The House of Lords recently considered the rules regarding the construction of contracts. In particular, the court considered whether pre-contractual negotiations can be admitted as evidence of the parties' intentions as to the meaning of a contract term.
When determining a dispute on the meaning of contract terms, the basic rule is that the court is required to take into account what a reasonable person would consider the language of a document to mean having knowledge of all the relevant circumstances surrounding the transaction. The courts' preferred approach is to deduce the meaning of a document (or a particular part of it) by looking at the document itself. However, where this is not possible, the court will take into account the 'factual matrix', which includes 'anything that would have affected the way in which the language of a document would have been understood by a reasonable man'. (Investors Compensation Scheme Limited v West Bromwich Building Society [1998] 1 WLR 896).
An exception to this approach is the exclusionary rule. This rule prohibits the admissibility of pre-contractual negotiations when interpreting a contract. The reason for excluding evidence of pre-contractual negotiations from the 'factual matrix' is that such negotiations will reflect the parties' subjective intentions before entering into the contract and by their very nature are not 'factual'.
There are two exceptions to the exclusionary rule that allow for the admissibility of pre-contractual negotiations as evidence:
- Rectification
This enables the court to correct a mistake in a contract that does not reflect the intentions of the parties. In order to succeed in this action, the party seeking to make the change must demonstrate the agreement does not reflect the parties intention and there was 'outward expression of accord' and continuing common intention in relation to the issue in question, prior to entering into the contract.
- Estoppel By Convention
This prevents a party contending that language has one meaning, when the parties negotiated on the assumption that the language would bear a different meaning.
In the judgment in question, Chartbrook Limited v Persimmon Homes Limited and others [2009] UKHL 38, the dispute revolved around a payment due under a development agreement between the parties. As a result of defective drafting, there was uncertainty over how a payment should be calculated. The ambiguity resulted in Chartbrook claiming over £3.5 million of the amount Permission contended it was entitled to. The High Court and Court of Appeal decided in favour of Chartbrook by strictly interpreting the language in the agreement. Persimmon appealed to the House of Lords claiming that the contract should be rectified and that the exclusionary rule should not apply.
On the facts of the case, the House of Lords found the necessary conditions for rectification and on this basis allowed the appeal. However, the House of Lords rejected arguments calling for a departure from the exclusionary rule and upheld an objective approach in the construction of contracts. Hoffman LJ stated that 'pre-contractual negotiations will be drenched in subjectivity and may, if oral, be very much in dispute.' In addition to this, admission of such evidence 'would create greater uncertainty of outcome in disputes over interpretation and add to the cost of advice, litigation or arbitration'.
This decision is a reminder that the parties must carefully read contractual documents to ensure the language is clear, unambiguous and reflects their intentions. Failure to do so may lead to costly litigation and the court imposing the view of a 'reasonable man', which may be very different from the parties' intentions.
An important lesson from this judgment is that the dispute would have easily been avoided if the parties included a 'mathematical notation' of how the calculation would work in practice. Where possible agreements should always include worked examples of any calculations. This will be relevant in numerous agreements, including, for example, licensing and publishing arrangements which often involve complex calculations for royalties.
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