Contract interpretation – the importance of precise drafting

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In Kason Kek-Gardner Ltd v Process Components Ltd [2017] EWCA Civ 2132, the Court of Appeal considered the correct approach to the interpretation of related contracts, concluded at different times by the same seller with different purchasers, and to the test for implying a term where necessary to give business efficacy to a contract.

When interpreting a contract, the court’s task is to ascertain the objective meaning of the language which the parties have chosen to express in their agreement when read in the context of the factual background known or reasonably available to the parties at the time of the agreement, excluding prior negotiations (Wood v Capita Insurance Services Ltd [2017]).

Following the administration of Kemutuc Powder Technologies Ltd (the Seller), the administrators entered into two asset sale agreements. The first with Process Components Ltd (Buyer1), a new company formed by the former directors of the Seller, for the sale of the assets of two divisions of the Seller. The second was entered into a couple of weeks later with Kason Kek-Gardner Ltd (Buyer2) in relation to the remaining assets of the Seller. Both agreements suffered from a lack of clarity in their drafting.

Buyer1 and Buyer2 subsequently entered into a licence agreement under which Buyer1 licenced the use of intellectual property rights formerly owned by the Seller. Buyer2 was then purchased by a competitor of Buyer1 and as part of the due diligence process disclosed the licence agreement to the purchaser. Buyer1 promptly terminated the licence agreement on the basis of a purported breach of confidentiality. A dispute then arose about what rights Buyer2 had actually acquired from the administrators and whether the same rights had already been sold to Buyer1.

The High Court was asked to determine whether, under the terms of its asset sale agreement, Buyer2 had acquired any (and if so what) intellectual property rights formerly belonging to the Seller.

The judge determined that all the parties had acted on the common assumption that Buyer1 had acquired the whole of the Seller’s intellectual property but that, construed as a whole, Buyer1’s sale agreement merely transferred the intellectual property rights in the divisions it had acquired. She considered what intellectual property rights were comprised in those divisions and necessary for trade to continue. The judge held that Buyer2 was permanently estopped from denying that Buyer1 owned the relevant intellectual property.

Buyer2 appealed. Buyer2 argued that as both agreements were made as part of the same administration, they should be read together. If this were done, the effect was that Buyer1 acquired the intellectual property rights it needed for its business and Buyer2 acquired the intellectual property rights it needed for its business. Furthermore, it would have been obvious to all parties that the administrators would not have intended to sell the assets they did to Buyer2 without the accompanying intellectual property rights and that therefore it could not have been the intention that those intellectual property rights would transfer to Buyer1.

Court of appeal decision

The Court of Appeal held:

  • The general rule was that parties’ conduct after concluding an agreement could not affect the interpretation of the agreement. The second asset sale agreement, concluded ten days after the first and with a different purchaser, could not be used to interpret the first agreement.
  • Admissible background was limited to facts that were known or reasonably available to all parties. There was nothing in the admissible background, or in the language of the agreement for the sale of the assets to Buyer1, to support the proposition that the intellectual property rights were divided according to purpose.
  • Buyer2’s interpretation of the agreements relied on commercial common sense and background and devalued the importance of the language of the agreements. Interpreting Buyer1’s sale agreement without reference to Buyer2’s sale agreement, Buyer2 had not acquired the intellectual property rights in the divisions it had purchased.
  • The judge was entitled to conclude that the trade mark referred to in Buyer1’s sale agreement was the registered trade mark with the different number. This was an exercise in judicial interpretation, involving application of the principle of falsa demonstratio non nocet (”a plain misdescription does no harm”). Either the number of the trade mark mentioned in the asset sale agreement must be rejected or the description of the mark as “registered” must be rejected. The KEK mark was one of a number of trade marks described as registered. In the circumstances, the judge was entitled to attach weight to that part of the description and to reject the number. The court emphasised that it was not rectifying the contract (in the sense of dealing with the equitable remedy of rectification); rather, it was a matter of interpretation. If it were a question of rectification, the intervention of third party rights might lead the court to refuse to grant the remedy. That did not apply where the question was one of interpretation.
  • That a term will not be implied into a detailed commercial contract unless it is necessary to give the contract business efficacy or if it is so obvious it goes without saying.

WM comment

The Court of Appeal decision does not formulate any new law but confirms the current approach of the courts to contract interpretation. It reflects the ongoing shift away from reliance on common sense and business context, and instead focussing on the precise language of the contract. It is a reminder to all of us to make sure that contracts are sufficiently clear and precisely drafted.