Update: commercial contracts

Lord Hoffmann's judgment in the House of Lords in Chartbrook v Persimmon Homes [2009] UKHL 38 (see solicitorsjournal.com 3 July 2009) is likely to have similar prominence to his landmark judgment in Investors Compensation Scheme Ltd v West Bromwich Building Society [1997] UKHL 28.

In Chartbrook, Lord Hoffmann reinforced his earlier judgment and summarised that on any interpretation of a contract 'the question is what a reasonable person having all the background knowledge which would have been available to the parties would have understood them to be using the language in the contract to mean'.

The following recent cases usefully illustrate how litigants are using Chartbrook.

In Westvilla Properties Limited v Dow Properties [2010] EWHC 30 (Ch), a contract for the sale of land, at auction and subject to a new lease, was not void for uncertainty even though it did not have attached to the draft lease the plans nor did it specify the percentage to be used to calculate the service charge. The court was able to reattach the plans because it was clear that a reasonable person, having all the background knowledge available to the parties, would have understood the contract to have been referring to the plans contained in the auction pack. It could also fill in the blank on the service charge by reference to the existing lease on the basis that that percentage was the only possible interpretation on these particular facts.

The court recognised that the situations in which a court would be able to fill in a contractual blank were limited, but these facts were unusual and the surrounding factual matrix and the commercial realities of the transaction supported its view.

By contrast, in ING Bank NV v Ros Roca SA [2010] EWHC 50 (Comm) although it was clear that something had gone wrong with the language used by the parties, a reasonable person would have understood what the parties meant when using the words they did. Indeed, such a person would be capable of ignoring parts of defined terms included by oversight and contrary to the parties' intentions.

In Crest Nicholson (Londinium) Ltd v (1) Akaria Investments Ltd (2) Helen Frances Isabella Smith [2010] EWHC 243 (Ch) the court considered whether, in a dispute between the parties as to the proper calculation of the contractual payment, a letter concerning its calculation and a reply constituted a binding agreement. The court had no difficulty in accepting that, following Chartbrook, the correspondence had to be construed in the context of the position of the person who was writing it and the person to whom it was written. On that basis, any person with the relevant experience and knowledge of the correspondents would have recognised that the letter was an offer capable of acceptance or rejection which had in fact been accepted.

In CDV Software Entertainment Ag v (1) Gamecock Media Europe Ltd (2) Southpeak Interactive Ltd (3) Southpeak Interactive Corporation (4) Gone Off Deep LLC [2009] EWHC 2965 (Ch) a distribution agreement gave a distributor the right on partial termination to recover advances paid and other costs. The distributor therefore claimed its advances and costs following partial termination. The court was required to determine whether there had been a partial termination. In dealing with some clumsy drafting, the court held that a reasonable person would have understood the parties to have meant that in the particular circumstances there had been a termination.

In HHR Pascal BV v W2005 Puppet II BV [2009] EWHC 2771 (Comm) a buyer under a conditional share sale agreement sued for, and obtained, the return of its deposit because the seller had failed, for want of proper notice, to satisfy the conditions.

The court found that the contractual provisions relating to the satisfaction of the conditions were less concerned with the fact of satisfaction, than with the process by which they were deemed to have been satisfied. Consequently, the defendant's submission that the actual physical completion of the conditions was an alternative to its strict adherence to the contractual process was entirely uncommercial. Ultimately, as the agreement was a carefully drafted document in which both language and legal principles were deployed logically and with care, there was no proper basis for the court to impose one party's conception of what would be sensible and reasonable.

Pre-contractual negotiations

Of course, Chartbrook's true significance may be its effect on the admissibility of pre-contractual negotiations. To recap, Prenn v Simmonds [1971] 1 WLR 1381established that evidence of pre-contractual negotiations cannot be used to aid construction.

In Chartbrook, Lord Hoffmann qualified the conditions for 'correction of mistakes' set out in East v Pantiles (Plant Hire) Ltd [1981] 263 EG 61 that 'there must be a clear mistake on the face of the instrument' and that 'it must be clear what correction ought to be made in order to cure the mistake' by establishing that 'the background and context must always be taken into consideration' not merely 'the face of the instrument'.

Could Chartbrook therefore open the door to allow pre-contractual negotiations to be admitted? Lord Hoffmann's judgment was simple: Lord Collins has been correct in the Court of Appeal that, as a matter of construction, the agreement meant what Persimmon said it did. He did not need to consider any other points. He recognised, however, that it was appropriate to open or shut the door. He therefore addressed, obiter, Persimmon's contention that the rule in Prenn only excluded 'unhelpful' evidence.

Lord Hoffmann made it very clear that the House of Lords was not departing from the exclusionary rule in Prenn. Moreover, there was 'no clearly established case for revisiting' that rule and the 'private dictionary' principle in Partenreederei MS Karen Oltmann v Scarsdale Shipping Co (The Karen Oltmann) (1976) 2 Lloyd's Rep 708 had gone too far.

However, when Lord Hoffmann considered rectification, he concluded that the real question was what an objective observer would have thought the parties' intentions were. Evidence as to what terms a party understood to have been agreed could be significant if there is 'a prior objective consensus' '“ it might carry very little weight but it would not be inadmissible.

Hence, following Chartbrook, pre-contractual negotiations remain largely inadmissible, except:

• if that rule is impeding the proper development of the law or is contrary to public policy;
• to establish an objective consensus between the parties as to what the contract was intended to mean and thereby to rectify the contract;
• to evidence that a term bears an unconventional meaning which the parties to the contract habitually used; or
• to justify estoppel by convention.

Without prejudice discussions

The natural next question to ask is whether without prejudice discussions can be used as evidence of facts relevant to construction. In the recent decision in Oceanbulk Shipping v TMT Asia [2010] EWCA Civ 79 (Solicitors Journal 154/7, 23 February 2010) the Court of Appeal had the opportunity to consider this in the light of Chartbrook.

The lord justices effectively rejected the right of the court to open up without prejudice discussions to such scrutiny.

The leading judgment concluded that it was more important to preserve the without prejudice principle than to allow it to be breached.

However, the dissenting judge, Ward LJ, questioned this logic, with some passion. He referred to Chartbrook and railed at the failure to use the principles set out in it:

'If you can use the antecedent negotiations to prove the agreement, to rescind it, or to rectify it, why on earth can you not use the negotiations to establish the truth of what the concluded contract means?

Not to do so would strike my mother as 'barmy'. Perhaps I should simply say it strikes me as illogical'¦ What is the justice of a self-imposed rule that one is not allowed to look at the facts which will establish what the parties truly meant by their compromise?... Where compromise has been reached, the purpose'¦ has been served and the inhibitions fall away'¦ Logic and justice seem to me to be good enough reasons to remove the protection.'

Given this small rebellion, it would be well not to dismiss the possibility that without prejudice discussions could be considered again in the House of Lords. Ironically, Collins LJ was in precisely the same dissenting minority as Ward LJ when Chartbrook was in the Court of Appeal and, eventually, his view prevailed unanimously in the Lords. Could Ward LJ's words prevail in the Lords one day?

Advice for draftsmen

The overwhelming lessons for draftsmen of commercial contracts are that:

• the words used must clearly reflect theintentions of the parties in all aspects without room for doubt;
• they should not be surprised at a challenge if one party is allowed by another to misunderstand a term;
• thought should be given to how effectively one has excluded (or included, as the case may require) all pre-contractual representations, discussions and documents;
• where the contract requires a formula, consider using a purely mathematical formula with worked examples, not defined terms;
• parties should not take comfort in clarification from the others as to what a clause means but should redraft toremove the doubt; and
• one should heed Lord Hoffmann's warning: 'It is, I am afraid, not unusual that an interpretation which does not strike one person as sufficiently irrational to justify a conclusion that there has been a linguistic mistake will seem commercially absurd to another... the subtleties of language are such that no judicial guidelines or statements of principle can prevent it from sometimes happening'¦'

But take with a pinch of salt his flattering conclusion:'It is fortunately rare because most draftsmen of formal documents think about what they are saying and use language with care.'