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Supreme Court contract interpretation

News / / Supreme Court contract interpretation

In the latest case to reach the Supreme Court concerning the approach to interpreting ambiguous contractual provisions, the court has explained that a balance has to be struck between (i) the natural, ordinary meaning of the language, and (ii) which interpretation is more consistent with commercial common sense. The quality of the drafting will be a significant factor in the weight given to these elements.

In Wood v Capita Insurance Services Limited [2017] UKSC 24, an indemnity had been given by the sellers to the buyer in a sale and purchase agreement for an insurance broking company.  The indemnity was in relation to mis-selling liabilities.  After the sale completed, mis-selling came to light. In accordance with its regulatory obligations, the company self-reported to the FSA, which ultimately resulted in the company paying compensation to former customers even though no claims were actually raised by affected customers. The buyer sought to recover under the indemnity.

The disputed wording was as follows:

“The Sellers undertake … to indemnify the Buyer … against all actions, proceedings, losses, claims, damages, costs, charges, expenses and liabilities suffered or incurred, and all fines, compensation or remedial action or payments imposed on or required to be made by the Company following and arising out of claims or complaints registered with the FSA, the Financial Services Ombudsman or any other Authority against the Company, the Sellers or any Relevant Person and which relate to the period prior to the Completion Date pertaining to any mis-selling or suspected mis-selling of any insurance or insurance related product or service.”

The sellers argued that the indemnity was limited to situations where a customer claim had been made against the company or a complaint had been made to the FSA pertaining to any mis-selling or suspected mis-selling prior to the sale date.  It did not apply in a self-reporting situation.

The court at first instance and the Court of Appeal had reached different conclusions on the meaning of the indemnity, which the Supreme Court held resulted from a “difficult” and “opaque provision” rather than any failure to apply the correct principles of contract interpretation.

The Supreme Court agreed with the Court of Appeal that the indemnity did not respond to the buyer’s claim. Lord Hodge reiterated that the court’s task is to ascertain the objective meaning of the language which the parties have chosen to express their agreement. He also took the opportunity to address perceptions that tension exists between the required reliance on the natural, ordinary meaning of the language used and the role of commercial common sense. In doing so he made clear that the guidance previously provided in both Rainy Sky 1 and Arnold v Britton 2 remained applicable: “On the approach to contractual interpretation, Rainy Sky and Arnold were saying the same thing.”

With reference to statements made in each of Rainy Sky and Arnold, Lord Hodge confirmed that where there are rival meanings a balancing exercise is to be conducted between the indications given by the language used (both in the subject clause and the wider contract) on the one hand and the factual background/commercial implications on the other.  This involves an iterative process by which each suggested interpretation is to be checked against the provisions of the contract and its commercial consequences investigated.

Lord Hodge highlighted that the weight to be given to each element will depend on the subject circumstances, observing that some agreements may be successfully interpreted principally by a textual analysis – for example because they have been professionally drafted and their meaning is clear - and in other contracts a greater emphasis on the context/commercial implications may be necessary to obtain the correct interpretation – for example because of a lack of clarity due to informality or brevity of the provisions.

In this case, the court noted the existence of other, wide-ranging, warranties which would have provided compensation for the subject losses had they been triggered within the specified two year time limit. The court concluded that it was not contrary to business common sense to agree wide warranties, which are subject to a time limit, and in addition agree a further indemnity not subject to a time limit but which is only triggered in limited circumstances.

The court’s statements make clear that that the correct approach to contract interpretation remains as identified in recent authorities (but provide a steer as to how the established principles should be applied in practice). Ultimately, where there is no ambiguity the court will enforce the agreement reached by the parties by reference to the words used. If there is ambiguity (as in this instance) the court will, inter alia, also look to commercial common sense (and the clarity of the drafting will influence the weight this is given). In either case, it is not the role of the court to improve a bad bargain.

The frequency with which cases on contract interpretation continue to come before the courts shows that it is not always clear how the established principles should be applied to particular facts and the further clarity provided by the Supreme Court in Wood v Capita is to be welcomed. In fact, since judgment in the case was handed down at the end of March, the case has already been applied in at least two other decisions.3

1  Rainy Sky SA v Kookmin Bank [2011] 1 WLR 2900

2  Arnold v Britton [2015] AC 1619 

3 Gard Shipping AS v Clearlake Shipping Pte Ltd [2017] EWHC 1091 (Comm); GB Building Solutions Ltd v SFS Fire Services Ltd (t/a Central Fire Protection) [2017] EWHC 1289 (TCC)

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