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Contractual interpretation: Literal meaning v commercial common sense

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14/11/2017

Recent years have seen a plethora of contractual interpretation disputes, but the correct approach to ascertaining the meaning of contractual provisions came before the Court of Appeal again this summer. In its recently published judgment in NHS Commissioning Board v Silovsky & Anor [1], the Court of Appeal has reiterated the supremacy of literal meaning, even where that produces an unusual commercial outcome.

Correct approach to contractual interpretation

The 2015 case of Arnold v Britton [2] concerned the service charge provisions in 25 modest holiday chalet leases. In accordance with the ordinary natural meaning of the wording of the relevant clause, the landlord had argued that the contract obliged the tenants to pay a fixed yearly service charge amount which rose at the rate of 10% per annum, even though that meant that service charges payable per year would top over £½ million by the end of the leases.  That would be a disastrous economic consequence for the tenants. The Supreme Court agreed with the landlord, however, and clarified the correct approach to contractual interpretation:

  • Whilst consideration of commercial common sense can, in the right circumstances, be taken into account, it is not a criterion of contractual interpretation that should undermine the importance of the clear language of a clause.
  • The starting point is the wording of the contract itself.
  • An objective test – that of what the reasonable business person would understand the clause to mean – is applied to ascertain the parties’ intention at the time the contract was entered into.
  • Commercial common sense can be a consideration, but:
    • it cannot be invoked ‘after the fact’ – it is only relevant to ascertaining how matters would or could have been perceived when the contract was made;
    • where there are two or more tenable interpretations, the most commercially sensible option will be preferred; and
    • it is not for the court to depart from clear contractual wording even where that represents a bad bargain for any party.

Although the Supreme Court’s guidance is clear, contractual interpretation disputes have continued to come to court. In the most recent of these, the question of an unusual commercial outcome has been addressed again.

Unusual commercial outcome

In 2004 the NHS Commissioning Board had entered into a funding agreement with a GP practice whereby financial assistance provided by the Board would correspond to interest payable under the GP’s loan. In 2007 the parties entered into a new contract.  The 2007 contract (the subject of the dispute) provided for payment to the Board of a fixed sum, as opposed to an amount linked to the cost of borrowing.  After completion of the contract the GP’s borrowing costs dropped significantly but the Board continued to pay the fixed contractual sum.  When the Board later brought a claim for repayment of sums which it alleged had been overpaid, the Court of Appeal confirmed that, according to the clear, literal meaning of the contract, the fixed sum was payable and so there was no reimbursement to be made.  The Court of Appeal confirmed:

  • The court’s task is to ascertain the objective meaning of the language which the parties have chosen to express their agreement;
  • The purpose and limits of contractual interpretation should be emphasised – it is not open to the court to make a different bargain because it thinks that a party or parties would have been wiser to do so; and
  • Commercial common sense is not to be invoked retrospectively.

Practical considerations

The law is now very clear as to the extent to which commercial common sense will influence interpretation. The question, therefore, is what can you do if you face an unfavourable outcome in any of your contracts?

  • Start with the wording in the clause itself. If there is genuine uncertainty, then commercial common sense may be taken into account and may assist.
  • Is there any scope for settlement? It is rare for any contractual interpretation dispute to be clear cut. Even if the odds are against you, the chances are that any grey area and inevitable litigation risk can be exploited in negotiations to encourage a commercial compromise.
  • In any event, it is good to talk. Interpretation disputes often arise by virtue of the fact that there is an ongoing contractual relationship between the parties. It can be in the interests of all concerned for the parties to behave in a reasonable and commercially sensible manner.
  • If the wording in the contract is clear and produces an unusual outcome, consider whether there has been a mistake in the drafting of the contract? Ask whether the clause genuinely reflects the parties’ intentions at the time the contract was entered into? If it does not, take legal advice to investigate the potential to pursue a claim for rectification. The rules for rectification claims are different and may give a party more scope to achieve a favourable outcome.
  • Alternatively, was the clause entered into in reliance on any misrepresentations? If so, the contract could be set aside and financial compensation could be payable.
  • Finally, consider whether you were properly advised when the contract was completed. It is possible that any losses could be recouped via a professional negligence claim.

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[1] [2017] EWCA Civ 1389
[2] [2015] UKSC 36

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