Contract Law: Interpreting Ambiguous Agreements and the Role of Extrinsic Evidence, Study notes of Construction

Download Contract Law: Interpreting Ambiguous Agreements and the Role of Extrinsic Evidence and more Study notes Construction in PDF only on Docsity! Guy Fetherstonhaugh QC E Falcon Chambers Rectifying mistakes in property documents A Paper for the PLA Conference 2010 Friday, 16 April 2010 Guy Fetherstonhaugh QC FALCON CHAMBERS Introduction 1. Recent years have seen a substantial change in the way the courts construe property agreements, and in particular in the extent to which they may be prepared to recognise and deal with errors in drafting. This paper considers how to employ context and matrix to best advantage in revealing and remedying error. It will examine the boundaries of implication and rectification. It will end by analysing the tactics to be employed in obtaining the most advantageous result for the client. Context and matrix: an overview 2. The purpose of the interpretation of a contract is to discover the real intention of the parties - but it is a fundamental principle of English law that this intention must be gathered from the contract itself, and not (save to a limited extent) from extrinsic evidence. 3. The principle is stated thus in a passage from Norton on Deeds cited with approval by Lord Simon of Glaisdale in L Schuler AG v Wickman Machine Tool Sales Ltd [1974] AC 235: “\..The question to be answered always is ‘What is the meaning of what the parties have said?’ not ‘what did the parties mean to say?’, it being a presumption ... that the parties intended to say that which they have said.” 4. To this can be added the words of Lord Wilberforce in Reardon Smith Line Ltd v Yngvar Hansen-Tangen [1976] 1 WLR 989: “When one speaks of the intentions of the parties to the contract, one is speaking objectively - the parties cannot themselves give direct evidence of what their intention was - and what must be ascertained is what is to be taken as the intention which reasonable people would have had if placed in the situation of the parties. Similarly, when one is Guy Fetherstonhaugh QC E Falcon Chambers speaking of aim, or object, or commercial purpose, one is speaking objectively of what reasonable persons would have in mind in the situation of the parties.” 5. Where the contract does not accord with the intention of the parties, then, as Lord Simon observed in Wickman Tools: “It is of course always open to a party to claim rectification of an instrument which has failed to express the common intention of the parties; but so long as the instrument remains unrectified, the rule of construction is as stated by Norton. It is, indeed, the only workable tule.” 6. This approach presupposes that the language used by the parties bears what the courts commonly refer to as its “natural and ordinary meaning”. Where however the words used possess a number of possible meanings, or have only one meaning that appears to make no sense in its context, problems of interpretation arise that the courts have striven to deal with in the ways set out in this paper. 7. Although it is fundamental that extrinsic evidence (ie evidence to be found outside the words of the contract) is not admissible to prove the intention of the parties, for the reasons explained above, it has long been recognised that extrinsic evidence is admissible for the strictly limited purpose of proving the context in which the parties made their contract. In Prenn v Simmonds [1971] 1 WLR 1381, Lord Wilberforce said: “It may be said that previous documents may be looked at to explain the aims of the parties. In a limited sense this is true: the commercial, or business object, of the transaction, objectively ascertained, may be a surrounding fact ... And if it can be shown that one interpretation completely frustrates that object, to the extent of rendering the contract futile, that may be a strong argument for an alternative interpretation, if that can reasonably be found.” 8. In Reardon Smith Line Ltd v Yngvar Hansen-Tangen [1976] 1 WLR 989, Lord Wilberforce again stressed the importance of the context in which the parties’ intention is to be construed: “No contracts are made in a vacuum: there is always a setting in which they have to be placed. The nature of what is legitimate to have regard to is usually described as ‘the surrounding circumstances’ but this phrase is imprecise: it can be illustrated but hardly defined. In a commercial contract it is certainly right that the court should know the commercial purpose of the contract and this in turn presupposes knowledge of the genesis of the transaction, the background, the context, the market in which the parties are operating.” 9. Lord Wilberforce went on to refer to the available body of admissible extrinsic evidence as the “matrix of fact”. Guy Fetherstonhaugh QC juy Fetherstonhaugh Q FB eon cramer to pursue this topic, important though it is, because the point does not arise on this appeal. I desire, however, to keep the point open for careful consideration on a future occasion.” 16. Moreover, in Chartbrook Ltd v Persimmon Homes Ltd [2009] 1 AC 1101, Lord Hoffmann added on this topic (obiter, and without express endorsement from any of the other judges): “{33.] I do however accept that it would not be inconsistent with the English objective theory of contractual interpretation to admit evidence of previous communications between the parties as part of the background which may throw light upon what they meant by the language they used. The general rule, as I said in Bank of Credit_and Commerce International SA v Ali [2002] 1 AC 251, 269, is that there are no conceptual limits to what can properly be regarded as background. Prima facie, therefore, the negotiations are potentially relevant background. They may be inadmissible simply because they are irrelevant to the question which the court has to decide, namely, what the parties would reasonably be taken to have meant by the language which they finally adopted to express their agreement. For the reasons given by Lord Wilberforce, that will usually be the case. But not always. In exceptional cases, as Lord Nicholls has forcibly argued, a rule that prior negotiations are always inadmissible will prevent the court from giving effect to what a reasonable man in the position of the parties would have taken them to have meant. Of course judges may disagree over whether in a particular case such evidence is helpful or not. ... As I have said, there is nothing unusual or surprising about such differences of opinion. In principle, however, I would accept that previous negotiations may be relevant.” 17. The rule against the admissibility of the parties’ negotiations is not, however, invariable. In Bank of New Zealand v Simpson [1900] AC 182, the Privy Council held that, although words with a fixed meaning in a written document cannot be explained by oral evidence to mean something different from what they express, where the words used are susceptible of more than one meaning, then extrinsic evidence is admissible to show what the negotiating parties had in their minds. In that way, the parties’ pre-contract negotiations can be brought into account. 18. The purpose of such an investigation, however, is not to construe the contract, but rather to identify the subject matter of the contract. This slender distinction is one that is well made in the decision of the Court of Appeal of New South Wales in Australian Mutual Provident Society _v__ Overseas Telecommunications Commission (Australia) [1972] 2 NSWLR 806. Ambiguity 19. | Where the words used in the contract are capable of bearing more than one meaning, then the court may select that meaning which accords with commonsense and the perceived commercial purpose of the contract. Thus, in Guy Fetherstonhaugh QC juy Fetherstonhaugh Q FB eon cramer Mitsui Construction Co Ltd v Attorney-General of Hong Kong [1986] 33 BLR 1, Lord Bridge of Harwich said: “It is obvious that this is a badly drafted contract. This, of course, affords no reason to depart from the fundamental rule of construction of contractual documents that the intention of the parties must be ascertained from the language they have used, interpreted in the light of the relevant factual situation in which the contract was made. But the poorer the quality of the drafting, the less willing any court should be to be driven by semantic niceties, to attribute to the parties an improbable and unbusinesslike intention if the language used, whatever it may lack in precision, is reasonably capable of an interpretation which attributes to the parties an intention to make provision for contingencies inherent in the work contracted for on a sensible and businesslike basis.” 20. In order to divine this “businesslike basis” or commercial purpose of the contract, it is of course legitimate to have regard to its background and context. Moreover, it may also be legitimate to have regard to such matters in order to ascertain whether an apparently unambiguous expression used in the contract was in fact intended to bear another meaning. A recent expression of this approach in a rent review case is to be found in the speech of Lord Hope in The Melanesian Mission Trust Board v_ Australian Mutual Provident Society (1997) 74 P & CR 297: “The approach which must be taken to the construction of a clause in a formal document of this kind is well settled. The intention of the parties is to be discovered from the words used in the document. Where ordinary words have been used they must be taken to have been used according to the ordinary meaning of these words. If their meaning is clear and unambiguous, effect must be given to them because that is what the parties are taken to have agreed to by their contract. Various rules may be invoked to assist interpretation in the event that there is an ambiguity. But it is not the function of the court, when construing a document, to search for an ambiguity. Nor should the rules which exist to resolve ambiguities be invoked in order to create an ambiguity which, according to the ordinary meaning of the words, is not there. So the starting point is to examine the words used in order to see whether they are clear and unambiguous. It is of course legitimate to look at the document as a whole and to examine the context in which these words have been used, as the context may affect the meaning of the words. But unless the context shows that the ordinary meaning cannot be given to them or that there is an ambiguity, the ordinary meaning of the words which has been used in the document must prevail.” 21. It should be noted that an ambiguity need not be established before the surrounding circumstances may be taken into account — see the Investors Compensation Scheme case. Absurdity 22. Even where the background matrix does not assist in the interpretation of a contractual provision, it has long been recognised that too literal an approach is to Guy Fetherstonhaugh QC E Falcon Chambers be avoided in the interpretation of contracts. The reason for this was explained thus by Lord Reid in Schuler AG v Wickman Machine Tool Sales Ltd [1974] AC 235: “No doubt some words used by lawyers do have a rigid inflexible meaning. But we must remember that we are seeking to discover intention as disclosed by the contract as a whole. .. The fact that a particular construction leads to a very unreasonable result must be a relevant consideration. The more unreasonable the result, the more unlikely it is that the parties can have intended it, and if they do intend it the more necessary it is that they shall make that intention abundantly clear.” 23. On the same theme, in Antaios Compania Naviera SA v Salen Rederierna AB (“The Antaios”) [1985] AC 191, Lord Diplock famously stated that: “., if detailed semantic and syntactical analysis of words in a commercial contract is going to lead to a conclusion that flouts business common sense, it must be made to yield to business common sense.” 24. In Co-operative Wholesale Society Ltd v National Westminster Bank plc [1995] 1 EGLR 154, a rent review case, Hoffmann LJ added the following gloss on Lord Diplock’s words: “This robust declaration does not, however, mean that one can rewrite the language which the parties have used in order to make the contract conform to business common sense. But language is a very flexible instrument and, if it is capable of more than one construction, one chooses that which seems more likely to give effect to the commercial purpose of the agreement”. 25. Notwithstanding the clarity with which this limitation was expressed, other courts have shown themselves prepared to dispense with parts of the contract altogether: if the intention of the parties is plain, it must colour all the words they have used - so much so that a word, a phrase, or even a whole clause can be disregarded if it is irreconcilable with the plain intention of the parties gathered from other parts of the document. 26. In Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1997] AC 749, the question in the appeal was whether a tenant’s notice to determine a lease which was expressed to take effect on 12 January 1995 was validly served under a provision which entitled the tenant to determine the lease by not less than six months’ notice ‘to expire on the third anniversary of the term commencement date’ in circumstances in which the term had commenced on 13 January 1992. Lord Hoffmann pointed out that commercial contracts were to be construed in the light of all the background which could reasonably have been expected to be available to the parties; so that: Guy Fetherstonhaugh QC E Falcon Chambers decades before by Lord Blackburn in River Wear Comrs v Adamson (1877) 2 App Cas 743: “’.. [shall ... state, as precisely as I can, what I understand from the decided cases to be the principles on which the Courts of Law act in construing instruments in writing ... . In all cases the object is to see what is the intention expressed by the words used. But, from the imperfection of language, it is impossible to know what that intention is without inquiring farther, and seeing what the circumstances were with reference to which the words were used, and what was the object, appearing from those circumstances, which the person using them had in view; for the meaning of words varies according to the circumstances with respect to which they were used.” 31. I suggest that the real importance of Lord Hoffmann’s statement of principle is that it synthesises traditional principles, while emphasising that the modern approach does not allow the meaning, or even “the natural meaning” of words to be established without a full understanding of those circumstances, known to both parties, which would have informed them in choosing precisely which words should express their intention. 32. These authorities establish apparently clear limitations to the extent to which courts may elaborate upon the language used by the parties in order to arrive at an interpretation that appears to make for good commercial common sense. In practice, however, I suggest that different judges will draw the line between what is permissible and what is not in different positions in individual cases. The battle lines are drawn between (a) those judges who are reluctant to allow the business commonsense of the contract to cause them to depart from the natural meaning of the words used; (b) those who strain the meaning of words in order to arrive at what they consider to be a commercial outcome that best expresses the perceived intention of the parties while avoiding absurdity; and (c) those who feel able to disregard or even rewrite the parties’ words to achieve the same effect. The remainder of this paper seeks to examine the tools available to the parties to forecast, and fight for, the construction that best suits them. Correctable mistakes 33. It is now generally accepted that Brightman J was right in Re Butlin’s Settlement Trusts [1976] Ch 251 in holding that rectification is available not only when the parties intended to use different words but also when they mistakenly thought their words bore a different meaning. 34. Had this flexibility been available to the Court of Appeal in Frederick E Rose (London) Ltd v William H Pim Junior & Co Ltd [1953] 2 QB 450, it might yet have been possible for them to hold that the parties had contracted for feveroles rather than the less valuable feves — whether the cause of action lay in construction or in rectification. 10 Guy Fetherstonhaugh QC juy Fetherstonhaugh Q FB eon cramer The approach to construction 35. In what follows, an apparent distinction is drawn between the various processes of interpretation that are considered. In practice, these should be seen not as alternative processes, but rather as part of the single process of arriving at the meaning of the contract. As Carnwath LJ said in KPMG LLP v Network Rail Infrastructure Ltd [2007] EWCA Civ 363, [2007] Bus LR 1336: “{50] ... Both in the judgment, and in the arguments before us, there was a tendency to deal separately with correction of mistakes and construing the paragraph “as it stands”, as though they were distinct exercises. In my view, they are simply aspects of the single task of interpreting the agreement in its context, in order to get as close as possible to the meaning which the parties intended.” Correction (1): The correction of mistakes by construction 36. Where the contract has an obvious omission or other mistake, it is unnecessary to resort to rectification: the contract can be construed by reading in the words which have been omitted, or otherwise correcting the mistake. The relevant requirements for this approach were summarised thus by Brightman LJ in East v Pantiles Plant Hire Ltd [1982] 2 EGLR 111: “Two conditions must be satisfied: first there must be a clear mistake on the face of the instrument; secondly it must be clear what correction ought to be made in order to cure the mistake. If those conditions are satisfied, then the correction is made as a matter of construction. If they are not satisfied then either the claimant must pursue an action for rectification or he must leave it to a court of construction to reach what answer it can on the basis that the uncorrected wording represents the manner in which the parties decided to express the manner in which the parties decided to express their intention.” 37. Lord Bingham added in Homburg Houtimport BV v Agrosin Private Ltd (“the Starsin’’) [2004] 1 AC 715: “T take it to be clear in principle that the court should not interpolate words into a written instrument, of whatever nature, unless it is clear both that words have been omitted and what those omitted words were ...” 38. These words received the following further gloss from Carnwath LJ in KPMG: “{64.] ... I think it would be wrong to apply too literally Lord Bingham’s reference to the need for clarity both as to the omission of words and “what those relevant words were”. As Lord Millett said, it is sufficient if the court is able to ascertain “the gist” of what has been omitted. I would go further. Once the court has identified an obvious omission, and has found in admissible background materials an obvious precedent for filling it, it should not 11 Guy Fetherstonhaugh QC E Falcon Chambers be fatal that there may be more than one possible version of the replacement, or more than one explanation of the change.” 39. In Chartbrook, the House of Lords agreed, adding, in the words of Lord Hoffmann: “{25.] 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.” 40. A number of authorities bear witness to the use by the courts of this interpretive tool. The following examples serve to illustrate the point. 4l. In Littman v Aspen Oil (Broking) Ltd [2005] EWHC 1369 (Ch), a lease contained a break clause allowing either party to terminate the lease at the end of the third year of the term. The clause provided that in the case of a notice given by the /andlord the tenant should have paid the rent and duly observed and performed the covenants on the part of the tenant, but provided no similar restriction upon the tenant. 42. The tenant purported to bring the lease pursuant to the clause, despite the fact that it was in breach of covenant. The landlord disputed the effectiveness of the break on the ground that the words “in the case of a notice given by the landlord” should be read as if they said “in the case of a notice given by the tenant” or “in the case of a notice given to the landlord”, alternatively that the clause should be rectified so to provide, with the result that operation of the break clause by the tenant would be conditional on due performance of the covenants. 43. Hart J held that it was quite plain that something had gone wrong with the drafting of the break clause because there was no commercial purpose in making the exercise by the landlord of its right to terminate conditional on the performance by the tenant of its obligations under the lease. The inclusion of such a provision would put it in the power of the tenant, by its own breach of covenant, to defeat the right conferred on the landlord. It was obvious not only that a mistake had been made in its formulation but also obvious what that mistake was. The words “in the case of a notice given by the landlord” should be construed as if they read “in the case of a notice given by the tenant”. 44. In KPMG itself, the Court of Appeal had to consider the following break clause in a renewed lease made in 1985: 12 Guy Fetherstonhaugh QC E Falcon Chambers (c) Before a term will be implied, it must be so obvious that “it goes without saying”; (d) It is more difficult to imply a term where the parties “have entered into a lengthy and carefully-drafted contract”; (e) The argument that a term must be implied will frequently arise after a problem has arisen, and the Court must therefore be wary of using the benefit of hindsight not available to the parties when they made the contract; (f) A term should only be implied to solve a particular problem if the Court is satisfied that there is “only one contractual solution or that one of several possible solutions would without doubt have been preferred”. 54. In general, claims for implication are often made, but seldom succeed. One of the most common contexts for such claims is development contracts, where parties commonly indulge in a degree of crystal ball gazing as to the probability of certain events that may turn out, with the benefit of hindsight, to have been less than prophetic. 55. A recent illustration of such a difficulty in a development agreement context is provided by the decision of the Court of Appeal in Anglo-Continental Educational Group (GB) Ltd v Capital Homes (Southern) Ltd [2009] EWCA Civ 218. In that case, the claimant agreed to sell property to the defendant, at a price of £862,000 less the amount required to obtain a deed of release of certain restrictive covenants. By the date set for completion, no such deed had been obtained, and the claimant contended that no discount was to be allowed. The defendant argued for an implied term allowing for the estimated cost of releasing the covenants to be taken into account in some way. The Court of Appeal rejected the case based on implied term for a number of reasons, but went on to prefer an interpretation of its own devising which arose from the express terms of the agreement. 56. Given the difficulties associated with the implication of terms, if the claimant considers that its case may be supported by evidence forming part of the background matrix that is not reflected in the contract, it may be more fruitful for it to bring proceedings for rectification, rather than to seek to imply a term into the contract. 15 Guy Fetherstonhaugh QC E Falcon Chambers Correction (3): Rectification for mutual mistake 57. Rectification of a contract is however no soft alternative to an argument based upon implication for a term'. As I go on to suggest at the end of this paper, the reason for bringing a claim in rectification may more often be based upon tactics rather than a realistic evaluation of the prospects of success. I deal here with rectification for mutual mistake. Rectification for unilateral mistake is a subject that deserves a paper to itself. 58. The standard of proof in rectification cases is the usual civil standard of balance of probabilities, but there must be convincing proof*: Thomas Bates & Son Ltd v Wyndham’s (Lingerie) Ltd [1981] 1 WLR 505. Although that is not to say that the claimant’s case must be proved to a level other than the balance of probabilities, the evidence adduced in support of the claim must be firm. 59. Although the party seeking rectification has to produce convincing evidence, the standard of proof is the civil standard; that is to say the balance of probabilities. However, as Chadwick LJ pointed out in Fuller v Strum [2002] 2 All ER 87, (first quoting from Lord Nicholls): “Where matters in issue are facts the standard of proof required in non-criminal proceedings is the preponderance of probability, usually referred to as the balance of probability’. “But, as Lord Nicholls went on to point out there was ‘[bJuilt into the preponderance of probability standard ... a generous degree of flexibility in respect of the seriousness of the allegation’. Lord Nicholls said: ‘This approach also provides a means by which the balance of probability standard can accommodate one’s instinctive feeling that even in civil proceedings a court should be more sure before finding serious allegations proved than when deciding less serious or trivial matters.” 60. Where parties instruct lawyers to set out the terms of their agreement in writing it is inherently unlikely that the lawyers will make a mistake in recording the terms that they have agreed. It is that factor that has led the court to require convincing proof. ' The differences are analysed in the scholarly Jonathan Brock Memorial Lecture “If it ain’t broke don’t fix it: Rectification and the Boundaries of Interpretation”, given by Sir Kim Lewison to the London Common Law and Commercial Bar Association on 21 May 2008. ? “strong irrefragable evidence”, to use the description given by the Lord Chancellor in Countess of Shelburne v Earl of Inchiquin (1784) 1 Bro CC 338. 16 Guy Fetherstonhaugh QC E Falcon Chambers 61. Generally speaking (see Swainland Builders Ltd v Freehold Properties Ltd [2002] 2 EGLR 71), in order to obtain the remedy of rectification, the following must be demonstrated to the satisfaction of the court: (a) that the parties had a common continuing intention, whether or not amounting to an agreement, in respect of a particular matter in the instrument to be rectified; (b) that there was an outward expression of this common intention; (c) that this common intention continued up to and including the time when the contract was executed; (d) that by mistake the contract as executed failed to give effect to that common intention; (e) that the contract as executed can be rectified so as to give effect to the common intention; (f) that there is no discretionary reason why rectification should be refused. 62. Some of these ingredients benefit from a little more detail. In relation to the second, Joscelyne v Nissen [1970] 2 QB 86 established that the accord need not be enforceable as a contract, provided that it is outwardly expressed. However, whether there is a need for this accord to be spoken or signified in some way, however, is currently a matter of debate. In cases where a common assumption is so obvious that it goes without saying, there is much to be said for the view that no outward expression is necessary — see JIS (1974) Ltd v MCP Investment Nominees 1 Ltd [2003] EWCA Civ 721. 63. The third ingredient may be difficult to demonstrate. It may be possible to adduce evidence of an earlier common accord (perhaps in the form of an exchange of correspondence). Proving that that accord remained in existence in that same form thereafter will often mean inviting the court to draw the inference from the lack of any further material evincing a change of mind. However, the change of mind may be said to lie in differing wording of the contract itself. Much may therefore depend upon the extent to which oral evidence of the progress of the negotiations may still be available. 64. The fifth ingredient normally requires the court to be satisfied as to exactly what was the nature of the prior agreement but in Thomas Bates & Son Ltd v Wyndham’s (Lingerie) Ltd [1981] 1 WLR 505, the Court of Appeal was prepared to go some way towards implying into the parties’ accord certain details which they had not actually agreed. 17