Supreme Court rules again on interpretation of contracts: business common sense may not save the day

United Kingdom

In Wood v Capita Insurance Services Limited [2017] UKSC 24, the Supreme Court has sought to reconcile the approaches to contractual construction and interpretation adopted by the Supreme Court in in Rainy Sky v Kookmin Bank [2011] UKSC 50 and Arnold v Britton [2015] UKSC 36.

In doing so, it decided that, where there are rival meanings to a clause, consideration of the words of the contract (as a whole) and commercial common sense both have a role to play. The clause that was the subject of the appeal was an indemnity contained in a share sale and purchase agreement of a business that sold motor insurance products to consumers. The Supreme Court decided that, in the context of there being a warranty in that sale and purchase agreement which covered the relevant losses (under which the buyer could not claim because it was time-limited), on a careful examination of the language of the indemnity (which was not time limited), the indemnity did not cover the losses.

Facts

In about August 2008 Sureterm Direct Limited (the “Company”) began to sell motor insurance through online aggregator sites such as Confused.com.

In 2014, Capita Insurance Services Limited (the “Buyer”) acquired the entire issued share capital of the Company from Mr Andrew Wood (the “Seller”) and two others pursuant to the terms of a sale and purchase agreement dated 13 April 2014 (the “SPA”). The SPA contained an indemnity by which the Seller agreed to indemnify the Buyer against any losses arising out of claims made against the Company due to the mis-selling of insurance policies to consumers. The indemnity (which was clause 7.11 of the SPA) had no time limit, so claims under it could be made for up to six years from liability. It stated:

“The Sellers undertake to pay to the Buyer an amount equal to the amount which would be required to indemnify the Buyer and each member of the Buyer’s Group against all actions, proceedings, losses, claims, damages, costs, charges, expenses and liabilities suffered or incurred, and all fines, compensation or remedial action or payments imposed on or required to be made by the Company following and arising out of claims or complaints registered with the FSA, the Financial Services Ombudsman or any other Authority against the Company, the Sellers or any Relevant Person and which relate to the period prior to the Completion Date pertaining to any mis-selling or suspected mis-selling of any insurance or insurance related product or service.”

The SPA also contained a suite of extensive and detailed warranties, which were subject to a two-year limitation period. These warranties included, among other things, warranties that the Company had conducted its business in accordance with the requirements of all financial services laws applicable to the business. Notwithstanding the fact that the SPA was a professionally drafted document and both parties were legally represented, clause 7.11 above was “not precisely drafted” and was “avoidably opaque”.

After the warranty limitation period had expired, employees of the Company raised concerns about potential mis-selling prior to the purchase. As a result of the ensuing internal investigation, the Buyer and the Company were obliged to inform the Financial Services Authority (“FSA”) of the findings. The FSA informed them that the customers had been treated unfairly and had suffered detriment and that there would have to be redress. The Buyer and the Company agreed with the FSA to conduct a remediation scheme to pay compensation to customers who were identified as potentially affected by the Company’s mis-selling.

As the Buyer was too late to commence a warranty claim, it attempted to claim under the indemnity. However, the Seller argued that the natural and ordinary meaning of the words in the indemnity covered customers’ complaints to the FSA only, not self-reporting to the FSA. The Seller argued that the indemnity required a claim to be made against the Company.

The Buyer succeeded in the High Court, where the court decided that business common sense required self-reporting to fall within the scope of the indemnity. However, the Court of Appeal decided that self-reporting was not within the language of the indemnity clause, applying the approach in Arnold v Britton. The Buyer appealed to the Supreme Court, arguing that the Court of Appeal’s decision was wrong, because it incorrectly placed too much emphasis on the words of the SPA and gave insufficient weight to the context in which they were agreed (the factual matrix).

Decision

The Supreme Court found in favour of the Seller. Lord Hodge (with whom the other judges agreed) undertook a detailed analysis of the terms of the indemnity in the context of the other contractual terms, and found that its terms (on a close examination) did not cover self-reporting for mis-selling.

Importantly, Lord Hodge did not accept the Buyer’s argument that Arnold v Britton had altered the guidance given by the Supreme Court in Rainy Sky (see below).

Lord Hodge explained that the approach to determining the meaning of the clause is:

not a literalist exercise, focused solely on a parsing of the wording of the particular clause… [The] court must consider the contract as a whole and, depending on the nature, formality and quality of drafting of the contract, give more or less weight to elements of the wider context in reaching its view as to that objective meaning.”

Lord Hodge gave the following guidance which he considered consistent with Arnold and Rainy Sky:

  • The exercise of contractual interpretation is a unitary process.
  • Where there are rival meanings to a clause, the court can give weight to the implications of rival constructions by reaching a view that is more consistent with business common sense.

  • However, in striking the balance between the implications of rival constructions the court must also consider the quality of drafting of the clause.

  • The court must also be alive to the possibility that a party may have agreed a clause that does not serve its interests.

  • It follows that the ‘unitary exercise’ involves an iterative processes whereby rival interpretations are checked against the whole contract and the commercial consequences. 

  • Once it is established that there are rival interpretations, it does not matter whether this more detailed analysis commences with checking against the whole contract or the factual background and establishing the commercial consequences – so long as the court balances the indications given by both approaches.

  • It may be that the circumstances of the drafting of the contract suggest that more weight should be given to one, or other, of the approaches of checking against the whole contract or the factual background (matrix) / commercial consequences. For example, in the context of a sophisticated contract, checking against the contract might be given more weight, Even then, however, the drafting might lack clarity due to a number of factors, such as the parties’ conflicting aims, failures of communication, tight deadlines and differing drafting practices.

Applying the above, Lord Hodge decided that:

  • The indemnity clause was “avoidably opaque”.
  • It was necessary to place the clause in the context of the contract as a whole and consider the factual matrix.

  • The contractual context was significant because of the detailed warranties, which were subject to a time-limit.

  • Whilst the Buyer would have an interest in gaining a broad indemnity for mis-selling, the Seller would likely have the converse incentive. Against this background, “in the tug o’ war of commercial negotiation, business common sense can rarely assist the court in ascertaining on which side of the line the centre line marking on the tug o’ war rope lay, when negotiations ended”. 

After a consideration of the detail of the clause, Lord Hodge decided that, had clause 7.11 stood on its own, the requirement of a claim or complaint by a customer and the exclusion of loss caused by regulatory action which was otherwise prompted might have appeared anomalous. But clause 7.11 was in addition to wide-ranging warranties which probably covered the circumstances which eventuated. It was not contrary to business common sense for the parties to agree wide-ranging warranties which were subject to a time limit, nor to agree a further indemnity which had no time limit but which was triggered only in limited circumstances. On that basis, the appeal failed.

Comment

In a series of decisions culminating in the Supreme Court’s decision in Rainy Sky, the courts decided that, if there are two possible ways of reading a contract, the reading which is consistent with commercial common sense can be preferred. Following Rainy Sky, parties routinely argued commercial common sense in support of their construction of disputed terms in contracts.

However, some commentators queried whether such an approach was still relevant after Arnold v Britton, which appeared to place an emphasis on the natural and ordinary meaning of the words of the contract and cautioned against using ‘business sense’ to relieve a party of a bad bargain.

Lord Hodge’s comments seek to clarify the misconception that Arnoldrowed back” on the role of business common sense in the interpretation of contracts. Where there are rival meanings to a clause, the Supreme Court seems to have identified that English law permits a variety of methods to arrive at the correct answer. The correct approach will likely depend upon the circumstances of the case. In some cases, a textual approach to the contract will be more useful. In others, the context and business sense will more likely yield the answer. However, hindsight is not part of the exercise.

Although it seems likely that the courts will place more emphasis on the words of the contract where it has been professionally drafted, Lord Hodge recognised that negotiators of complex and formal contracts might not achieve a logical and coherent text because of factors such as the challenges of the negotiation process and the conflicting interests of the parties. Therefore, even where a contract has been professionally drafted and heavily negotiated, its commercial context must not be ignored, and the commercial context may be particularly helpful in interpreting the contract.

The dispute in Wood arose because there were rival interpretations of the language of the clause in question arising from the natural and ordinary meaning of the words used. Arguably, what the decision in Wood does not directly deal with is where the rival interpretations arise from construing the natural and ordinary meaning of the words against the factual matrix as opposed to the words of the contract itself. For example, in the case of Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1997] A.C. 749, the House of Lords allowed an appeal that notices to terminate leases which had been served on 12 January were actually held to be effective on 13 January, because the factual matrix permitted that interpretation notwithstanding the fact that the language of the notices did not. The series of court decisions surrounding Mannai Investment, arguably culminating in Rainy Sky, remain difficult to reconcile with Arnold and Wood, notwithstanding the Supreme Court’s decision in Wood.