Summary
In Rainy Sky S.A. & Ors v Kookmin Bank
[2011] UKSC 50, the Supreme Court held that where language used in
a contract has more than one potential meaning, it is generally
appropriate to adopt the construction that is most consistent with
business common sense.
The case arose out of the defendant bank's provision of refund
guarantees ("Bonds") given in favour of the claimant
purchasers in respect of pre-delivery instalment payments under
various shipbuilding contracts. The shipbuilder encountered
financial difficulties and entered into a debt workout procedure
under Korean law. Under the contracts, that event triggered a right
of the purchasers to be reimbursed for the instalments already
paid, the contract then reverting to a payment on delivery
mechanism – if the shipbuilder ultimately delivered the
vessels. The purchasers sought reimbursement from the bank under
the Bonds. The bank refused to pay on the basis that the Bonds did
not apply to that situation.
The key issue between the parties concerned the proper construction
of two paragraphs in the Bond documentation. The second paragraph
of each Bond provided that the purchasers were entitled to
"repayment of the pre-delivery instalments" upon their
"rejection of the vessel...termination, cancellation or
rescission of the Contract...". The third paragraph of each
Bond stated that, in consideration of each purchaser's
agreement to make the pre-delivery instalments, the bank undertook
to pay "all such sums due to you under the Contract". The
bank argued that "such sums" referred only to the limited
circumstances referred to in the second paragraph, which did not
include where repayment was triggered by an insolvency event. The
purchasers argued that "such sums" simply meant the
pre-delivery instalments, however they may become repayable.
The legal issue
At first instance, the Court found in favour of the purchasers,
holding that the bank's construction would lead to a surprising
and uncommercial result. The Court of Appeal found (by a majority
of 2:1) in favour of the bank, holding that it had no alternative
but to give effect to a contract's terms unless the most
literal meaning of the words produced a result so extreme it would
suggest that it was unintended. To do otherwise would risk imposing
obligations on the parties which they were never willing to assume
and in circumstances which amount to no more than guesswork on the
part of the Court.
The Supreme Court adopted a different approach and unanimously
allowed the purchasers' appeal. The central approach to the
construction of the Bonds was not in dispute. Lord Clarke (who gave
the sole judgment and with whom all the other judges agreed)
concluded that the long line of case law in this area (including
Lord Hoffmann's judgment in Chartbrook Ltd v Persimmon
Homes Ltd [2009] UKHL 38) had established that the Court's
task was to determine what a reasonable person, who had all of the
background knowledge reasonably available to the parties at the
relevant time, would have understood the parties to have meant by
the words that they used.
The question for the Court was the role to be played by
considerations of business common sense in determining what the
parties meant. The Court held that where the terms of the contract
were clear and unambiguous, effect would be given to them without
any consideration of business common sense, even if the result is
improbable. However, where there were two possible constructions of
the language used (as would often be the case), the construction
that was most consistent with business common sense would generally
be adopted. It was not necessary to conclude (where more than one
construction was available) that a particular construction would
produce an absurd or irrational result before proceeding to have
regard to considerations of business common sense.
Adopting this approach, the Court held that, although the
purchasers were unable to provide a very good reason why the second
paragraph was included in the Bonds, a construction of the third
paragraph which excluded the shipbuilder's insolvency from the
situations that triggered the bank's refund obligations would
make no commercial sense – it would have been one of the
key events against which the purchasers would have wanted to obtain
protection. Accordingly, of the two possible constructions of the
third paragraph of the Bonds, the purchasers' construction was
preferred.
Comment
The Supreme Court has provided helpful clarification of the
circumstances in which the Court will invoke considerations of
business common sense. The decision will not assist a party seeking
to avoid a bad bargain where the wording of the contract is clear
and unambiguous, even if the result seems improbable or
uncommercial. However, as acknowledged by Lord Clarke, the language
used by the parties will often have more than one potential
meaning. In such cases, the Court will adopt the interpretation
that is most consistent with business common sense. It will
therefore often be the case that, where a contractual dispute has
arisen, considerations of business common sense will come into
play.
For a full copy of the judgment, please click here.
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Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.
The original publication date for this article was 11/11/11.
