Fri 31 Mar 2017

Contractual Interpretation - Another day in the sun for Rainy Sky

There have been numerous decisions in the Scottish Courts and Supreme Court in recent years which deal with the proper principles applicable to contractual interpretation. From time to time, reading these decisions, one wonders whether Lord Mansfield would have been depressed that in the 21st century, we were still struggling with these issues. The recent decisions of the Supreme Court, particularly those in Rainy Sky SA v Kookmin Bank [2011] 1 WLR 2900 and Arnold v Britton [2015] AC 1619 which were intended to clarify the law have led to a degree of confusion in the lower courts and a greater perceived scope for argument among solicitor and advocates.

In Rainy Sky, Lord Clarke made clear that where there were competing interpretations of a contractual clause the court was entitled to choose the interpretation which accorded most closely with commercial common sense. That decision did not herald any particular change in the law. It has always been accepted that practical commercial considerations can be taken into account. Indeed in Rainy Sky the examples given include Lord Steyn both writing judicially in Society of Lloyd's v Robinson [1999] WLR 756 and extra-judicially in an article entitled Contract Law - Fulfilling the Reasonable Expectations of Honest Men 113 LQR 433. The applicable principles, however, are equally apparent in earlier cases such as Prenn v Simmons [1971] 1 WLR 1381 or Reardon Smith Line Ltd v Yngvar Hansen-Tangen [1976] 1 WLR 989.

However, the decision in Rainy Sky occasionally led to courts below approaching the exercise of interpretation the wrong way. As soon as a clause was ambiguous (and almost all disputed clauses will be to a certain extent) commercial common sense was taken as the starting point. It appeared that it was used in some cases to either override the ordinary and natural meaning of the words of the contract or to correct a bad bargain when the clause heavily favoured one of the parties over the other. Accordingly, in Arnold the Supreme Court sought to give guidance as to the correct approach when considering commercial implications of a clause as part of the interpretation process.

Unfortunately, that led to a different problem - namely, that advocates and solicitors began to rely on Arnold as, in some way, heralding a departure from what Lord Clarke said in Rainy Sky. They argued that Lord Neuberger's decision in Arnold meant that less reliance should be placed on commercial common sense and that the courts should re-focus on the natural and ordinary meaning of the words of the contract. The Scottish courts have very recently rejected that notion (Fulton v Muir [2017] COSH 25; Kinloch v Corral Racing Limited [2017] CSOH 43). However, the matter has now been put firmly beyond doubt by a unanimous decision of the Supreme Court in Wood v Capita Insurance Services Limited [2017] UKSC 24).

This was a case which concerned the construction of an indemnity clause in an agreement for the sale and purchase of the entire share capital of a company, Sureterm Direct Limited by Capita Insurance Services. As a result of alleged mis-selling resulting in the then Financial Services Authority obliging Capita to agree a remediation scheme to pay compensation to customers, Capita sued the defendants for around £2.5million. In the context of the legal argument, counsel for Capita argued that the Court of Appeal had fallen into error because it has been influenced by a submission from the defendant's counsel that Arnold had "rowed back" from the guidance on contractual interpretation given in Rainy Sky. This had led to the Court of Appeal giving too much weight to the words of the contract and too little weight to the factual matrix.

In a decision given by Lord Hodge, the Supreme Court firmly rejected the proposition that Arnold and Rainy Sky say different things. Mercifully Lord Hodge starts his decision by saying "It is not appropriate in this case to reformulate the guidance given in Rainy Sky and Arnold; the legal profession has sufficient judicial statements of this nature". This is a welcome statement in itself from the court. In recent years there has been a number of statements of principle by the courts and it is helpful that Wood does not contain another. The focus of any contractual interpretation exercise should be on the question before the court - what did the parties mean by the words which they have chosen to express their agreement? If that question is the focus and the principles are applied bearing the question in mind then the courts are unlikely to go far wrong.

Lord Hodge then goes on to summarise the principles set out by Lord Hoffman in Investors Compensation Scheme v West Bromwich Building Society [1998] 1 WLR 896 and those in Rainy Sky and Arnold. He stresses that "textualism and contextualism are not conflicting paradigms in a battle for exclusive occupation in the field of contractual interpretation. Rather, the lawyer and the judge, when interpreting any contract, can use them as tools to ascertain the objective meaning of the language which the parties have chosen to express their agreement". Again, that is welcome guidance as it refocuses on the question and recognises that while there are principles of construction there are no rules, as such, which take precedence.

Lord Hodge goes onto explain that the extent to which each approach will be relevant will, of course, vary depending on the circumstances of the particular case. If the contract is a very good document and the meaning is crystal clear from the words alone then less emphasis may need placed on the surrounding factual background or commercial considerations. If, on the other hand, the contract is a poorly drafted document then these other considerations will become more relevant. The judge or lawyer must simply employ all the necessary principles in order to ascertain the objective meaning of the disputed provisions (In re Sigma Finance Corporation [2010] 1 All ER 571).

Lord Hodge ends with the simple statement - "on the approach to contractual interpretation, Rainy Sky and Arnold were saying the same thing". That will be a welcome clarification for practitioners and the decision in Wood is a welcome line in sand.

Make an Enquiry

From our offices we serve the whole of Scotland, as well as clients around the world with interests in Scotland. Please complete the form below, and a member of our team will be in touch shortly.

Morton Fraser MacRoberts LLP will use the information you provide to contact you about your inquiry. The information is confidential. For more information on our privacy practices please see our Privacy Notice