Contract Interpretation Principles

In Arnold v Britton, the court has considered the limits on the use of commercial common sense in construction of contracts. In this case, the judgment of Lord Neuberger emphasised on the need to take into account the natural meaning of a provision in the contract and not just commercial common sense. Therefore, the decided principle in the case is that at the starting point of contract interpretation, the approach should be to interpret the plain words of the contract in the natural sense. This can be explained by the decision of the court in Chartbrook, where the court held that when interpreting a written contract, the court identifies the intention of the parties by reference to how a reasonable person with relevant background knowledge would understand the terms using the language in the contract.

In Arnold v Britton, the court has emphasised that it is under specific circumstances only that the court should look outside the words used in the written document. Such a need arises particularly when the relevant words are not clear and unambiguous, and when the words can be interpreted in different ways. In such cases, the court may depart from the natural meaning of the words and rely on commercial common sense and surrounding circumstances. As was observed in the case, in general, the interpretation of words in a written contract is for the identification of the terms that the parties have agreed to; the court is not to give interpretation of the words as what it thinks that the parties should have agreed to. Even if the interpretation of the words in the natural sense gives a result that may appear to be ill-advised, the court has to interpret the words in the natural sense because “it is not the function of a court when interpreting an agreement to relieve a party from the consequences of his imprudence or poor advice.”

While the decision in Arnold v Britton clearly emphasises the accepted position on contractual interpretation, it cannot be said that the law is absolutely clear on the interpretation of written contracts in this context. There are decisions of the Supreme Court, which provide that there are situations where the court may prefer construction of words in commercial sense rather than natural sense. In two cases decided prior to Arnold v Britton, the court has preferred a purposive and commercial approach to interpretation.

In Rainy Sky v Kookmin, the court held that in case of two possible constructions of a contract, the court may prefer the construction which is consistent with business common sense and reject another construction. While this clearly seems to be giving the prerogative to the court to prefer commercial sense, the court also observed in the case that where the wordings of the contract are clear, then that is the construction that will be preferred by the court no matter how bad a bargain it may be for the parties. The approach is based on the decision in Investors Compensation Scheme Ltd. v West Bromwich, in which the court held that a common sense approach should be taken to understand words within their factual context so that a more pragmatic approach can be taken to construction rather than emphasising on an over literal approach.

Nevertheless, the decision in Arnold does mark a shift towards a literal approach. This is consistent with the decision in BMA Special Opportunity Hub Fund Ltd, where the court held that "commercial common sense" cannot be raised to be an overriding criterion of construction of words in the contract. However, this does not indicate the clear position of law as is indicated by the Supreme Court decision in Wood v Capita, where the court held that the approaches in Arnold and Rainy Sky were essentially the same. The court also held that its function is not to provide literalist interpretation of terms in contract but also to consider the contract as a whole and depending on the drafting of the contract, also to give weight to the wider context in reaching its opinion on the objective meaning.

Post the decision in Arnold, the Supreme Court has had more opportunities to consider interpretation of contracts. In Exsus Travel Ltd v Baker Tilly, the court chose to take a literal approach to interpretation of a clause in a standstill agreement. In MetLife Seguros De Retiro SA, the court chose literal interpretation although the dissenting opinion of Lewison LJ needs to be considered here as he opined that the interpretation of financial agreements should be based on the authority of Re Sigma Finance and not Arnold v Britton. This may indicate a possible opening of door for the purposive interpretation of contractual clauses in future. A more definite example of commercial sense prevailing over natural sense after the Arnold decision can be seen in BNY Mellon Corporate Trustee Services, wherein the court allowed reference to wider documentary context for interpreting complex financial instruments based on the ground that there was a drafting mistake in the agreement. In this case, the court considered that the drafting mistake necessitated the reference to commercial common sense instead of natural meaning. Again, like Metlife, the decision of BNY Mellon also signifies a possible shift to a more purposive approach in the future. The position can be clarified if principles of interpretation of commercial contracts are laid down in legislation. Looking for further insights on Breach of Contract by Owl Barn? Click here.

To conclude, the law is clear to some extent on the point of interpretation of contracts on the basis of natural meaning except where the words are unclear, ambiguous and open to different interpretations, in which case commercial common sense may be referred to for interpretation of contract. However, it is not clear whether this principle can be applied in specific business contracts, like financial agreements as the decisions in Metlife and BNY Mellon keep the possibility of a possible shift to a more purposive approach in the future intact. There needs to be clarity on this issue which can come from legislative acts, which can provide clear directions on how commercial contracts can be interpreted.

Table of cases

• Arnold v Britton [2015] UKSC 36
• BMA Special Opportunity Hub Fund Ltd & Ors v African Minerals Finance Ltd [2013] EWCA Civ 416
• BNY Mellon Corporate Trustee Services v LBG Capital No.1 Plc [2016] UKSC 29
• Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38
• Exsus Travel Ltd v Baker Tilly [2016] EWHC 2818
• Investors Compensation Scheme Ltd. v West Bromwich Building Society [1997] UKHL 28
• MetLife Seguros De Retiro SA v JP Morgan Chase Bank [2016] EWCA Civ 1248
• Rainy Sky v Kookmin Bank [2011] UKSC
• Re Sigma Finance [2009] UKSC 2
• Wood v Capita Insurance Services Ltd [2017] UKSC 24

Books

Stone R and Devenney J, Text, Cases and Materials on Contract Law (Taylor & Francis 2017).