Contracts: A question of interpretation

Stuart Pemble is really rather excited about a recent speech given by Lord Sumption on contracts. Here’s why. Contracts matter. They regulate most of the commercial interactions – and a fair few of the personal ones – between people, businesses and organisations. Anyone entering into a contract wants certainty that the bargain reached will be upheld and enforced. However, it is not just contracts themselves that matter. The rules we use to interpret them, and give them certainty, matter as well. However, for the past 20 years, it would require the most positive of spin doctors to suggest that the courts have provided anything resembling certainty when interpreting contracts. This unsatisfactory state of affairs might be about to change. The good old days? Traditionally, the English common law adopted an objective approach to contractual interpretation. Judges weren’t interested in what the parties thought they were agreeing. They would enforce the contract that was actually agreed. As Lord Wright said in Inland Revenue Commissioners v Raphael and others [1935] AC 96, the “principle of the common law has been to adopt an objective standard of construction and to exclude general evidence of actual intention of the parties: the reason for this has been that otherwise all certainty would be taken from the words in which the parties had recorded their agreement”. The problem with this approach was that, while delivering certainty, it could result in unfair outcomes, especially where parties (or their lawyers) mistakenly recorded their agreement. The courts would not consider any evidence of the mistake and would enforce the words actually used. The more-recent days That potential for unfairness gradually resulted in some of our senior judges proposing ideas for change. Two are significant. The first – that the courts should consider the “surrounding circumstances” of the contract – was most famously discussed by Lord Wilberforce in Prenn v Simmonds [1971] 1 WLR 1381 and Reardon Smith Line Ltd v Yngvar Hansen-Tangen [1976] 1 WLR 989. He said in Prenn: “The time has long passed when agreements… were isolated from the matrix of facts in which they were set and interpreted purely on internal linguistic considerations.” The second – that contracts should be interpreted using “commercial common sense” – was thrown into the mix by the House of Lords in Antaios Compania Naviera SA v Salen Rederierna AB (The Antaios) [1985] AC 191, with Lord Diplock stating: “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.” Lord Hoffmann’s revolution Notwithstanding these decisions, the idea that there should be a move away from an objective approach to contractual interpretation did not receive significant judicial traction until Lord Hoffmann’s judgments in Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1997] UKHL 19; [1997] 24 EG 122 and Investors Compensation Scheme v West Bromwich Building Society [1997] UKHL 28 (“ICS”). In Mannai, Lord Hoffmann used Mrs Malaprop (from Richard Brinsley Sheridan’s 18th-century play The Rivals) as an example of how the words people use do not always convey the meaning that an ordinary personwould understand them to have. Mrs Malaprop famously used words that didn’t have the meaning she intended, but which sounded similar to words that did. When she described someone as “obstinate as an allegory on the banks of the Nile”, Lord Hoffmann emphasised how “we reject the conventional or literal meaning of allegory as making nonsense of the sentence and substitute alligator by using our background knowledge of the things likely to be found on the banks of the Nile and choosing one that sounds rather like allegory”. That approach to interpretation meant that a tenant’s notice terminating a lease on the wrong day was held to be valid because the ordinary person would have understood which date was intended. If Mannai was the undercard for Lord Hoffmann’s revolution, ICS was very much the main event, with Lord Hoffmann stressing that “all the old baggage of ‘legal’ interpretation” no longer applied. In its place, he asserted five principles. The first three expanded the concept of the surrounding circumstances to include anything that would have affected how an objectively reasonable man would have interpreted the contract, apart from pre-contract negotiations and information unavailable to the parties. The other two had a similar effect in relation to commercial common sense, with Lord Hoffmann emphasising the point from Mannai that the true meaning of a document may not be the same as the meaning of the words used in it and that “if one would…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.” Although the House of Lords tried to suggest that this was nothing more than the next stage in an ongoing development of the law of contract, it was actually revolutionary. It also created a conundrum: if the words used in the contract did not mean what they said, just what was the agreement reached between the parties? Uncertainty prevails Following ICS, the House of Lords and the Supreme Court had to deal with a number of cases dealing with the consequences of the new approach. Bank of Credit and Commerce International SA v Ali [2001] UKHL 8, Chartbrook v Persimmon Homes [2009] UKHL 38; [2009] 27 EG 91, Rainy Sky SA v Kookmin Bank [2011] UKSC 50, Arnold v Britton [2015] UKSC 36; [2015] EGLR 53 and Wood v Capita Assurance Services Ltd [2017] UKSC 24 are, perhaps, the best-known examples of the struggles that parties, their lawyers and the judiciary have had with interpreting contracts since, often with our senior judges feeling able to make significant changes to the words agreed. Lord Sumption’s suggestions However, change might be afoot. On 8 May, Lord Sumption, the Supreme Court justice, gave the Harris Society Annual Lecture in Oxford. A number of the presumptions behind ICS come in for persuasive criticism. First, Lord Sumption challenges the idea that the language used in a contract can have meaning only when viewed against a particular background. Dictionaries and grammar guides help with our understanding of the parties’ intentions. If they are abandoned as a tool of interpretation, “we are no longer discovering how the parties understood each other. We are simply leaving the judges to reconstruct an ideal contract which the parties might have been wiser to make, but never actually did.” He also attacks the focus on the surrounding circumstances as being an independent source that can reveal the parties’ intentions. He stresses that the language used is the key to assessing intention: “The parties are the masters of their own agreement, and anything which marginalises the role of words… is a direct assault on their autonomy.” His second challenge is to highlight the inconsistency in trying to use the surrounding circumstances to modify the contract when English law still prohibits the use of pre-contractual negotiations as evidence. He argues that it is wrong for judges to expect contracts to contain rational or explainable terms, noting that harsh or unreasonable ones might be in the contract by way of compromise, in exchange for a concession elsewhere or (and most practitioners would concede the truth in this) “because the deal was concluded at 3am and one of the parties was more interested in going to bed than in the finer points of drafting”. His third critique is to note that “judges are not necessarily well placed to determine what commercial common sense requires”, as they look at the contract after the dispute has occurred. Contracts can be a bad bargain for one party; and Lord Sumption does not think it is the role of a judge to save that party from the consequences of having made it. Finally, he notes that Lord Hoffmann’s approach arguably makes the law regarding implied terms and rectification obsolete, suggesting that the doctrines are unnecessary if “the parties can have an intention attributed to them which is not reflected in the language of the agreement”. What next for contracts? It should be stressed that Lord Sumption’s speech has no legal effect. It is not a judgment of the court. It is, however, a brilliantly persuasive plea for contracts once again to be interpreted in accordance with the words they actually contain. I, for one, wholeheartedly agree. More certainty, please. Stuart Pemble is a partner at Mills & Reeve Photo:Alto/REX/Shutterstock