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Supreme Court backs common sense in contracts

Ruling will allow courts to 'ignore chunk of original wording'

7 November 2011

‘Business common sense’ must be applied when interpreting commercial contracts, the Supreme Court has ruled.

Andrew Quick, dispute resolution partner at Stevens & Bolton, said the ruling in Rainy Sky SA and others v Kookmin Bank [2011] UKSC 50 would give parties choosing English law to regulate their contracts more certainty.

“This ruling comes as no surprise,” Quick said. “In setting aside the majority Court of Appeal decision which had prioritised the giving of meaning to all the words used by the parties, the Supreme Court has made clear its commitment to see contractual ambiguity resolved, where possible, consistent with business sense.

“If that means ignoring a chunk of the original contract wording, so be it – the courts will clearly have no problem with that.”

Delivering judgment on behalf of the court, Lord Clarke said: “If there are two possible constructions, the court is entitled to prefer the construction which is consistent with business common sense and to reject the other.”

Lord Clarke said the language used by the parties to a commercial contract “would often have more than one potential meaning”.

He accepted Rainy Sky’s argument that construing contracts was “essentially one unitary exercise” in which courts must consider what a reasonable person would have understood the parties to mean.

Lord Clarke specifically rejected the approach taken in the case by Lord Justice Patten at the Court of Appeal last year, who said that “unless the most natural meaning of the words produces a result which is so extreme as to suggest that it was unintended, the court has no alternative but to give effect to its terms”.

Instead he endorsed the dissenting judgment of Sir Simon Tuckey, who argued that the Rainy Sky’s construction should be preferred because it was consistent with the commercial purpose of the bonds.

Rainy Sky was one of six buyers of ships from Jinse Shipbuilding, each priced at $33.3m. In each case a Korean bank provided the buyer with a refund guarantee.

Buyers were also provided with advance payment bonds by the Kookmin Bank. In return, all six paid the first instalments of the purchase price and Rainy Sky paid a second.

The dispute centred on interpretation of a single phrase in the bond, which stated that the bank promised to pay “all such sums due to you under the contract”.

In January 2009 the shipbuilder entered a form of insolvency under Korean law and the buyers demanded an immediate refund of all the instalments plus interest.

He said: “One would naturally expect the parties to agree (and the buyer’s financiers to insist) that in the event, for example, of the insolvency of the builders, the buyers should have security for the repayment of the pre-delivery instalments which they paid.”

Lord Clarke said the High Court judge in the case had described the bank’s construction of the bonds as having the “surprising and uncommercial result” that the buyers would not be able to call on the bonds after the insolvency of the builder, the event most likely to require the security.

He said that, of the two arguable constructions of paragraph three of the bonds, “the buyer’s construction is to be preferred because it is consistent with the commercial purpose of the bonds in a way which the bank’s construction is not”.

Lord Clarke allowed the appeal. Lords Phillips, Mance, Kerr and Wilson contributed to the judgment.

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Company, Consumer, and Contract