A recent case in the House of Lords, Chartbrook Ltd v Persimmon Homes Ltd , has underlined again the need for clarity in drafting contracts.
Chartbrook had entered into an agreement with Persimmon, the well known house-builder, for the development of a site which Chartbrook had recently acquired. After the development was completed a dispute arose between the parties over the calculation of an element of the price defined as the 'additional residential payment' ('ARP'). The dispute turned on the interpretation of the contractual definition of the ARP, a balancing payment which Persimmon was to pay to Chartbrook.
Chartboork contended that the definition should be given its conventional syntax, and that this meant that the value of the ARP due from Persimmon was approximately £4.5m. On the other hand, Persimmon argued that applying the commercial purpose of the clause, the value of the ARP which Chartbrook was entitled to was limited to approximately £900,000. So there was much riding on which contractual construction prevailed.
The Principles Of Interpretation
There was no dispute that the principles on which a contract should be interpreted are those summarised by Lord Hoffman in Investors Compensation Scheme Ltd v West Bromwich.
"Interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract."
Lord Hoffman gave the leading judgment in this case too and confirmed this objective approach, which seeks to identify what the parties to a contract meant by the words they used rather than the literal meaning of the words, taking into account the background and context in which the contract was made.
Has Something 'Gone Wrong' With The Drafting?
Whilst the starting point is that the words of the contract are to be given their ordinary and natural meaning, the background and context might force a court to conclude that 'something must have gone wrong with the language of the contract', and in such a case the court would not attribute to the parties an intention they could not sensibly have had.
The court may conclude that 'something has gone wrong' with the drafting for a number of reasons. The language may be grammatically wrong or ambiguous, but even where the wording is clear and could be applied literally, the court must objectively interpret it against the surrounding circumstances known to the parties at the time. If a literal interpretation 'flouts business commonsense, it must be made to yield to business commonsense'.
However, Lord Hoffman also made clear that this will not be a conclusion readily reached; the courts do not easily accept that people have made linguistic mistakes in formal documents. But the contract between Chartbrook and Persimmon was one such exceptional case in which the drafting was careless and to interpret the definition of the ARP in accordance with ordinary rules of syntax made no commercial sense.
The striking feature of this case was not merely that the provisions as interpreted by the judge and the Court of Appeal appeared to be unduly favourable to Chartbrook, (which would not of itself be sufficient reason for supposing that the contract did not mean what it said), but that this interpretation made the language of the various contractual provisions appear arbitrary and irrational, when it was possible for them to be construed in a rational way. The appeal was allowed in favour of Persimmon’s ‘rational’ construction.
Correcting Mistakes By Construction
The court's ability to 'correct mistakes in a contract by construction' is an aspect of interpreting the contract in its context. This process is to be distinguished from rectification of the contract.
Lord Hoffman confirmed the two conditions which must be satisfied, that there must be a clear mistake 'on the face of the instrument' and that it must be clear what correction ought to be made in order to cure the mistake. However, in deciding whether there is a clear mistake ‘on the face of the instrument’, he stressed that the court must not confine itself to reading the document without regard to the background and context, which must always be taken into consideration. These conditions were satisfied in this case.
'Red ink' Correction
The judgment is helpful in confirming that once satisfied that something has ‘gone wrong’ with the drafting of a contract, the court can rewrite those provisions freely and is not limited to formulating some alternative form of words which has to approximate as closely as possible to that of the parties. There was no ‘limit to the amount of red ink or verbal rearrangement or correction which a court was allowed’ as long it was clear that something had gone wrong with the language and what a reasonable person would have understood the parties to have meant.
Lord Hoffman also dealt with the issue whether the court should have taken into account pre-contractual negotiations in interpreting the contract, contrary to the long-standing rule that these are excluded from the admissible background which the court takes into account. It had been argued that the rule was illogical and prevented the court from putting itself in the position of the parties and ascertaining their true intent.
Lord Hoffman said that pre-contractual negotiations were different from other admissible background to the making of a contract and he was not prepared to depart from the exclusionary rule. The surrounding circumstances were objective facts, whereas statements in the course of negotiations 'will be drenched in subjectivity and may, if oral, be very much in dispute'. He acknowledged that this may mean on occasion that parties are held bound by a contract in terms a reasonable observer would not have taken them to mean had the course of negotiations been investigated, but justified this on the pragmatic basis that their exclusion generally provided for predictability in adjudicating contractual disputes. Lord Hoffman said that 'it was after all usually possible to avoid surprises by carefully reading the documents before signing them.'
Lord Hoffman did not clarify the boundaries of the rule against the admission of pre-contractual negotiations in contractual interpretation, so that issues are likely still to arise where to draw the line between prior negotiations and the admissible 'background' to the contract.
He referred to the 'two safety nets' of rectification and estoppel by convention, which are often claimed in the alternative. Evidence of pre-contractual negotiations is admissible in support of these claims.
The exclusionary rule excludes evidence of what was said or done during the course of negotiations for the purpose of drawing inferences about what the contract meant but does not exclude the use of such evidence for other purposes such as to support a claim for rectification. This is outside the rule as in such a claim the meaning of the instrument is not in issue; the claim is premised on the basis that as a matter of construction the instrument, by mistake, does not reflect the common intention of the parties.
This case is a reminder of the need for careful drafting to ensure that the contract contains the agreed and tested contractual definitions. It should not be assumed that the courts will come to your aid where definitions in the contract are not clearly the ones which were intended during pre-contractual negotiations.