WHERE ARE WE NOW ON THE INTERPRETATION OF CONTRACTS? A ... · After all, the seed merchants did supply seeds. True, they were the wrong kind altogether. But they were seeds. On the

WHERE ARE WE NOW ON THE INTERPRETATION OF CONTRACTS?

A CLOAK AND DAGGER TALE

A paper presented to the Society of Construction Law at meetings in Sheffield on 8th June, Birmingham on

13th October and Tunbridge Wells on 8th December 2015

Peter Rees QC

January 2016

196

www.scl.org.uk

http://www.scl.org.uk/

1

WHERE ARE WE NOW ON THE

INTERPRETATION OF CONTRACTS?

A CLOAK AND DAGGER TALE

Peter Rees QC

Mr Smith and Mr Jones

I am going to start with a story. This is a story about Mr Smith and Mr Jones.

Mr Smith inherited the lease of his father’s bicycle shop in London in 1975.

Bicycles are in Mr Smith’s blood, and he is the third generation of Smiths to

have a bicycle shop. But cycling in London is a dying business – literally.

London traffic is intense and no one cycles any more. Sales of bicycles are at

an all time low.

Mr Smith receives an offer from Mr Jones to acquire the lease of the shop. Mr

Jones is going to apply to the authorities for a change of use to sell the latest

music technology from the shop – eight-track stereo cartridges. It is a good

offer, and Mr Smith reluctantly accepts, but he cannot let go of the fact that

this is really a bicycle shop, and so he enters into a contract with Mr Jones that

contains a provision that if Mr Jones ever makes an application to the

authorities to sell bicycles from the shop again, he will bring Mr Smith in as a

50:50 partner. Not unreasonably, Mr Jones says that he cannot be held to this

stipulation forever and so they agree a 35 year time period. Mr Jones’

obligation is to end on 31st July 2010.

Over the years Mr Jones’ music shop thrives. He moves with the times and

goes from eight-track cartridges to cassette tapes and, eventually, to CDs, but

by the end of 2009, Mr Jones can see that the writing is on the wall, even for

CDs. Digital downloads have started to gain popularity and sales of CDs are

declining.

However, in one of those strange twists of fate, in 2007, the Mayor of London,

Ken Livingstone, announced he is going to consider a bicycle hire scheme in

London similar to that in use in Paris. This initiative is taken up by his

successor, Boris Johnson, who announces he will implement it in July 2010,

along with a number of other measures to encourage more and more cycling in

London.

By early 2010, sales of bicycles are increasing rapidly, and Mr Jones realises

that the thing to do is to move out of the music business and into bicycles. But

he is aware of the deadline of 31st July 2010. So, during the spring and early

summer of 2010 he pre-orders a supply of bicycles, and makes all the

preparations, and fills out all the forms to apply to the authorities for a change

of use of the shop; but waits until 1st August before he actually submits his

application.

2

Mr Smith brings a claim saying that he is entitled to 50% of the business

because the intention of the contract was, clearly, that if Mr Jones decided,

during the 35 year period, to apply to sell bicycles, he would bring Mr Smith

into the business. He argues on two bases:

1. The contract says ‘makes’ an application and although he did not

submit his application until after the deadline, he ‘made’ it, in that

he completed the forms – he just did not send them in; and

2. Mr Jones has not acted fairly or in good faith in waiting,

deliberately, until the expiry of the deadline. To give the contract

business sense, an obligation of fairness, or good faith in

performance, must be implied into the contract.

How do you think this case should be decided? I shall return to the story, and

the decision made, at the end.

Alice Through the Looking Glass

In his seminal judgment in Investors Compensation Scheme v West Bromwich

Building Society, Lord Hoffmann famously said that ‘Almost all the old

intellectual baggage of “legal” interpretation has been discarded’.1 He then

summarised the principles which should apply to the interpretation of

contracts. This paper considers where we are now on interpretation given

recent developments, and the extent to which any of that baggage has been

reclaimed, or whether it still remains consigned in the ‘left luggage’ area of

contractual interpretation.

The obvious starting point, therefore, is Lord Hoffman’s judgment and it is

worth recalling that, at first instance, Evans-Lombe J had come to a particular

conclusion about the meaning of words in the contract, with which Leggatt J,

in the Court of Appeal, had disagreed. Lord Hoffmann had this to say about

it:

‘In the Court of Appeal, Leggatt LJ said, on the authority of Alice

Through the Looking Glass, that the judge’s interpretation was “not an

available meaning of the words”. “Any claim (whether sounding in

rescission for undue influence or otherwise)” could not mean “Any

claim sounding in rescission (whether for undue influence or otherwise)”

and that was that. He was unimpressed by the alleged commercial

nonsense of the alternative construction. ... My Lords, I will say at once

that I prefer the approach of the learned judge.’2

I am going to pause in Lord Hoffmann’s judgment there and go back to an

earlier case. A case from the Court of Appeal in 1982 called George Mitchell

v Finney Lock Seeds.3 Rather than summarise the case myself, I will quote

from the Master of all legal summary, the Master of the short sentence, the

1 Investors Compensation Scheme Ltd v West Bromwich Building Society (No 1) [1998] 1

WLR 896, page 912; also [1998] 1 All ER 98 (HL).

2 ICS v West Bromwich, note 1, [1998] 1 WLR 896, page 912.

3 George Mitchell (Chesterhall) Ltd v Finney Lock Seeds [1983] QB 284, [1983] 1 All ER

108, [1982] 3 WLR 1036, [1983] 1 Lloyd’s Rep 168 (CA).

3

Master of the Rolls, Lord Denning, who started his judgment in this case as

follows:

‘In outline

Many of you know Lewis Carroll’s “Through the Looking Glass”.4 In it

there are these words: “The time has come”, the Walrus said, “to talk of

many things – of ships and shoes and sealing wax – of cabbages and

kings”.

Today it is not “of cabbages and kings” – but of cabbages and what-nots.

Some farmers (called George Mitchell Ltd) ordered 30 lbs of cabbage

seed. It was supplied. It looked just like cabbage seed. No one could

say it was not. The farmers planted it over 63 acres. Six months later

there appeared out of the ground a lot of loose green leaves. They

looked like cabbage leaves but they never turned in. They had no hearts.

They were not “cabbages” in our common parlance because they had no

hearts. The crop was useless for human consumption. Sheep or cattle

might eat it if hungry enough. It was commercially useless. The price

of the seed was £192. The loss to the farmers was over £61,000. They

claimed damages from the seed merchants. The judge awarded them

that sum with interest. The total comes to nearly £100,000.

The seed merchants appeal to this court. They say that they supplied the

seed on a printed clause by which their liability was limited to the cost

of the seed, that is, £192.’5

Let me leave Lord Denning there for a moment in order to state what I am sure

will be obvious, namely that this case is about limitation of liability clauses.

However, what is of particular interest when it comes to contractual

interpretation, is what Lord Denning has to say about how judges go about

construing contracts.

So, let us return to the case and the limitation of liability clause. The

significant part of it (as emphasised by Lord Denning) read:

‘… we will, at our option, replace the defective seeds or plants, free of

charge to the buyer or will refund all payments made to us by the buyer

in respect of the defective seeds or plants and this shall be the limit of

our obligation. We hereby exclude all liability for any loss or damage

arising from the use of any seeds or plants supplied by us and for any

consequential loss or damage arising out of such use ... The price of any

seeds or plants sold or offered for sale by us is based upon the foregoing

limitations upon our liability. The price of such seeds or plants would

be much greater if a more extensive liability were required to be

undertaken by us.’6

After setting out these provisions, Lord Denning went on to say:

4 It seems there was only one book in the judge’s reading room in those days.

5 George Mitchell v Finney Lock Seeds, note 3, [1983] QB 284, page 294.

6 George Mitchell v Finney Lock Seeds, note 3, [1983] QB 284, pages 295, 6.

4

‘The natural meaning

There was much discussion before us as to the construction of that

condition. I am much impressed by the words I have emphasised.

Taking the clause in its natural plain meaning, I think it is effective to

limit the liability of the seed merchants to a return of the money or

replacement of the seeds. The explanation they give seems fair enough.

They say that it is so as to keep the price low: and that if they were to

undertake any greater liability, the price would be much greater.

After all, the seed merchants did supply seeds. True, they were the

wrong kind altogether. But they were seeds. On the natural

interpretation, I think the condition is sufficient to limit the seed

merchants to a refund of the price paid or replacement of the seeds.’7

Cloaks and daggers

Pausing there, it should be noted that that was not actually his decision, but, in

order to explain why he came to the opposite decision, he launched into a

wonderful description of the approach taken by judges when having to

interpret contracts with exclusion or limitation of liability clauses in them. He

said:

‘The heyday of freedom of contract

None of you nowadays will remember the trouble we had – when I was

called to the Bar – with exemption clauses. They were printed in small

print on the back of tickets and order forms and invoices. They were

contained in catalogues or timetables. They were held to be binding on

any person who took them without objection. No one ever did object.

He never read them or knew what was in them. No matter how

unreasonable they were, he was bound. All this was done in the name of

“freedom of contract”. But the freedom was all on the side of the big

concern which had the use of the printing press. No freedom for the

little man who took the ticket or order form or invoice. The big concern

said, “Take it or leave it”. The little man had no option but to take it.

The big concern could and did exempt itself from liability in its own

interest without regard to the little man. It got away with it time after

time. When the courts said to the big concern, “You must put it in clear

words”, the big concern had no hesitation in doing so. It knew well that

the little man would never read the exemption clauses or understand

them.

It was a bleak winter for our law of contract. ...

The secret weapon

Faced with this abuse of power – by the strong against the weak – by the

use of the small print of the conditions – the judges did what they could

to put a curb upon it. They still had before them the idol, “freedom of

contract”. They still knelt down and worshipped it, but they concealed

under their cloaks a secret weapon. They used it to stab the idol in the


5

back. This weapon was called “the true construction of the contract”.

They used it with great skill and ingenuity. They used it so as to depart

from the natural meaning of the words of the exemption clause and to

put upon them a strained and unnatural construction. In case after case,

they said that the words were not strong enough to give the big concern

exemption from liability; or that in the circumstances the big concern

was not entitled to rely on the exemption clause. ... But when the clause

was itself reasonable and gave rise to a reasonable result, the judges

upheld it; at any rate, when the clause did not exclude liability entirely

but only limited it to a reasonable amount. ...

The change in climate

In 1969 there was a change in climate. Out of winter into spring. It

came with the first report of the Law Commission’s Exemption Clauses

In Contracts, First Report: Amendments to the Sale of Goods Act 1893

(Law Com No 24, HC 403) which was implemented in the Supply of

Goods (Implied Terms) Act 1973. In 1975 there was a further change.

Out of spring into summer. It came with the Law Commission’s

Exemption Clauses, Second Report (Law Com No 69, HC 605) which

was implemented by the Unfair Contract Terms Act 1977. No longer

was the big concern able to impose whatever terms and conditions it

liked in a printed form – no matter how unreasonable they might be.

These reports showed most convincingly that the courts could and

should only enforce them if they were fair and reasonable in themselves

and it was fair and reasonable to allow the big concern to rely on them.

So the idol of “freedom of contract” was shattered. In cases of personal

injury or death, it was not permissible to exclude or restrict liability at

all. In consumer contracts any exemption clause was subject to the test

of reasonableness.’8

Whilst this paper is not about exemption or limitation of liability clauses, I do

think that judgment of Lord Denning provides an insight into how judges (or

at least some judges) go about the task of construing contractual provisions

and it may cast some light on how they may need to do so in the future in view

of the latest developments in this area.

The five principles

Back to Lord Hoffmann, and ICS v West Bromwich. You will recall that after

having referred to Legatt LJ’s reliance on Alice Through the Looking Glass in

the Court of Appeal, Lord Hoffmann said he preferred the first instance

judge’s approach to that of the Court of Appeal. He then went on to say:

‘But I think I should preface my explanation of my reasons with some

general remarks about the principles by which contractual documents are

nowadays construed. I do not think that the fundamental change which

has overtaken this branch of the law, particularly as a result of the

speeches of Lord Wilberforce in Prenn v Simmonds [1971] 1 WLR

1381, 1384-1386 and Reardon Smith Line Ltd v Yngvar Hansen-Tangen

8 George Mitchell v Finney Lock Seeds, note 3, [1983] QB 284, page 296-9.

6

[1976] 1 WLR 989, is always sufficiently appreciated. The result has

been, subject to one important exception, to assimilate the way in which

such documents are interpreted by judges to the common sense

principles by which any serious utterance would be interpreted in

ordinary life. Almost all the old intellectual baggage of “legal”

interpretation has been discarded. The principles may be summarised as

follows:

(1) 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) 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) The law excludes from the admissible background the previous

negotiations of the parties and their declarations of subjective intent.

They are admissible only in an action for rectification. The law makes

this distinction for reasons of practical policy and, in this respect only,

legal interpretation differs from the way we would interpret utterances in

ordinary life. The boundaries of this exception are in some respects

unclear. But this is not the occasion on which to explore them.

(4) The meaning which a document (or any other utterance) would

convey to a reasonable man is not the same thing as the meaning of its

words. The meaning of words is a matter of dictionaries and grammars;

the meaning of the document is what the parties using those words

against the relevant background would reasonably have been understood

to mean. The background may not merely enable the reasonable man to

choose between the possible meanings of words which are ambiguous

but even (as occasionally happens in ordinary life) to conclude that the

parties must, for whatever reason, have used the wrong words or syntax:

see Mannai Investments Co Ltd v Eagle Star Life Assurance Co Ltd

[1997] 2 WLR 945.

(5) The “rule” that words should be given their “natural and ordinary

meaning” reflects the common sense proposition that we do not easily

accept that people have made linguistic mistakes, particularly in formal

documents. On the other hand, if one would nevertheless conclude from

the background that something must have gone wrong with the

language, the law does not require judges to attribute to the parties an

intention which they plainly could not have had. Lord Diplock made

this point more vigorously when he said in The Antaios Compania

Neviera SA v Salen Rederierna AB [1985] 1 AC 191, 201: “if detailed

semantic and syntactical analysis of words in a commercial contract is

http://www.bailii.org/cgi-bin/redirect.cgi?path=/uk/cases/UKHL/1997/19.html

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going to lead to a conclusion that flouts business common sense, it must

be made to yield to business common sense.”’9

Alice Through the Looking Glass (encore)

Before going on to look at case law since ICS v West Bromwich, it is worth

examining, in a little more detail, what is meant by those five principles and

how they interact. I should say that how they interact is fundamental to any

exercise of contract interpretation. They are not a series of logic steps, or flow

chart, or decision tree. You cannot simply start at principle 1 and, if the

answer is ‘yes’ go on to principle 2 and so on. It is necessary to consider them

as a whole, and it is the fact that you have to do that, and the fact that you can

play one off against the other, that means, so far as I am concerned, that judges

still have what Lord Denning described as a secret weapon beneath their

cloaks, to stab the idol of freedom of contract.

Let us start by looking at the first principle that: ‘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.’10

And consider how that interacts with the fourth principle that: ‘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.’11

How, exactly, are those two principles to be applied? How does the

reasonable person’s background knowledge come to change the ordinary

meaning of a word?

It may be that the easiest way of understanding this is to use the example Lord

Hoffmann gave in his judgment, but to do so some context is needed, and to

do that (as, it seems with all serious legal issues) reference needs to be had to

Alice Through the Looking Glass. This is the discussion which took place,

between Alice and Humpty Dumpty as to the meaning of words. Alice asks

Humpty:

‘“I mean, what is an un-birthday present?” “A present given when it

isn’t your birthday, of course.” Alice considered a little. “I like birthday

presents best”, she said at last. “You don’t know what you’re talking

about!” cried Humpty Dumpty. “How many days are there in a year?”

“Three hundred and sixty-five”, said Alice. “And how many birthdays

have you?” “One.” “And if you take one from three hundred and sixty-

five what remains?” “Three hundred and sixty-four, of course.” “And

that shows that there are three hundred and sixty-four days when you

9 ICS v West Bromwich, note 1, [1998] 1 WLR 896, page 912-3.



8

might get un-birthday presents.” “Certainly”, said Alice. “And only one

for birthday presents, you know. There’s glory for you!” “I don’t know

what you mean by ‘glory’”, Alice said. Humpty Dumpty smiled

contemptuously. “Of course you don’t – till I tell you. I meant ‘there’s

a nice knock-down argument for you!’” “But ‘glory’ doesn’t mean ‘a

nice knock-down argument’”, Alice objected. “When I use a word”,

Humpty Dumpty said, in rather a scornful tone, “it means just what I

choose it to mean – neither more nor less.” “The question is”, said

Alice, “whether you can make words mean so many different things.”

“The question is”, said Humpty Dumpty, “which is to be master – that’s

all.”’

So, with that background information, we can now look at the example Lord

Hoffmann used to explain the interaction between the first and the fourth

principle.

‘Finally, on this part of the case, I must make some comments upon the

judgment of the Court of Appeal. Leggatt LJ said that his construction

was “the natural and ordinary meaning of the words used”. I do not

think that the concept of natural and ordinary meaning is very helpful

when, on any view, the words have not been used in a natural and

ordinary way. In a case like this, the court is inevitably engaged in

choosing between competing unnatural meanings. Secondly, Leggatt LJ

said that the judge’s construction was not an “available meaning” of the

words. If this means that judges cannot, short of rectification, decide

that the parties must have made mistakes of meaning or syntax, I

respectfully think he was wrong. The proposition is not, I would

suggest, borne out by his citation from Through the Looking Glass.

Alice and Humpty Dumpty were agreed that the word “glory” did not

mean “a nice knock-down argument”. Anyone with a dictionary could

see that. Humpty Dumpty’s point was that “a nice knock-down

argument” was what he meant by using the word “glory”. He very fairly

acknowledged that Alice, as a reasonable young woman, could not have

realised this until he told her, but once he had told her, or if, without

being expressly told, she could have inferred it from the background, she

would have had no difficulty in understanding what he meant.’12

So, following ICS v West Bromwich it seems that words do not necessarily

mean what they would ordinarily mean, if the background information

available shows that they actually mean something else.

Commercial common sense

Now, let us add to our interactive mix of Hoffmann principles, the fifth

principle and see where that leads us. The fifth principle says:

‘The “rule” that words should be given their “natural and ordinary



documents. On the other hand, if one would nevertheless conclude from


9

the background that something must have gone wrong with the

language, the law does not require judges to attribute to the parties an

intention which they plainly could not have had.’13

So, how are we to conclude something must have gone wrong with the

language? Well, what is very clear is that we should not simply take the literal

meaning of the words as determinative.

In his judgment in Sirius International Insurance v FAI General Insurance,

Lord Steyn (who clearly read more widely than other judges), referred to the

18th century moral philosopher, William Paley, and said:

‘The tendency should therefore generally speaking be against literalism.

What is literalism? It will depend on the context. But an example is

given in The Works of William Paley (1838 ed), Vol III, 60. The moral

philosophy of Paley influenced thinking on contract in the 19th century.

The example is as follows: The tyrant Temures promised the garrison of

Sebastia that no blood would be shed if they surrendered to him. They

surrendered. He shed no blood. He buried them all alive. This is

literalism. If possible it should be resisted in the interpretative

process.’14

Lord Steyn then repeated what had been said in Mannai Investment v Eagle

Star Life Assurance:

‘In determining the meaning of the language of a commercial contract ...

the law therefore generally favours a commercially sensible

construction. The reason for this approach is that a commercial

construction is more likely to give effect to the intention of the parties.

Words are therefore interpreted in the way in which a reasonable

commercial person would construe them and the standard of the

reasonable commercial person is hostile to technical interpretations and

undue emphasis on niceties of language.’15

But what if the application of the principles produce two different, perfectly

acceptable, constructions? Which trumps? Is it the construction which is the

product of the application of the background knowledge, as in Lord

Hoffmann’s example of Alice and Humpty Dumpty, or is it the commercial

construction?

In Rainy Sky v Kookmin the basic approach to construction as set out in ICS v

West Bromwich was not in dispute.16

What was in issue was the role played

by considerations of business common sense in determining what the parties

meant. Lord Clarke (with whom the others in the Supreme Court agreed) said

this:


14 Sirius International Insurance Co (Publ) v FAI General Insurance Ltd [2004] UKHL 54,

[2004] 1 WLR 3251, [2005] 1 All ER191; [2005] 1 Lloyd’s Rep 461, para 19.

15 Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1997] AC 749, page

771; also [1997] 2 WLR 945, [1997] 3 All ER 352.

16 Rainy Sky SA v Kookmin Bank [2011] UKSC 50, [2011] 1 WLR 2900, [2012] 1 All ER

1137, [2012] 1 Lloyd’s Rep 34, [2012] BLR 132, 138 Con LR 1.

10

‘The language used by the parties will often have more than one

potential meaning. I would accept the submission made on behalf of the

appellants that the exercise of construction is essentially one unitary

exercise in which the court must consider the language used and

ascertain what a reasonable person, that is a person who has all the

background knowledge which would reasonably have been available to

the parties in the situation in which they were at the time of the contract,

would have understood the parties to have meant. In doing so, the court

must have regard to all the relevant surrounding circumstances. If there

are two possible constructions, the court is entitled to prefer the

construction which is consistent with business common sense and to

reject the other.’17

In that case, Kookmin Bank (‘the Bank’) issued refund guarantees to protect

the buyers’ contractual advance payments to a shipbuilder. The shipbuilder

suffered financial difficulties. The buyer claimed under the guarantees. The

Bank said its guarantee obligations were not triggered by the shipbuilder’s

insolvency. Insolvency was not specifically mentioned in the guarantee but

other events such as rejection or total loss of the vessel were. Under the

shipbuilding contract, however, the shipbuilder was required to refund

advance payments if it became insolvent. On the Bank’s interpretation, the

guarantees would cover every situation in which the buyers could claim a

refund, except the one situation in which they were most likely to need it – the

shipbuilder’s insolvency. The Bank could not suggest any commercial reason

for the buyer to have agreed to this. The Supreme Court therefore, preferred

the buyer’s interpretation.

In some respects, therefore, in the absence of any other sensible construction,

this seems a pretty straightforward decision, but what if both possible

constructions make some commercial sense? In Luxembourg v Barclays Bank

Longmore LJ said it was not necessary to show that the competing

construction made no commercial sense, all you had to do was simply pick the

most commercial. He said:

‘If a clause is capable of two meanings ... it is quite possible that neither

meaning will flout common sense. In such circumstances, it is much

more appropriate to adopt the more, rather than the less, commercial

construction.’18

Of course, there are those who would argue that judges are not necessarily the

best arbiters of what is, and is not, commercial. Commercial and business life

is not something of which many judges have deep experience, so there is,

inevitably, a danger in giving a judge the choice between two commercial

constructions and allowing him or her to pick the most commercial one.

Having said that, however, it is important to be very clear. You only get into

the issue of which competing construction is the most commercial if the

language is ambiguous. If the language is unambiguous then there should be

17 Rainy Sky v Kookmin, note 16, para 21.

18 HHY Luxembourg SARL v Barclays Bank Plc[2010] EWCA Civ 1248, para 26.

11

no question of looking at commerciality. Lord Clarke was very clear about

this in Rainy Sky v Kookmin. He said:

‘… where a term of a contract is open to more than one interpretation, it

is generally appropriate to adopt the interpretation which is most

consistent with business common sense. ... Where the parties have used

unambiguous language, the court must apply it.’19

This was reinforced in BMA Special Opportunity Hub Fund Ltd v African

Minerals Finance Ltd. Aikens LJ warned that ‘commercial common sense’

was not to be elevated to an overriding criterion of construction. Further the

parties should not be subjected to ‘… the individual judge’s own notions of

what might have been the sensible solution to the parties’ conundrum’. Still

less should the issue of construction be determined by ‘what seems like

“commercial common sense” from the point of view of one of the parties to

the contract’.20

There is nothing new about this. This is simply another way of expressing the

fifth principle in ICS v West Bromwich which is, by way of a reminder:

‘The “rule” that words should be given their “natural and ordinary



documents.’21

If, however, the language has gone wrong, and judges need, effectively, to re-

draft a provision of the contract, it seems there is no conceptual limit to the

amount of re-writing that a court can do when interpreting a contract. In

Chartbrook v Persimmon Homes Lord Hoffman said this:

‘What is clear from these cases is that there is not, so to speak, a limit to

the amount of red ink or verbal rearrangement or correction which the

court is allowed. All that is required is that it should be clear that

something has gone wrong with the language and that it should be clear

what a reasonable person would have understood the parties to have

meant. In my opinion, both of these requirements are satisfied.’22

The parol evidence rule

Mentioning Chartbrook v Persimmon is the perfect opportunity to move on to

perhaps the most controversial of the principles enunciated in ICS v West

Bromwich namely the third principle: ‘The law excludes from the admissible

background the previous negotiations of the parties and their declarations of

subjective intent’.23

19 Rainy Sky v Kookmin, note 16, paras 30 and 23.

20 BMA Special Opportunity Hub Fund Ltd v African Minerals Finance Ltd [2014] EWCA

Civ 416, paras 8 and 24.


22 Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38, [2009] 1 AC 1101, [2009] 3

WLR 267, [2009] 4 All ER 677, [2009] BLR 551, 125 Con LR 1., para 25.


12

ICS v West Bromwich was decided in 1997, but the third principle, the so-

called parol evidence rule, was not invented then. The third principle in ICS v

West Bromwich was simply a restatement of a principle that had been made

clear in many earlier cases, and the origin of which is generally thought to be

the Countess of Rutland’s Case, where Popham CJ said:

‘... it would be inconvenient, that matters in writing made by advice and

on consideration, and which finally import the certain truth of the

agreement of the parties should be controlled by averment of the parties

to be proved by the uncertain testimony of slippery memory.’24

That principle has been applied pretty strictly by the courts ever since, and in

1971, Lord Wilberforce, in Prenn v Simmonds said, by way of justification of

the rule:

‘The reason for not admitting evidence of these exchanges is not a

technical one or even mainly one of convenience ... 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 document which records a consensus.’25

However, post 1971, came two developments in the wider legal world that

caused some to question the sense of this rule.

In 1980, the United Nations Convention on the International Sale of Goods

was signed in Vienna (and is generally known as the ‘Vienna Convention’). It

came into force in 1988 after being ratified by 11 nations. In 1994 the

Unidroit Principles of International Commercial Contracts were published.

Both the Vienna Convention and the Unidroit Principles provide that, in

ascertaining the common intention of the parties, regard shall be had to prior

negotiations. England paid no heed to these instruments and, indeed, the UK

is now the only major commercial nation not to be a signatory to the Vienna

Convention.

The Unidroit Principles were revised in 2004, but still had no impact on

English law, and this may well have led Lord Nicholls, in 2005, to write his

article in the Law Quarterly Review entitled ‘My Kingdom for a Horse: the

Meaning of Words’ and, in so doing, gently stir the pot.26

The title was a reference to William Shakespeare’s well-known line in Richard

III: ‘A horse! A horse! My kingdom for a horse!’ Lord Nicholls asked what

King Richard meant. Did he mean that he would give up his kingdom if only

he could have a horse? Or that simply for lack of a horse he was losing his

kingdom? Lord Nicholls pointed out that in Shakespeare’s play the difference

in meaning did not matter but, in the law, meaning did matter and, in his view,

the time had come to abandon the exclusionary rule where the issue is one of

interpretation of a written contract.

24 Countess of Rutland’s Case (1604) 5 Co Rep 25, 77 ER 89 (Crt King’s Bench).

25 Prenn v Simmonds [1971] 1 WLR 1381, page 1384; also [1971] 3 All ER 237 (HL).

26 Lord Nicholls, ‘My Kingdom for a Horse’ (2005) 121 LQR 577.

13

This article, as well as the Vienna Convention and the Unidroit Principles,

were all referred to by Lord Hoffmann in his judgment in Chartbrook v

Persimmon. It was his last judgment before retirement and he was keen to put

this issue to bed once and for all. He said:

‘The conclusion I would reach is that there is no clearly established case

for departing from the exclusionary rule. The rule may well mean, as

Lord Nicholls has argued, that parties are sometimes held bound by a

contract in terms which, upon full investigation of the course of

negotiations, a reasonable observer would not have taken them to be

intended. But a system which sometimes allows this to happen may be

justified in the more general interest of economy and predictability in

obtaining advice and adjudicating disputes. It is, after all, usually

possible to avoid surprises by carefully reading the documents before

signing them and there are the safety nets of rectification and estoppel

by convention.’27

Now, you may remember that in setting out the exclusionary rule (the third

principle) in ICS v West Bromwich Lord Hoffmann said:

‘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.’28

It seems, that as Chartbrook v Persimmon was his last judgment, he decided

this was the occasion to do a bit of exploration and he clarified some of the

boundaries as follows:

‘The rule excludes evidence of what was said or done during the course

of negotiating the agreement for the purpose of drawing inferences about

what the contract meant. It does not exclude the use of such evidence

for other purposes: for example, to establish that a fact which may be

relevant as background was known to the parties, or to support a claim

for rectification or estoppel. These are not exceptions to the rule. They

operate outside it.’29

It follows, therefore, that if the court can be persuaded that the negotiations of

the parties, and the previous drafts of the contract, are needed as part of the

background matrix of fact, they can be admitted in evidence. The significance

of this will become apparent when I return to it shortly.

Before doing so, however, we should get right up to date.

Arnold v Britton

Oxwich Leisure Park is close to the beautiful Oxwich Beach on the Gower

Peninsula. It consists of 91 chalets on long leases, and was first developed in

27 Chartbrook v Persimmon, note 22, para 41.


29 Chartbrook v Persimmon, note 22, para 42.

14

1974. If you look online it seems the chalets were selling in 2012 for around

£70,000 each. If, however, you are tempted to buy one now: a word of

warning. Please read, carefully, the service charge provisions in the lease. 21

of the chalets have the following service charge provisions in their leases

which were granted from 1974 onwards: the lessee, the chalet owner,

promises:

‘To pay to the Lessor … as a proportionate part of the expenses and

outgoings incurred by the Lessor in the repair maintenance renewal ...

and the provision of services … the yearly sum of Ninety Pounds … for

the first Year of the term hereby granted increasing thereafter by Ten

Pounds per hundred for every subsequent year or part thereof.’30

The interpretation of that provision went to the Supreme Court in January

2015 and judgment was given on 10th June 2015.

The landlord argued that, what the service charge provision meant, was that

the chalet owners had to pay £90 for service charge in the first year and that

sum would be increased annually by 10% on a compound basis. The chalet

owners argued that was an absurd interpretation, and that the true construction

was that their liability for service charges was to pay a proportionate part of

the expenses of the leisure park, which liability was capped at £90 in the first

year and the cap, but not the actual liability, would increase by 10% each year.

Effectively, the chalet owners argued that the 10% increase was an inflation

hedge.

Lord Carnwath, in his dissenting judgment, produced a little table showing

what the result of each side’s argument would be for a lease granted in 1974 at

a service charge, then, of £90. His table showed what the service charge

would be in 2012, on each side’s interpretation, and in 2072, when the 99 year

leases would expire.

On the chalet owner’s interpretation, by 2012 the service charge would have

risen to £794, on the landlord’s interpretation it was already at £3,366.

Understandably, Lord Carnwath was not willing to speculate on inflation up to

2072, so his table did not give a figure for the chalet owner’s interpretation.

However, it did for the landlord’s interpretation. By 2072, the annual, and I

stress annual, service charge, on the landlord’s interpretation, would be

£1,025,004.

What did the Supreme Court decide?

Before getting to that, a quick reminder of what some of the previous cases

had said. In Rainy Sky v Kookmin Lord Clarke said: ‘If there are two possible

constructions, the court is entitled to prefer the construction which is

consistent with business common sense and to reject the other’.31

In Sirius

International Insurance v FAI General Insurance, Lord Steyn said: ‘The

30 Arnold v Britton [2015] UKSC 36, [2015] AC 1619, [2015] 2 WLR 1593, [2016] 1 All

ER 1, para 7. 31 Rainy Sky v Kookmin, note 16, para 21.

15

tendency should therefore generally speaking be against literalism’.32

And, of

course, in ICS v West Bromwich, Lord Hoffmann said: ‘The “rule” that words

should be given their “natural and ordinary meaning” reflects the common

sense proposition that we do not easily accept that people have made linguistic

mistakes, particularly in formal documents’.33

Lord Neuberger gave the judgment of the majority of the Supreme Court as to

the service charge the chalet owners should pay. He said:

‘It is true that the first part of the clause refers to a lessee paying a

“proportionate part” of the cost of the services, and that, unless inflation

increases significantly in the next 50 years, it looks likely that the

service charge payable under each of the 25 leases may exceed the cost

of providing services to the whole of the Leisure Park. However, if, as I

believe is clear, the purpose of the second part of the clause is to

quantify the sum payable by way of service charge, then the fact that, in

future, its quantum may substantially exceed the parties’ expectations at

the time of the grant of the lease is not a reason for giving the clause a

different meaning. As already explained, the mere fact that a court may

be pretty confident that the subsequent effect or consequences of a

particular interpretation was not intended by the parties does not justify

rejecting that interpretation.’34

So, where does all this leave us? Let me conclude by looking at this in theory

and, perhaps more importantly, practically.

The theory

The theory seems to have changed markedly since Arnold v Britton.

1. Prior to Arnold v Britton it seems that if the words were unambiguous

the parties were likely to be stuck with them unless they did not make

common sense. However, the words did not need to be ambiguous for the

background matrix of fact to be taken into account in construing them. Now,

however, we have what Lord Neuberger said:

‘First, the reliance placed in some cases on commercial common sense

and surrounding circumstances ... should not be invoked to undervalue

the importance of the language of the provision which is to be construed.

The exercise of interpreting a provision involves identifying what the

parties meant through the eyes of a reasonable reader, and, save perhaps

in a very unusual case, that meaning is most obviously to be gleaned

from the language of the provision. Unlike commercial common sense

and the surrounding circumstances, the parties have control over the

language they use in a contract.

Secondly, when it comes to considering the centrally relevant words to

be interpreted, I accept that the less clear they are, or to put it another

way, the worse their drafting, the more ready the court can properly be

32 Sirius International Insurance v FAI General Insurance, note 14, para 19.


34 Arnold v Britton, note 30, para 34.

16

to depart from their natural meaning. That is simply the obverse of the

sensible proposition that the clearer the natural meaning the more

difficult it is to justify departing from it. However, that does not justify

the court embarking on an exercise of searching for, let alone

constructing, drafting infelicities in order to facilitate a departure from

the natural meaning.’35

2. Prior to Arnold v Britton it seems that if the plain language of the words

used did not make sense, leading to the conclusion something must have gone

wrong with the language, the law did not require judges to attribute to the

parties an intention which they plainly could not have had. In addition, it

seems that if the plain meaning did not make sense and another construction

did make commercial sense, that would be the construction the court would

adopt.

However, in Arnold v Britton Lord Neuberger also said:

‘The third point I should mention is that commercial common sense is

not to be invoked retrospectively. The mere fact that a contractual

arrangement, if interpreted according to its natural language, has worked

out badly, or even disastrously, for one of the parties is not a reason for

departing from the natural language. Commercial common sense is only

relevant to the extent of how matters would or could have been

perceived by the parties, or by reasonable people in the position of the

parties, as at the date that the contract was made.’36

3. Also, prior to Arnold v Britton, it seems that if there were two possible,

sensible, interpretations the court would go with the one that made most

commercial sense. However, in Arnold v Britton Lord Neuberger also said:

‘Fourthly, while commercial common sense is a very important factor to

take into account when interpreting a contract, a court should be very

slow to reject the natural meaning of a provision as correct simply

because it appears to be a very imprudent term for one of the parties to

have agreed, even ignoring the benefit of wisdom of hindsight. The

purpose of interpretation is to identify what the parties have agreed, not

what the court thinks that they should have agreed. Experience shows

that it is by no means unknown for people to enter into arrangements

which are ill-advised, even ignoring the benefit of wisdom of hindsight,

and it is not the function of a court when interpreting an agreement to

relieve a party from the consequences of his imprudence or poor advice.

Accordingly, when interpreting a contract a judge should avoid re-

writing it in an attempt to assist an unwise party or to penalise an astute

party.’37

4. Finally, prior to Arnold v Britton, pre-contractual negotiations and

earlier contract drafts would not be taken into account in construing the

contract, but were capable of being used as part of the background matrix of




17

fact against which the court should conclude what the reasonable person,

armed with the knowledge made available by that background information,

would conclude the meaning to be. This does seem to have survived. What

Lord Neuberger said was:

‘The fifth point concerns the facts known to the parties. When

interpreting a contractual provision, one can only take into account facts

or circumstances which existed at the time that the contract was made,

and which were known or reasonably available to both parties. Given

that a contract is a bilateral, or synallagmatic, arrangement involving

both parties, it cannot be right, when interpreting a contractual provision,

to take into account a fact or circumstance known only to one of the

parties.’38

The overall conclusion to be drawn from Arnold v Britton is that the use of the

background matrix of facts as an aid to interpreting a contract in accordance

with commercial common sense seems to have been thrown out of the

window.

It will be recalled that Lord Hoffmann said in ICS v West Bromwich:

‘The meaning which a document (or any other utterance) would convey

to a reasonable man is not the same thing as the meaning of its words.

The meaning of words is a matter of dictionaries and grammars; the

meaning of the document is what the parties using those words against

the relevant background would reasonably have been understood to

mean. The background may not merely enable the reasonable man to

choose between the possible meanings of words which are ambiguous

but even (as occasionally happens in ordinary life) to conclude that the

parties must, for whatever reason, have used the wrong words or

syntax.’39

However, Lord Neuberger has now made clear that:

‘… the reliance placed in some cases on commercial common sense and

surrounding circumstances (eg in Chartbrook, paras 16-26) should not

be invoked to undervalue the importance of the language of the

provision which is to be construed.’40

So, that is the theory. What will happen in practice? How will judges go

about construing contracts going forward?

The practice?

Remember these words of Lord Denning in George Mitchell v Finney Lock

Seeds:

‘Faced with this abuse of power – by the strong against the weak – by

the use of the small print of the conditions – the judges did what they




18

could to put a curb upon it. They still had before them the idol,

“freedom of contract”. They still knelt down and worshipped it, but they

concealed under their cloaks a secret weapon. They used it to stab the

idol in the back. This weapon was called “the true construction of the

contract”. They used it with great skill and ingenuity.’41

That was in the 50s, 60s and 70s but, following Arnold v Britton, will there be

a temptation to adopt this approach again? In divining whether this will occur,

it may help to look at what a selection of judges have said in the last few years

to explain how they go about interpreting contracts.

In Welsh v Greenwich London Borough Council Robert Walker LJ said that,

basically, much of interpretation is intuitive. He commented: ‘... questions of

construction are frequently a matter of impression and are not readily

susceptible of precise explanation’.42

In Fabio Perini Spa v LPC Group, and in an interesting contrast to Arnold v

Britton, Lord Neuberger said this:

‘The process of construction has to start somewhere, and when the

ultimate issue is the interpretation of a common English word, it is often

helpful to begin with its ordinary meaning before one turns to its

documentary context and other relevant factors. After all, issues of

interpretation (whether arising in connection with patents or any other

commercial documents) often require an intracranial iterative process,

involving multiple factors, including natural meaning, documentary

context, technical considerations, commercial context, and business

common sense.’43

In Multi-Link Leisure Developments v Lanarkshire Council Lord Rodger

suggested:

‘When translating a document written in a foreign language, it often

makes sense to start with the parts whose meaning is clear and then to

use those parts to unravel the meaning of the parts which are more

difficult to understand. The same applies to interpreting contracts or

statutes.’44

Baroness Hale agreed: ‘... construe the words you can understand and see

where that takes you’.45

As a careful reading of the cases to which I have referred reveals, the outcome

of contract interpretation litigation is notoriously difficult to predict. Professor

McLauchlan in ‘Contract Interpretation: what is it About?’ said this:

‘... the division of opinion that one finds in the cases is remarkable.

Time and again judges will disagree on such elementary questions as


42 Welsh v Greenwich LBC [2000] 3 EGLR 41, (2001) 81 P & CR 12 (CA).

43 Fabio Perini Spa v LPC Group Plc [2010] EWCA Civ 525, para 24.

44 Multi-Link Leisure Developments Ltd v North Lanarkshire Council [2010] UKSC 47,

[2011] 1 All ER 175, para 28.

45 Multi-Link Leisure v North Lanarkshire Council, note 44, para 42.

19

whether particular words have a plain meaning and what is the “common

sense” or “commercially realistic” interpretation.’46

If you want an example of this, then just consider Chartbrook v Persimmon.

Of the nine judges who considered the meaning of the words in issue in its

passage through the courts, three preferred Chartbrook’s interpretation and six

preferred Persimmon’s. An interpretation which had been perfectly acceptable

for the first instance judge and the majority of the Court of Appeal was

described as ‘arbitrary and irrational’ in the House of Lords.47

But, perhaps the most significant comment in Chartbrook v Persimmon was

made by Baroness Hale in a four paragraph judgment agreeing with Lord

Hoffmann and the rest of the House of Lords. She said:

‘But I have to confess that I would not have found it quite so easy to

reach this conclusion had we not been made aware of the agreement

which the parties had reached on this aspect of their bargain during the

negotiations which led up to the formal contract. On any objective view,

that made the matter crystal clear.’48

So, whilst the theory may be that the negotiations are only admissible as

background information, the practical answer is that, if they are in front of the

judges, they will read them and, likely as not, that will influence their

decision.

What is particularly interesting about Arnold v Britton, and may go some way

to explaining the result, is that there was nothing before the court as to the

background circumstances. The only document, apart from the leases, that

any of the judges, from first instance to the Supreme Court, had before them

was the published Retail Price Index for the years 1970 – 2010.

Following Arnold v Britton, the importance of getting background documents

in front of judges may well be the subject of increased focus by parties and

their counsel. Given that the easiest way of achieving this is to include in the

pleading a claim for rectification, we may well see an increase in rectification

claims in contractual disputes, even if the real reason behind such a claim is to

help the court interpret the contract.

Mr Smith and Mr Jones (encore)

In conclusion, and with all this in mind, let us return to the dispute between

Mr Smith and Mr Jones. How should their contract be construed?

Can Mr Smith’s argument that Mr Jones ‘made’ the application once he had

completed filling in the application succeed? Is that what the contract says?

Is it the natural meaning of the words or does it fly in the face of commercial

common sense? To what extent is commercial common sense relevant in

46 Professor McLauchlan in, ‘Contract Interpretation: what is it about?’ (2009) 31 Sydney

Law Review 5.

47 Chartbrookv Persimmon, note 22, para 20, Lord Hoffman.

48 Chartbrookv Persimmon, note 22, para 99.

20

interpreting this contract? But, without it, does the contract really mean that

unless Mr Jones actually submitted the application before the deadline, Mr

Smith would be deprived of 50% of the profits of the new bicycle shop? Is

that what the reasonable person would have concluded the contract to mean?

And what about the argument that to give the contract business sense an

implied term of good faith should form part of the contract? It may be

reasonable to do so but, in Lord Clarke’s words, is it necessary? In any event,

as we all know, there is no generally implied obligation of good faith in the

performance of contracts under English law.

What conclusion do you think the court would come to, simply by looking at

the contract? Would it say Mr Smith was entitled to 50% of the profits of the

new bicycle shop or not? Moreover, what conclusion do you think the court

would come to if counsel for Mr Smith had included a claim for rectification

in his pleading, and the following letter from Mr Jones to Mr Smith was in

evidence before the judge:

‘Dear Mr Smith,

We talked about the deadline and you suggested that if I decided to sell

bicycles before the deadline that should trigger your entitlement. I fully

agree, that once I have decided, you should be brought in. But I think

we need more certainty in the contract, as knowing when a decision is

made is not an easy thing. I suggest we make the trigger when I make

an application to the authorities. That is easily ascertainable and I doubt

there will be much of a delay between my decision and an application

being made.

Yours sincerely,

Mr Jones.’

I venture to suggest that, with that letter in evidence, the judge might, in Lord

Denning’s words, take out his concealed weapon from beneath his cloak, the

weapon called ‘the true construction of the contract’ and use it to stab the idol

of ‘freedom of contract’ and give the words Mr Smith and Mr Jones used a

strained and unnatural construction.

Are we back in a world of cloaks and daggers?

Peter Rees QC is a barrister practising at 39 Essex Chambers, London.

© Peter Rees and the Society of Construction Law 2016

The views expressed by the author in this paper are his alone, and do not necessarily

represent the views of the Society of Construction Law or the editors. Neither the

author, the Society, nor the editors can accept any liability in respect of any use to

which this paper or any information or views expressed in it may be put, whether

arising through negligence or otherwise.

21

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