Summary
In its decision in Arnold v Britton [2016] AC 1619 the Supreme Court has restored the supremacy of the traditional approach to the construction of commercial contracts.
- The parties have the greatest control over the words that they have used in their contract and those words should not be undervalued or forced to defer to “business common sense”;
- The courts must avoid actively seeking out ambiguity; the clearer the meaning of the words used the harder it will be to depart from their natural meaning;
- It is not the role of the courts to save contracting parties from bad bargains.
Contractual interpretation
The last 45 years have seen our highest courts grapple with and develop the principles on which commercial contracts are to be interpreted. From the outset of that process, beginning with Prenn v Simmonds [1971] 1 WLR 1381, the House of Lords showed an increasing flexibility in the process of interpretation, with the requirements of “business common sense” often being allowed to prevail over the strict language used by the parties.
In a much-quoted passage from Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896 Lord Hoffmann provided what many regarded as the last word in contractual interpretation, presented in 5 core principles. In each case, the question for the Court is what a reasonable person, having all the background knowledge which would have been available to the parties, would have understood them to be using the language in the contract to mean: see also Chartbrook Ltd v Persimmon Homes Ltd [2009] 1 AC 1101 per Lord Hoffmann.
The ICS principles were seen by many lawyers as an open invitation to argue that a contract unfavourable to their clients defied business common sense. The highpoint for that line of argument came with the Supreme Court’s decision in Rainy Sky SA v Kookmin Bank [2011] 1 WLR 2900. In Rainy Sky Lord Clarke held that, in the face of competing interpretations, the construction which best favoured business common sense was to be adopted. Many saw this as introducing a judicial discretion into matters of contractual construction.
The most recent analysis of the principles that underlie the construction of commercial documents, provided by the Supreme Court in Arnold v Britton [2016] AC 1619, suggests a return to a more orthodox approach.
Having reviewed the leading cases on the construction of commercial documents including ICS and Chartbrook, Lord Neuberger restated the applicable principles:
- The interpretation of any contractual term involves identifying what the parties meant by the language they have used, viewed through the eyes of a reasonable reader. Therefore, the importance of the language used by the parties should not be undervalued or made to defer to “commercial common sense” or the surrounding circumstances;
- The clearer the natural meaning of words used in a contractual provision the more difficult it will be to justify departing from it. Conversely, where the crucial words are less clearly drafted the court may more easily justify a departure from their natural meaning. However, this does not entitle the court actively to seek out drafting errors in order to entitle it to depart from the natural meaning of the words used;
- Thirdly, the commercial common sense against which a contractual term is judged is that prevailing at the time that the contract was made. It cannot be invoked retrospectively simply because a term, interpreted according to its natural meaning, has worked out badly for one party;
- On a related note, courts have been cautioned against using commercial common sense as a basis for rejecting the natural meaning of the words used in a contract simply because the term was an imprudent one for one of the parties to have agreed, even ignoring subsequent developments. The process of contractual interpretation cannot be used to help an unwise party or to penalise an astute one;
- In construing a contractual term the only facts to be taken into account are those known to both parties at the time that the contract was made
- However, where an event occurs that was plainly not intended or contemplated by the parties, judged by the language that they have used, then the court will give effect to their intention, provided that it is clear on the evidence what they would have intended.
Conclusion
In Arnold v Britton it is possible to see the first signs of the tide ebbing away from high-water mark of contractual interpretation represented by Rainy Sky and ICS. The emphasis must now be on achieving clarity of drafting at the outset of a contract because, except in the clearest cases of ambiguity, parties are less likely to see the courts rescue them from bad bargains.