The Court of Appeal clarifies the test to be applied in deciding whether the written terms of a contract may be rectified because of a common mistake.
The Claimant claimed rectification of two deeds which it executed on 18 November 2016. The purpose of executing the deeds was to provide security which the Claimant had previously agreed to provide in connection with a corporate acquisition which took place in 2012. The missing security – an assignment of the benefit of a shareholder loan – was a very small piece of a complex transaction and no one had noticed the omission until it was spotted by the Claimant's lawyers during a review of the security documentation in 2016.
The trial judge found that when the deeds were executed, both the Claimant's representatives and those acting for the Defendant understood and intended the deeds to do no more than provide the missing security. However, the mechanism chosen to achieve this was for the Claimant, by entering into the deeds, to accede to two pre-existing security agreements. The effect of acceding to these agreements was not only to provide the missing security over the shareholder loan but to undertake additional, onerous obligations.
The judge found that no one involved in the transaction realised before or at the time of execution of the deeds that this was their effect. The judge also concluded that it was both 'objectively' and 'subjectively' the common intention of the parties to execute a document which satisfied the Claimant's obligation to grant security over the shareholder loan and which did no more than this. In these circumstances, the judge granted rectification of the deeds so as to exclude the additional obligations from their scope.
The Defendant did not challenge any of the judge's findings of fact, however, it argued, that the test for rectification should be purely objective. In particular, the Defendant argued that the communications between the parties would not have led an objective observer to conclude that the parties intended to do anything other or less than procure the Claimant's accession to all the terms of the pre-existing security agreements – including the additional obligations.
After conducting a detailed review of the previous case law relating to the equitable doctrine of rectification, the Court of Appeal dismissed the appeal. It concluded that rectification may be granted in two circumstances:
- where a document fails to reflect the terms of a prior concluded contract between the parties - this is based on the principle that agreements must be kept and should be understood as a type of order for specific performance of the agreement to execute the document. As such, the terms of the prior contract must be objectively determined in the same way as any other contract; or
- when they executed the document, the parties had a common intention in respect of a particular matter which, by mistake, the document did not accurately record – this, the court said, is entirely concerned with the parties' subjective states of mind and is based on considerations of good faith. However, the parties must not merely have had the same subjective intention, but must have communicated that intention to each other.
On the facts, the Court of Appeal held that the latter circumstances applied and so the applicable test was subjective. Based on the findings at first instance, there had been a shared subjective intention as to the legal effect of the supplemental deeds that had been communicated by the Claimant to the Defendant.
Points to Note
This judgment sets out the tests that are to be applied in claims for rectification and when each one should be used. For the latter type of claim (i.e. where the common intention was not accurately recorded) the subjective element sets a much higher burden for claimants. The courts will now heavily rely on the actual communications passing between the parties, rather than what an objective person would reasonably consider to be the consensus.
This decision emphasizes the importance of:
- accurately reflecting the parties' intentions and the agreement reached within the written terms of any agreement; and
- keeping a detailed record of any negotiations prior to entering into an agreement such as meeting minutes, attendance notes, emails/other correspondence and related documentation including non-binding heads of terms. Should a dispute arise, these will show the Court what was agreed, discussed and intended by the parties.
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.