Contractual interpretation: reading between the lines | KPMG | UK

M&A Matters - Contractual interpretation: Reading between the lines

Contractual interpretation: Reading between the lines

Two recent court cases show that, when it comes to business contracts, the common law is moving towards a more holistic approach, rather than a strict black and white interpretation of the wording alone.

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Executive summary

Two recent Court of Appeal and Supreme Court cases have confirmed key components of the existing legal framework for the interpretation of business contracts. At the same time, they have affirmed the reluctance of the courts to step in where commercial parties are of equal bargaining power. These two cases show the common law continuing to move away from an approach based on strict interpretation, and towards one which seeks to balance the literal meaning of the wording, the contract as a whole, the wider context and business common sense in order to interpret wording. 

In its judgement earlier this year in Persimmon Homes Limited & Ors v Ove Arup & Partners Limited & Ors (Persimmon Homes) the Court of Appeal considered the reduced application of the contra proferentem rule to exclusion clauses suggesting it is now only relevant to indemnity clauses. The Court of Appeal additionally held that the guidelines relating to exclusion of negligence clauses did not assist where the meaning of the clause was clear. In Wood v Sureterm Direct Limited (Wood v Sureterm), again earlier this year, the Supreme Court reconfirmed that the literal meaning of the language used, the contract as a whole and the wider context in which the contract was arrived at, where appropriate, should all be taken into account when construing the terms of a contract. Business common sense should be applied, but will always remain subordinate to the literal meaning, if this is clear. 

Traditional rules and guidance for interpretation

Traditionally, the contra proferentem rule applied to resolve any ambiguity in the interpretation of a clause or contract against the party who proposed it. The reasoning behind this is that a party who imposes terms on another must make those terms clear, and should be the one that suffers the consequences, if it fails to do so. It has tended to be applied to clauses or contracts that have not been negotiated. 

Separately, the case of R v Canada SS Lines Ltd [1952] AC 192 (Canada Steamship) (Canada Steamship) established a number of key guidelines for interpreting clauses that seek to exclude liability for negligence. Canada Steamship’s main principle is that, where one party seeks to avoid liability for its own negligence, that position must be spelt out expressly (and not in general terms). 

Persimmon Homes

The recent case of Persimmon Homes related to the redevelopment of an industrial site in Barry, Wales. The respondents (Arup) were engaged by the previous owners of the site as civil engineers to give advice and supervise the development. Following an initial regeneration phase, the previous owners opened a tendering process. The claimants formed a consortium (the Consortium) that engaged Arup for consultant engineering services as part of the process of putting together the Consortium's bid. The Consortium was successful in its bid and purchased the site in September 2007. The Consortium and Arup then entered into a second agreement in September 2009 (the 2009 Agreement). The 2009 Agreement included the following language in the exclusion clause:

"…Liability for any claim in relation to asbestos is excluded." 

Arup additionally entered into deeds of warranty with each of the Consortium members in 2010, which included the same language in the exclusion clause. 

Separate consultants engaged by the Consortium discovered a large amount of asbestos at the site in 2012, which was substantially higher than the amount identified by Arup. The Consortium brought a claim for breach of contract, negligence and breach of statutory duty, arguing that that it had suffered loss as, had they been properly advised by Arup at an appropriately early stage, they would not have paid as much for the site and would have not incurred the additional costs relating to the asbestos. Arup sought to rely on the exclusion clauses to shield itself from any liability. 

The Consortium was unsuccessful at first instance, as the court held that the clauses excluded liability for all the claims made by the Consortium. The Consortium appealed the decision. 

In its appeal, the Consortium made two arguments as to why the exclusion would not cover the claims being brought against Arup:

  1. the exclusion clause did not encompass any claim for not identifying asbestos, as the words “liability for” in the exclusion should be understood to mean liability for “causing the uncontrolled spread of” the asbestos; or 
  2. in the alternative and any event, the exclusion clause would need to have words implied into it in order to exclude negligence, such that “liability for any claim in relation to asbestos (unless incurred in negligence) is excluded”. 

The Consortium also argued that the judged at first instance should have applied the contra proferentem rule and the Canada Steamship principles. 

However, the Court of Appeal rejected the Consortium’s arguments and upheld the lower court’s decision for the following reasons:

  1. despite the Consortium’s argument to the contrary, the language of the exclusion clause was clear and unambiguous and, therefore, must be given its natural meaning and taken at face value. Accordingly, there was no basis to argue that the words “causing the uncontrolled spread of” needed to be inserted into the clause, particularly as this interpretation would have been contrary to business common sense;
  2. as the wording was clear, the contra proferentem rule did not assist the Consortium. The court additionally commented that, in relation to commercial contracts negotiated between parties of equal bargaining power, the contra proferentem rule has only a very limited role, as the literal meaning, wider context and commercial common sense should normally be sufficient to determine meaning; and
  3. commercial contracting and risk allocation have evolved greatly since the 1950s (when Canada Steamship was decided) and therefore the guidance provided by that case is of very little assistance in the present dispute.

Wood v Sureterm

The case of Wood v Sureterm centred on the sale of a specialist insurance brokerage company, Sureterm Direct Limited (Sureterm), by Andrew Wood (Mr Wood), the majority shareholder, and two minority shareholders. The purchase of Sureterm was completed in April 2010. Under the sale and purchase agreement, the sellers had undertaken to indemnify the purchaser against losses and claims:

"…imposed on or required to be made by [Sureterm] following and arising out of claims or complaints registered with the FSA, the Financial Services Ombudsman or any other Authority..." 

Shortly after completion, it was discovered that Sureterm had been mis-selling motor insurance policies. The purchaser and Sureterm notified the Financial Services Authority (FSA) under their regulatory obligations and agreed a remediation scheme where Sureterm paid compensation to customers potentially affected by the mis-selling. The purchaser subsequently brought a claim against the sellers under the indemnity in the sale and purchase agreement for the estimated cost of the compensation plus interest and the costs of the remediation scheme. 

At first instance, the court held in the purchaser's favour that Mr Wood must indemnify the purchaser, even though the purchaser and Sureterm had self-reported the mis-selling to the FSA and there had been no claim or complaint by a customer. Mr Wood appealed this decision. 

The Court of Appeal held that the indemnity only covered loss and damage which arose out of claims or complaints to the FSA by customers. The notification to the FSA by the purchaser and Sureterm was, therefore, not included in this. The purchaser appealed to the Supreme Court. 

In dismissing the appeal, the Supreme Court held that, applying a literal reading of the indemnity, there had been no complaints from customers, which meant that the indemnity was never triggered. Whilst that may have been a bad bargain for the purchaser to make, it was not the job of the court to improve that bargain. 

Conclusion and implications

In their judgements in Persimmon and Wood v Sureterm, the English courts have confirmed the modern approach to exclusion clauses, which accepts that commercial parties to a contract are free to assign risks as they see fit – and that exclusion clauses, therefore, should be given their ordinary and natural meaning. The contra proferentem rule now has a very limited role in relation to commercial contracts negotiated between parties of equal bargaining power. It should only be applied in cases where there is genuine ambiguity as to meaning. Similarly, the test for interpreting exclusion clauses in Canada Steamship now has little relevance in the context of commercial contracts. 

The recent line of cases in this area has highlighted the importance of clear drafting in contracts, as the ordinary and natural meaning of language will, usually, be given effect. The courts appear to have maintained their consistency in applying this approach, which will give a level of comfort to commercial parties that the courts will not seek to overturn wording freely negotiated. Importantly, it also emphasises the value of obtaining legal advice in relation to the drafting of commercial contracts. Parties engaging in M&A transactions should give consideration to the approach of the courts in light of the above.

 

 

For further information please contact:

Richard Phillips - Director

Lucy Elkins - Manager

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