Roll with it – contractual interpretation

Posted: 04/12/2017

Earlier this year, the Supreme Court sought to resolve a longstanding question as to how a contract should be interpreted under English law. Previous, seemingly conflicting, Supreme Court authorities on contractual interpretation had caused uncertainty among practitioners as to whether to take a literal approach (Arnold v Britton) or a purposive / "commercial common sense" approach (Rainy Sky v Kookmin Bank). In Wood v Capita Insurance Services, the Supreme Court clarified that the two approaches can be reconciled and that a balance must be struck between them.

In his leading judgment in Wood, Lord Hodge explained that “textualism (ie looking at the literal meaning of the words) and contextualism (ie looking also at the wider context or purpose) are not conflicting paradigms in a battle for exclusive occupation of the field of contractual interpretation” (paragraph 13). In other words, the two approaches are in fact tools that work together to enable us to ascertain the objective meaning of the language of the contract. Contractual interpretation is a balancing act between the two, with the balance depending on the particular circumstances of the case.

So, several months down the line from Wood, how has the issue of contractual interpretation fared in practice? Wood has been cited several times this year, in both the Court of Appeal and the High Court. This article takes a look at its recent treatment and practical application in the Court of Appeal to see what lessons can be learned. 

Come together: two points of view

The case of National Health Service Commissioning Board v Silovsky & Anr was an appeal to the Court of Appeal on the sole issue of the true construction of a contractual clause regarding what sums the appellant was liable to pay to the respondents (two GPs) towards the cost of their GP practice premises. The respondents had previously succeeded on a summary judgment application to dismiss the appellant’s claim. 

Schedule 7 to the agreement was in the following terms:

Premises payments

Rent  77,238  Calendar monthly  15th of each month

with the figure of 77,238 located in a column headed ’Annual Value’. The primary question before the Court of Appeal was whether the sum specified to be paid by the appellant to the respondents in respect of rent was:

• a fixed amount of £77,238 per annum, or
• a variable sum, broadly intended to track the amounts actually paid by the respondents under a bank loan. 

The appellant had been making (and in fact continued to make) fixed-sum payments to the respondents in accordance with the first interpretation, but due to a significant reduction in the respondents’ bank borrowing costs, this had essentially resulted in a windfall to the respondents. The appellant thus contended that the correct interpretation was in fact the second one, which, it argued, meant that the sum payable should have been adjusted downwards and the respondents had consequently received an overpayment which should be returned.

Siding with the respondents and dismissing the appeal, the Court of Appeal endorsed the approach taken by the judge at first instance of looking at the ordinary and natural meaning of the clause, which plainly meant that rent per annum of £77,238 was intended to comprise a fixed amount for each year that the agreement remained in force. In coming to that conclusion, the following points (among others) were relevant:

• There was nothing in the agreement to suggest that the sum was intended to be variable. It was especially significant, in this regard, that other sums in the same schedule were specifically stated to be variable, yet this was not.
• The appellant argued that the agreement incorporated the National Health Service (General Medical Services – Premises Costs) (England) Directions 2004 on premises costs (which linked the provision of financial assistance to the costs of borrowing payable). The 2004 directions had applied to an earlier agreement between the parties which the current agreement replaced. This argument failed, because:
  • The wording of the agreement said nothing about any such incorporation;
  • Moreover, incorporation would have been no simple matter, needing to extend to a complex scheme of payment mechanisms as found in the 2004 directions;
  • The agreement contained an 'entire agreement' clause which also expressly confirmed that the agreement superseded any prior agreements;
  • The agreement was different from the earlier agreement. It had been redrafted by different solicitors. In those circumstances, it did not follow that because the earlier agreement had one meaning, the later agreement must have the same meaning.
  • The appellant’s argument that the second interpretation must be the correct one in order for the agreement to make commercial common sense also foundered. The same form of agreement was offered to all GPs with whom the appellant’s predecessor was dealing, and thus gave it certainty that its liability for premises payments was capped at a particular level. The agreement for payment of a fixed annual sum, without any provision for altering it upwards or downwards, was therefore, as the judge at first instance had found, not an ’obviously irrational’ arrangement for the parties to have entered into.
  • It was also relevant that this was a lengthy, detailed and complex agreement which had been professionally drafted. 

Don’t look back (in anger): hindsight

The Court of Appeal concluded that, pulling all the threads together and whether viewed textually or contextually, the agreement meant that the sum to be paid in respect of rent was a fixed amount, not a variable amount. In doing so, it cited Lord Hodge’s judgment in Wood at length, including his submission that “the court…must be alive to the possibility that one side may have agreed to something which with hindsight did not serve his interest…”(paragraph 11). The Court of Appeal reinforced this warning against courts seeking to reformulate a contract with the benefit of hindsight, as this was not the parties’ intention at the time the contract was formed.

Gross LJ (giving the leading judgment) stated: “…the purpose and limits of contractual interpretation must be underlined. The task of the Court is to identify and give effect to the agreement of the parties; it is not for the Court to make some different bargain because it thinks that the parties or a party would have been wiser to do so. As Lord Neuberger of Abbotsbury PSC observed in Arnold v Britton (supra), it is therefore first necessary to strip out hindsight: ‘...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.’”(paragraph 40).

In conclusion, Gross LJ said: “If mistake there was on the part of the appellant in entering into such an agreement, it is not a mistake which, as a matter of construction, the court can or should correct. As already underlined, there are limits to the role of the court when construing a contract; that role is to identify and give effect to the bargain agreed by the parties – not, as the Judge put it, to indulge in ‘some process of creative interpretation to make up for the deficiency in the drafting…’” (paragraph 48).

The Court of Appeal in Silovsky hence clearly affirmed Wood (by reference too to Arnold v Britton) as stating the current position of the law on contractual interpretation, and demonstrated the practical application of the combined textual and contextual approach. The literal reading of the words was the starting point here, with, as the first instance judge noted, the ’burden of persuasion’ being on the appellant to show otherwise (paragraph 27). That starting point was also all the stronger for the fact that the agreement was a detailed and professionally drafted one, underlining that context and background are more likely to come second to a textual and literal approach where a contract has been heavily negotiated and carefully drafted by professional advisors. In Silovsky however, the appellant struggled to establish that the respondents’ construction would not make sense in a commercial common sense context in any event. In such instances, parties will face an uphill battle to convince the court that there is any reason to depart from the literal meaning of the words in question.

Better let you know: notice to quit

The Court of Appeal again this year grappled with principles of contractual interpretation in Terence Frances Grimes v The Trustees of the Essex Farmers and Union Hunt, an appeal on whether a notice to quit an agricultural holding was validly served on the appellant tenant by his respondent landlords. Once again, the appeal turned on the true construction of a contractual clause, this time found in a tenancy agreement. Clause 14.2 stated: ’Either party may serve any notice (including any notice in proceedings) on the other at the address given in the particulars [at the beginning of the tenancy agreement] or such other address as has previously been notified in writing.’

The respondents had served a notice to quit on the appellant’s address as shown in the particulars, even though the appellant had moved away from that address nearly six years earlier and had given notice of his change of address to the respondents. So had the appellant been validly served with the notice? Was it open to the respondents to serve him at his old address as stated in the particulars, despite having been notified of his new address (the fact that such notification was received by the respondents being a finding of fact which they failed to overturn)?

The first instance judge considered so. In his view, the literal meaning of the wording of clause 14.2 was that good service could be effected “either at the address stated on the lease or at the other address that has since been notified to the other party” ie the ’or’in the clause gave the respondents a choice between the two addresses (paragraph 32).

The Court of Appeal however disagreed. Referring to the line of case law in which the principles of contractual construction have been expounded, and relying in particular on the judgments in Wood and Arnold v Britton, Henderson LJ stated in his leading judgment that “the relevant wording has to be considered in the context of the contract as a whole, and is not (as Lord Hodge said in Wood v Capita Insurance Services Ltd…) ‘a literalist exercise focused solely on a parsing of the particular clause’. If the [first instance] judge had approached the question in this way, he would I think have realised that the language can naturally be read as providing for an alternative which is not only exclusionary but also substitutive; and that, viewed objectively, this is what the parties must have intended (paragraph 34).”   

The Court of Appeal’s analysis here again demonstrates the balancing and reconciliation of the textual and contextual approaches as advocated by the Supreme Court in Wood. Accepting the appellant’s argument that the ’or’in clause 14.2 could be construed as substitutive as well as disjunctive, it found that as a matter of the natural and ordinary language of the contract, the provision of notice of a new address was intended to replace the old address shown in the particulars. Thus the literal and textual approach to interpretation was deployed.

The 'commercial common sense' contextual approach was also utilised and confirmed the Court of Appeal’s interpretation – Henderson LJ noting in this regard that there would be no point in enabling the appellant to notify the respondents of a new address for service if the respondents remained free to continue to serve notices at the appellant’s previous and now obsolete address. That could not have sensibly been what the parties had intended.

Accordingly, the Court of Appeal unanimously overturned the first instance judgment and allowed the appeal.

An oasis of interpretative certainty

Both these cases illustrate in practice the approach set out in Wood of employing the tools of textualism and contextualism together, seeking a balance between the literal meaning of the words and their context to arrive at the correct interpretation. In these particular cases however, the literal interpretation appeared to receive greater emphasis - that may well be due to the fact that the agreements in both these cases were professionally negotiated and drafted, in which case the literal words will bear greater weight than if that were not the case.

Furthermore, as was emphasised repeatedly in Silovsky, parties and practitioners must guard against seeking to apply a commercial common sense approach with the benefit of hindsight. The correct question to be asked is what the parties objectively intended at the time that the contract was entered into, with the knowledge and understanding that they had at that point in time. Lord Neuberger’s words in Arnold v Britton cautioning against invoking the commercial common sense approach retrospectively remain good law. 

However, as Gross LJ also underlined in Silovsky, matters do not rest with eliminating hindsight alone. Again borrowing from the succinct words of Lord Neuberger as quoted by Gross LJ: “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.” In other words, the courts will not simply rescue a party from a bad bargain.

This article was published in Commercial Litigation Journal in November 2017.

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