Open To Interpretation

In this article we will examine how the court approaches disputes where the parties to a contract are unable to agree what the contract means and look at some recent examples showing how the court's approach applies in practice.

In theory, when the terms of a transaction are agreed the document drawn up to reflect the agreement should always be perfect. In reality, as we at Clyde & Co often see in the course of our work in the professional indemnity sector (where we regularly find ourselves defending solicitors against claims relating to allegedly negligent drafting), this is not always the case.

Disputes over the meaning of contracts are commonplace, and the property sector is no exception. Particularly in difficult economic times parties may sometimes look for ways to extract themselves from deals which have not turned out as well as they hoped at the time of negotiating the agreement. For example, if a contract for the sale of a property provides for a delay between exchange and completion, and if the property market takes a turn for the worse after exchange, the purchaser may look for any possible argument that the wording of the contract allows it to walk away from the transaction.

In a dispute over the meaning of a contract the court will consider:

• how the contract should properly be interpreted; and/or
• whether the contract should be rectified in order to reflect the parties' true agreement or by reason of the unilateral mistake of one of the parties.

The two tests are separate and independent, and can often be mutually exclusive (if a contract can be interpreted as one party claims then it probably does not need to be rectified). We therefore take each in turn below.

Contractual interpretation

In the words of Lord Hoffman in Investors Compensation Scheme Ltd v West Bromwich Building Society, "interpretation [of a contract] is the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract". When called upon to interpret a contract, the courts will therefore seek to determine the objective meaning of the wording of the contract. The emphasis is primarily on analysing what the contract as a whole says, rather than what the parties may subjectively have intended it to say.

The courts are increasingly taking a more flexible and commercial approach to the interpretation of contracts. In one of the recent leading authorities, Chartbrook Ltd v Persimmon Homes, the House of Lords held that there was no limit to the extent to which courts could amend and rearrange contractual provisions in order to interpret a contract to reflect the objectively identifiable true agreement. Taking the opportunity to develop further his judgment in the Investors Compensation Scheme case, Lord Hoffman said:

"There is not, so to speak, a limit to the amount of red ink or verbal rearrangement or correction which the court is allowed. All that is required is that it should be clear that something has gone wrong with the language [of the contract] and that it should be clear what a reasonable person would have understood the parties to have meant."

The court is therefore able to read between the lines, adding words which are not present in the contract or changing the order of the wording if that is necessary to give the contract its correct, commercial meaning.

Evidence of prior negotiations and pre-contractual correspondence is generally not admissible in a dispute over the interpretation of a contract as the test is an objective one, based on what a reasonable businessperson would interpret the contract to mean. This can seem counter-intuitive, since it involves the court shutting its eyes to what might appear to be relevant evidence of what the parties actually intended the contract to mean. The recent case of Proteus Property Partners Ltd v South Africa Property Opportunities Plc explored this issue.

Proteus Property Partners v South Africa Property Opportunities

Proteus Property Partners Ltd (Proteus) brought a claim against South Africa Property Opportunities Plc (Property Opportunities) in respect of performance fees and management fees which Proteus claimed were due under a contract relating to the acquisition and development of properties in South Africa.

The remuneration payable to Proteus under the contract was based upon a percentage of the net asset value of the properties which were the subject of the agreement. During the negotiation of the contract, unbeknown to either of the parties, changes were made to the International Financial Reporting Standard's definition of net asset value. This created uncertainty as to how Proteus' remuneration was to be calculated.

In seeking an interpretation of the contract which allowed for the most favourable definition of net asset value, Proteus argued that the court should consider exchanges between the parties during negotiations as they were relevant background facts known by both of the parties.

MacKay J acknowledged that Proteus' argument "would be highly persuasive to most intelligent laymen, who might consider it strange to close their eyes to such exchanges and expressions of the company's understanding, which might well seem obviously relevant to them". However, despite his sympathy for Proteus' argument, Mackay J came to the conclusion that:

"Apparent or actual pre-contractual consensus is not an exception to the exclusionary rule prohibiting evidence of negotiations or statement of a party's subjective intent [in a dispute relating to the interpretation of a contract]. Powerful as it might seem at first sight this evidence has, I find, no role to play in the construction of the contract any more than the antecedent negotiations do."

Although Proteus did not succeed in adducing evidence of pre-contract negotiations, Mackay J was nevertheless able to find in their favour on the facts of this particular case. However, the judgment provides further clarification that, although it may at times seem contrary to common sense, when interpreting a contract the court will not have regard to evidence of pre-contract negotiations and statements of a party's subjective intent.

Rectification

In the context of a claim for rectification, however, the court can consider evidence of prior negotiations and pre-contractual correspondence. Rectification is a remedy which allows the court to change the wording of a document so that it records the parties' true agreement. To succeed with a claim for rectification a claimant must show that the wording did not reflect the intentions of the parties as a result of a mistake. This can be either a "common mistake" or a "unilateral mistake".

Common mistake

A common mistake will occur if the terms of a contract do not reflect what both parties had previously agreed. A party seeking rectification of a contract term based upon a common mistake must prove that:

• the parties had a common and continuing intention (regardless of whether any agreement was concluded) in respect of the disputed term;
• the common intention was outwardly communicated between the parties;
• the common intention existed at the time of execution of the contract; and
• it was by mistake that the contract did not reflect that common intention.

The courts will assess the parties' intentions objectively by looking at the correspondence that passed between them. Any inward thoughts are disregarded.

Unilateral mistake

A unilateral mistake will occur if the terms of a contract do not reflect what one of the parties understood to have been agreed. For rectification to be applicable in these circumstances it must be proved that:

• the claimant erroneously believed the contract meant something which it does not in fact mean; and
• the defendant was aware of this mistake, but failed to draw it to the claimant's attention and unconscionably took advantage of the mistake.

The defendant will have the requisite level of awareness of the mistake if it:

• has actual knowledge;
• wilfully shuts its eyes to the mistake; or
• wilfully or recklessly fails to make the enquiries that an honest and reasonable man would have made.

The recent case of Daventry DC v Daventry Housing Ltd is a good illustration of how the courts approach claims for rectification.

Daventry DC v Daventry Housing

The dispute arose from Daventry District Council's (DDC) agreement to sell some of its housing stock to Daventry Housing Ltd (Housing). The sale included the transfer of DDC employees and their pensions, but an issue arose regarding the treatment of a liability for a £2.4 million deficit in the pension fund. DDC understood that Housing would be responsible for the deficit; however Housing thought that DDC would retain the liability.

The parties and their lawyers had been at cross-purposes throughout negotiations but there was one individual, a senior negotiator for Housing, who spotted the mistake. He knew that DDC expected Housing to pay the deficit, but that that was not reflected in the draft contact, and decided to keep quiet. At the last minute, just before the contract was concluded, DDC proposed some additional wording which (despite DDC's intention to the contrary) made DDC liable for the pension deficit. The final agreement was completed on this basis.

DDC made a claim for rectification on the grounds that the commercial agreement had always been for Housing to pay the deficit. Housing argued that it never intended to pay and that the contract as signed accorded exactly with its intentions.

At first instance the High Court found in favour of Housing. It was of the view that Housing's negotiator had acted badly, but the position was saved for Housing as a result of DDC's last-minute addition to the contract.

However, the Court of Appeal granted rectification and ordered Housing to pay the pension deficit. On an objective basis the Court held that it was reasonable for DDC to conclude, from the words and actions of Housing as a whole, that Housing had agreed to pay the pension deficit. This was notwithstanding that Housing's negotiator knew, and intended, that the contract did not require Housing to pay the deficit.

In reaching this decision the Court of Appeal focussed particularly on the actions of Housing's negotiator. It seems clear that if the negotiator had not realised DDC's mistake rectification would not have been available.

Conclusion

These cases show that where the wording of a contract is not as clear as the parties might like the court will often strive to identify the correct commercial agreement when dealing with the subsequent dispute. Parties who take technical points on the wording of an agreement, which do not accord with what appears to have been intended or agreed, will often be given short shrift. The important point is for all parties to be as clear as possible as to what a contract is supposed to achieve. If there is any uncertainty it is always best for it to be aired, rather than for one party to make assumptions as to what the other party intends.

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.