When you are trying hard to look after the pennies there can be few things worse than realising that your contract doesn't mean quite what you thought it did...and that you might lose out as a result. A missing definition, a comma in the wrong place or an extra zero on an already high figure can lead to a costly and time-consuming dispute. Whilst there is, of course, no substitute for getting it right in the first place, the recent case in the House of Lords (Chartbrook Limited (Respondents) v Persimmon Homes Limited and others (Appellants) and another (Respondent) [2009] UKHL 38) is a good reminder of the arguments that might be encountered when things go wrong. As a House of Lords decision, the judgment is the latest and definitive word on contractual interpretation.

The dispute arose over the construction of a term in a contract entered into between the parties. The House of Lords held that Chartbrook's construction of the contract, which was probably the most literal interpretation of the words used, made "no commercial sense" and allowed Persimmon's appeal. Their Lordships also confirmed that pre-contractual negotiations are inadmissible as to the construction of a contractual term (the "exclusionary principle").

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Background

Chartbrook Limited acquired a piece of land in Wandsworth and entered into an agreement with Persimmon Homes Limited, whereby Persimmon obtained planning permission for the land, constructed a mixed residential and commercial development on the land and sold the properties on long leases. Persimmon received the proceeds from such sales and paid Chartbrook an agreed price for the land. In addition to the agreed payments relating to the land value, a balancing payment, defined in the agreement as the Additional Residential Payment ("ARP"), would also be payable by Persimmon and would be calculated in accordance with a specified formula. The formula contained a "grammatical ambiguity", with the result that each party put forward a different interpretation of the calculation with wildly different results: Persimmon claimed the amount payable by it was £897,051 whereas Chartbrook claimed it was £4,484,862.

The Court therefore had to consider what a reasonable person would have understood the contract to mean.

In its claim, Persimmon sought to introduce evidence of the parties' pre-contractual negotiations, in order to support its arguments as to the way it considered the formula was intended to work. It argued that, despite established case law stating that such evidence is inadmissible, in this instance the evidence was helpful as it showed what the parties may have had in contemplation as to the meaning of the words used. Persimmon was unsuccessful at first instance and appealed to the Court of Appeal.

Court of Appeal Decision – Term was Clear and Unambiguous

The Court of Appeal dismissed Persimmon's appeal. In reaching its decision, it held:

(i) the definition of ARP was clear, certain and unambiguous. Persimmon's construction required the definition to be "rewritten" and there was no basis on which this should be done (although Lawrence Collins LJ dissented on this point and stated the term must be construed in accordance with business common sense);

(ii) it was not appropriate to consider pre-contractual negotiations when construing the agreement. Such material could only be invoked for the purposes of a claim for rectification; and

(iii) whilst there was a strong case for rectification, the court of first instance had made a finding of fact which defeated any such claim and which was therefore not open to challenge.

House of Lords Decision – Lack of Commercial Sense

The House of Lords overturned the Court of Appeal decision and allowed Persimmon's appeal. Their Lordships unanimously agreed with Lawrence Collins LJ that the interpretation of the ARP in accordance with ordinary rules of syntax made no commercial sense. Lord Hoffman stated, "all that is required is that it should be clear that something has gone wrong with the language and that it should be clear what a reasonable person would have understood the parties to have meant. In my opinion both of these requirements are satisfied."

Their Lordships also revisited the general principles of contract construction, indicating that there was no clearly established case for revisiting the rule in Prenn v Simmonds (1971) 1 WLR 1381 that pre-contractual negotiations were inadmissible in construing a contract (the "exclusionary rule"). It was clear that any exception to the rule was intended to be applied in only a small number of cases where, for example, the results would otherwise be unjust or contrary to public policy. Lord Hoffman stated, however, that such evidence will often be before the court as part of a rectification or estoppel claim, and will be considered as part of the background that may be taken into consideration when construing a contract.

Rectification

Finally, the House of Lords considered, obiter, that there were grounds for a claim of rectification which, it clarified fell outside the scope of the exclusionary rule. At first instance the judge had found that the mistake was not common to both parties and dismissed the claim, as Chartbrook honestly believed that its interpretation of the ARP was what had been agreed. The Court of Appeal had dismissed Persimmon's appeal on this point, on the basis that it was not entitled to disturb the findings of fact made by the judge. However, Persimmon subsequently argued that both the judge and the Court of Appeal had been wrong in their assumption about what a party had to be mistaken about – it argued that rectification required a mistake about "whether the written instrument correctly reflected the prior consensus, not whether it accorded with what the party in question believed that consensus to be". English law stated that the terms of the prior consensus were what a reasonable observer would have understood them to be and not what one or even both of the parties considered them to be. The House of Lords agreed that both parties were mistaken in thinking that the definition of ARP reflected their prior consensus, although as the appeal had already been decided in Persimmon's favour, the point was largely academic.

Avoiding the Problem

This judgment, being Lord Hoffman's last, is a timely reminder of the importance of language in contracts and the limited options available to parties when things go wrong. Agreements are generally taken as having the meaning that would be understood by a reasonable person, having available to him the background knowledge reasonably available to the original parties. Only in very exceptional circumstances, or during a claim for rectification, will pre-contractual negotiations be relevant. On the face of it, the decision should be understood as maintaining the exclusionary principle that pre-contractual negotiations are inadmissible. Such a rule should encourage efficient and cost effective proceedings, as neither the court nor the parties will be expected to trawl through all previous documentation (which may be very significant indeed). However, such information may end up before the court either to support a rectification claim (often brought alongside a contractual interpretation claim as a back up), in relation to claims of estoppel (a claim that a prior position had actually been agreed between the parties and that it is inconsistent of a party to assert otherwise), or, exceptionally, as part of the overall background which the court is entitled to take into consideration. Accordingly, it is likely that parties will continue to try to put such evidence before the court in the hope that it influences the judge in understanding the background.

If you would like further advice on rectifying a contract or correcting an ambiguity, please contact either of the authors listed below or your usual contact at the firm.

Further reading: Chartbrook Limited (Respondents) v Persimmon Homes Limited and others (Appellants) and another (Respondent) [2009] UKHL 38

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

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 07/07/2009.