UK: The Rules Of Interpretation: A Seller Indemnity In A Share Purchase Agreement

Last Updated: 21 May 2018
Article by David Collins, Andrew Barber and Candice Chapman

The Supreme Court has dismissed an appeal over the meaning of an indemnity in a share purchase agreement, and in delivering its judgment has given guidance on the rules of contractual interpretation.

Facts:

Under the indemnity, the seller agreed to indemnify the buyer in respect of "... all actions, proceedings, losses, claims, damages, costs, charges, expenses and liabilities suffered or incurred, and all fines, compensation or remedial action or payments imposed on or required to be made by the Company following and arising out of claims or complaints registered with the FSA, the Financial Services Ombudsman or any other Authority against the Company ... pertaining to any mis-selling or suspected mis-selling of any insurance or insurance related product or service" in the period before the transaction took place.

The issue was whether the indemnity covered losses the buyer suffered as a result of the target company self-referring potential mis-selling to the FSA, as opposed to a customer making a claim or registering a complaint with the FSA. The Court of Appeal had held that it did not.

Decision:

The Supreme Court upheld the Court of Appeal decision. The court held that, properly interpreted, the indemnity was not triggered in circumstances where the target self-reported mis-selling to the FSA.

The court noted that the meaning of the drafting was avoidably opaque. About its task of interpretation, the court noted as follows:

  • The court's task is to discover the objective meaning of the language of the agreement. This is not a literalist exercise focused solely on a parsing of the words of the particular clause. The court must consider the contract as a whole and, depending on the nature, formality and quality of drafting of the contract, give more or less weight to elements of the wider context.
  • Where there are rival meanings, the court can give weight to these by reaching a view about which construction is more consistent with business common sense. But the court must consider the quality of drafting of the clause. It must also be alive to the possibility that one side may have agreed to something which with hindsight did not serve its interest or that the relevant clause resulted from a compromise reached during negotiations.
  • It does not matter whether the court's more detailed analysis begins with the factual background (contextualism) or a close examination of the relevant language in the contract (textualism). However, the court must balance the indications given by each.
  • The court can use both textualism and contextualism as tools to discover the objective meaning of the contract. The extent to which each tool will help the court in its task will vary according to the circumstances of the particular agreement or agreements.

Turning to the facts, business common sense suggested that the buyer had an interest in getting as broad an indemnity against the adverse consequences of mis-selling as it could. But the sellers had, elsewhere in the agreement, given warranties of compliance with regulatory requirements. These covered mis-selling, subject to the agreed limits of quantum and time. The sellers had an interest in minimising their further exposure to liability after that time had elapsed. But, as the court noted: "... in the tug o' war of commercial negotiation, business common sense can rarely assist the court in ascertaining on which side of the line the centre line marking on the tug o' war rope lay, when the negotiations ended.".

The court noted that, had the indemnity stood on its own, the requirement of a claim or complaint by a customer, and the exclusion of loss caused by regulatory action which was prompted in another way, might have appeared anomalous. However, the indemnity was additional to the wide-ranging warranties which probably covered the circumstances that had in fact come about. It was not contrary to business common sense for the parties to agree wide-ranging warranties, subject to a time limit, and also to agree a further indemnity, which was not subject to any limit but was triggered only in specific circumstances.

From the buyer's standpoint the agreement may have become a poor bargain, as the buyer did not appear to have notified the sellers of a warranty claim within the contractual time limit. However, it was not the role of the court to improve a party's bargain.

Comment:

Some commentators had interpreted a previous Supreme Court decision, Arnold v. Britton [2015] AC 1619, as signalling a move away from the use of business common sense as an aid to interpretation to a more literal approach. However, in this case, the Supreme Court rejected the idea that Arnold had involved any "rowing back" from the guidance on contractual interpretation given by the Supreme Court in Rainy Sky SA v. Kookmin Bank [2011] 1 WLR 2900 and stated that the two cases "were saying the same thing".

The principles of contractual interpretation summarised by the Supreme Court in this case were relevant because there was ambiguity in the drafting. Where the language of a contract is clear, the courts are unlikely to intervene, even if the result is a bad bargain for a party. So the case is a reminder of the importance of clear and precise drafting. It is also a reminder that the court will look at all drafting in the context of the contract as a whole and, therefore, of the importance of ensuring that a contract works as a whole.

Wood v. Capita Insurance Services Limited [2017] UKSC 24

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