgments within the tribunals themselves. The Laura Prima36 is a good example. Here there were two possible interpretations of a contract. The umpire said that the contract meant A. The judge at first instance said that it meant B. The Court of Appeal reversed the judge, and said that it meant A. And the House of Lords reversed the Court of Appeal and said that it meant B.

Pr.40  Another example is the Mannai case.37 There, in an interpretation dispute between a landlord and a tenant, the tenant won by three to two in the House of Lords, but only by four to five overall.

(p. 9) Pr.41  It is sometimes said that the history of the law of contractual interpretation is the history of a movement from formalism to rationalism, from the literal to the purposive.38 But that is not true. As Joanna McCunn has recently demonstrated39 purposive interpretation was all the rage in the mid-sixteenth century, and then gave way to a more textual approach in succeeding generations.

Pr.42  The truth is that trends in interpretation go in cycles. There is no doubt that the Investors Compensation Scheme case did herald a more purposive approach than had been common in the preceding decades. But there is now a considerable amount of evidence that the courts are moving back to a more textual approach and are much less comfortable to twist the meaning of the words to suit the desired commercial outcome. One only has to compare the approach of Lord Hoffmann in the Investors Compensation Scheme case with that Lord Neuberger in Arnold v Britton40 to see the difference.

Pr.43  It is therefore important to understand the reasons why different judges take different approaches. There are two main areas of dispute in relation to contractual interpretation:

  • •  how much background information should be available in interpreting a written contract; and

  • •  how much leeway a court should have in twisting the words of the contract to reach what it regards as a ‘commercial’ result.41

Pr.44  At one end of the spectrum are those who would severely limit the background information available and who would frown upon too much word-twisting. If the parties have written their contract, they expect it to be interpreted, not rewritten. At the other end of the spectrum are those who believe that words can only really be understood in the context of the entirety of the background facts, and that the court should do its best to resolve a case in a fair and commercial way.

Pr.45  It is rather like the conflict described by Sellar and Yeatman in 1066 and All That42 between the Cavaliers (Wrong but Wromantic) and the Roundheads (Right but Repulsive). In this context, the Cavaliers are those who would twist the words to (p. 10) reach the ‘right result’, the Roundheads those who would apply the words used without mercy.

Pr.46  Very few lawyers fall into either of these extreme camps. Most fall somewhere between. But where the line is drawn on this spectrum will vary depending on the background and nature of the person concerned.

Pr.47  There will always be a tension between accepting what the words say and trying to bend them. It is only by recognizing that fact that it is possible to understand how interpretation disputes are resolved in practice.

Pr.48  It is possible to give guidance as to the principles to be adopted but, ultimately, interpretation is a matter of intuition and judgement and defies logical analysis. It is as important to understand what principles of interpretation cannot do, as to understand what they can.


1  Steyn, ‘The Intractable Problem of the Interpretation of Legal Texts’ (2003) 25(1) Sydney Law Review 5, reproduced in Worthington (ed.), Commercial Law and Commercial Practice (Hart, 2003) 123 at 126. And see also Lord Steyn’s comment in Deutsche Genossenschaftsbank v Burnhope [1995] 1 WLR 1580 at 1587 that interpretation is often a matter of first impression.

2  [2002] EWCA Civ 899 at [94]. And see Lewison, The Interpretation of Contracts (6th edn, Sweet & Maxwell, 2015) at 2.12.

3  Steyn, ‘The Intractable Problem of the Interpretation of Legal Texts’, 123 at 126.

4  [2009] 1 AC 1101 at [15].

5  The process is sometimes called construction, and sometimes interpretation. In this context, interpretation and construction are synonyms.

6  Atiyah, Essays on Contract (Oxford University Press, 1986).

7  See the comments of Sir Christopher Staughton in: ‘How Do the Courts Interpret Commercial Contracts?’ (1999) 58 CLJ 303 at 303.

8  Didymi Corporation v Atlantic Lines [1988] 2 Lloyd’s Rep 108.

9  [1989] 1 WLR 255.

10  Didymi Corporation v Atlantic Lines [1988] 2 Lloyd’s Rep 108.

11  Walford v Miles [1992] 2 AC 128.

12  Sudbrook Trading Estate v Eggleton [1983] AC 444.

13  [1989] 1 WLR 255.

14  See Principle 8: Implied Terms.

15  Marley v Rawlings [2015] AC 129 at [23].

16  In Pratt v Aigaion Insurance Co [2009] 1 Lloyd’s Rep 225 at [9]. The need for simple and clear principles is also true of other areas of the law of contract—for instance, what constitutes a repudiation. See Eminence Property Developments v Heaney [2010] 2 All ER (Comm) 223.

17  See the comments of Lord Hoffmann in Bank of Credit & Commerce International v Ali [2002] 1 AC 251 at [51] and those of Moore-Bick LJ in Transocean Drilling v Providence Resources [2016] EWCA Civ 372 at [15]; and see Carter at 13.09.

18  See Lord Morris’s comments in Schuler v Wickman Machine Tool Sales [1974] AC 235 at 256. This issue is discussed further under Principle 5.

19  The Nema, Pioneer Shipping v BTP Tioxide [1982] AC 724 at 736 (Lord Diplock).

20  For instance, the Supreme Court recently gave judgment in Tael One Partners v Morgan Stanley [2015] UKSC 12, in a case where the amounts involved were substantial but there was no question of principle involved.

21  Davies, ‘Rectification Versus Interpretation’ (2016) 75 CLJ 62 at 71–2.

22  (2016) 75 CLJ 62 at 72.

23  [2014] 2 RCS 633 at [42]–[55].

24  Lord Hoffmann’s contribution to the law in this area is analysed by Paul Davies in ‘The Meaning of Commercial Contracts’ in Davies and Pila (eds), The Jurisprudence of Lord Hoffmann (Hart, 2015) at 215.

25  [1998] 1 WLR 896 at 912–13.

26  [1998] 1 WLR 896 at 912.

27  [1998] 1 WLR 896 at 912.

28  Hoffmann, ‘The Intolerable Wrestle with Words and Meanings’ (1997) 114 South African Law Journal 656.

29  See the penetrating observations on this point in Carter at [5.05]–[5.17].

30  Even to the extent of the titles of their novels, as Ian McEwan’s Enduring Love (Vintage, 1998) attests.

31  [1998] 1 WLR 896 at 912–13.

32  [2005] EWCA Civ 265 at [28], quoted in Mitchell, 61.

33  It should also be read in the light of the article which preceded it, and on which it is based: Hoffmann, ‘The Intolerable Wrestle with Words and Meanings’.

34  See, for instance, Arnold v Britton [2015] AC 1619 and Marks and Spencer v BNP Paribas [2016] AC 743.

35  McLauchlan, ‘Contract Interpretation: What Is It About?’ (2009) 31(1) Sydney Law Review 5.

36  Nereide v Bulk Oil [1982] 1 Lloyd’s Rep 1.

37  Mannai Investment Co v Eagle Star Life Assurance Co [1997] AC 749.

38  Wigmore, A Treatise on the Anglo-American System of Evidence, vol 9 (3rd edn, Little, Brown and Company, 1940).

39  McCunn, ‘Revolutions in Contractual Interpretation: A Historical Perspective’, available on the Social Science Research Network (https://www.ssrn.com).

40  [2015] AC 1619.

41  The Scottish Law Commission’s Discussion Paper on Interpretation of Contracts (Discussion Paper No. 147, February 2011) contains a useful review of the issues. Earlier discussions of the issues by the Scottish Law Commission are contained in Interpretation in Private Law (Discussion Paper No. 101, August 1996) and Report on Interpretation in Private Law (Scot Law Com No. 160, October 1997).

42  Methuen, 1930.