UK: Making Clear Contracts

Last Updated: 23 April 2008
Article by David Abbott and James Thomas

The drive for contract certainty has been described by the press and the Market Reform Group as, broadly, a success. Although there are some reports of difficulties in finalising contracts, it seems that around 80 per cent of contracts were 'certain' for the 2007 renewal season. A contract certainty code of practice is now in place. Alongside this, the drive towards electronic placement and, following that, electronic review of claims can be seen as part of a wider initiative to bring more certainty and efficiency into the business process.

Despite these leaps forward, however, it would be dangerous to consider the work on (re)insurance contracts complete.  Contract certainty, as evidenced by the Market Reform Group's definition, is about getting the contracts ready prior to inception. It does not focus on the quality of those contracts. With markets softening, underwriters are increasingly under pressure to change wordings.  It is of vital importance now that there is clarity on what clauses do and do not offer, and that the parties are clear about what their contracts mean.

How should those parties go about analysing the meaning of their contracts, testing for clarity? The way to assess this properly is to view the contract clauses as a court or tribunal would. If the contract is the subject of disagreement they are the only bodies who can provide finality on the meaning of a clause. Despite rules of interpretation being set out (as discussed below), this task is not straightforward as the courts themselves disagree on aspects of the process of interpretation, as recent case law shows.

Some basic underlying principles have developed. First and foremost, the courts will seek to give effect to the intentions of the parties.  The best evidence of those intentions is of course the words of the contract itself.  These will be interpreted in accordance with their 'ordinary and natural meaning'.  The two leading cases (Mannai Investment Co Limited v Eagle Star Life Assurance (1997) and Investors Compensation Scheme v West Bromwich Building Society (1998)) have provided further rules of interpretation.  They are as follows:

  1. The courts will ascertain the meaning a document would have to a reasonable person having all the background knowledge which would reasonably have been available to all the parties.  This makes it clear that contracts will be interpreted from an objective standpoint: what would a third party who had nothing to do with its drafting think?  To look at a contract from this point of view is very often a litmus test for the clarity of your contract.  If that third party (who understands market terminology) is unclear as to what the words mean (not having had the benefit of the discussions which led to their drafting) that indicates that the contract isn't as clear as had initially been thought.
  2. The 'background knowledge', also known as the 'matrix of fact', includes anything which would have affected the way in which the language of the document could have been understood.   In other words, the courts or tribunals are allowed to put contracts in their commercial context and use that context in ascertaining meaning.
  3. The meaning a document will convey to a reasonable person is not necessarily the same as the meaning of its words.  The courts will look for the general sense of the document and not slavishly follow every word.
  4. If it is obvious something must have gone wrong with the language, the law is not required to attribute to the parties an intention which they plainly could not have had.  Again, this is a recognition of a commercial rather than literal process of interpretation.  Of course, this application of common-sense commerciality by the courts, though welcome, is only necessary if the basic language of the contract is unclear. Undoubtedly it is better to be clear in the first place and avoid the courts second guessing the commercial intent of the contract.

    The courts have made one important exception to what may be considered in the interpretation of a contract:

  5. The law excludes consideration of previous negotiations of the parties or their subjective intentions.  The justification for this is that, as discussed above, the contract is supposed to be viewed objectively. However, most parties in a wording dispute will focus on what they thought had been agreed.  It is understandably argued that it is odd to ignore this, particularly as the courts are supposed to be giving effect to the parties' intentions.  This is especially so when negotiations may give (written) evidence of what the contract was intended to say. 

The Court of Appeal has, to some extent, recognised, in Proforce Recruit Limited v The Rugby Group Limited (the appeal against strike out was heard by the Court of Appeal in 2006 and judgment was given by the High Court in 2007) that excluding evidence of negotiations can be difficult. In that case, the courts allowed evidence from negotiations to see if they provided "objective" evidence of an undefined phrase that had no ordinary meaning.  Some of the judges criticised the exclusion of evidence of negotiations as unrealistic and not consistent with the general principle that a contract should be interpreted in light of its context.

Recent cases, however, have stated that negotiations should still be excluded from the evidence except in the instance identified in Proforce.  In Chartbrook v Persimmon Homes Ltd (2007), the High Court was determined to restrict the use of negotiations to that instance as it was keen to protect the interests of third parties who may need to understand the contract without having recourse to evidence of the negotiations of the parties.  On appeal, the Court of Appeal affirmed the decision. The case of Great Hill Partners II LP v Novator One LP (2007) also followed the reasoning in Chartbrook.

Clearly, the courts are in a state of flux on this issue. Practically speaking, the key is to remember that contract words will be interpreted objectively, taking the background into account. If there is clear evidence from the negotiations, it may be introduced in limited circumstances.  In any event, the process of stepping away from negotiations and implicit understandings, and considering what the clause would mean to an outsider, is a very useful exercise for any contract draftsman.  Uncertainty of meaning can be avoided in many cases and often leads to costly disputes.  Plain expression of intentions is the surest way to a certain contract.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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