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Interpretation of Contracts Have Shifted from a Literal Approach to a Contextual Approach

Info: 2931 words (12 pages) Law Essay
Published: 12th Nov 2020

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Discuss with reference to case law

When interpreting a contract English law has had a series of reluctance in looking beyond the written document, thus adopting a literal approach. On the contrary, some recent cases suggest that approach is shifting to a more contextual one, where some background information and intention of the parties are closely analysed.[1]However, Lord Neuberger’s speech in the case of Arnold v Britton (2015) highlighted a shift back to the traditional approach the landmark decision placing great emphasis on the importance of language used in the document. The present essay will aim to discuss and infer whether the interpretation of contracts have shifted from a literal approach to more of a contextual approach.

The ambiguity of whether interpretation has changed comes from within the Investors Compensation Scheme Ltd v West Bromwich building society case, a case which contradicts with the stereotypical interpretation of contracts within English law, thus taking a contextual approach.[2] It was in this case, whereby Lord Hoffman proposed a shift in approach on the basis of five common sense principles. Firstly, that the interpretation should be examined from the point of view of the reasonable person. [3]Secondly, the court should create a focus upon a ‘matrix of fact’ to decide how the reasonable person would interpret the words. Thirdly, previous negotiations would be excluded. Fourth, the meaning of words should be decided in regard to all the relevant information. It can be analysed that principle four especially creates a legal precedent that the court no longer has to resort to the literal approach and can thus consider the meaning. Lord Hoffman’s last principle highlights that words utilised that do not reflect the intentions of the parties removes any opportunity of parties being bound by it.

It can be argued that the principles of interpretation of contracts have changed significantly since the House of Lords decision in Investors Compensation Scheme Ltd v West Bromwich Building society (1998). [4] As Lord Hoffman has widely criticised the use of the parol evidence rule, a rule used in the cases of L’estrange v F Gracoub Ltd (1934) and Jacob v Batavia (1924), both cases setting a legal precedent that if a contract is signed, parties cannot depart from the written document. This shows the constraints of the literal approach which was utilised until Lord Hoffman subverted this expectation of the literal approach used for interpretation in numerous cases, adopting a contextual approach. Lord Hoffman does this by bringing light upon the significance of background information as a ‘factual matrix’ in the case of Investors Compensation Scheme Ltd v West Bromwich building society. Correspondingly, in the case of Chartbrook Ltd v persimmon Homes Ltd (2009) he suggested that some background information that parties could have had at the time of contracting should be taken into consideration.[5]Lord Wilberforce similarly outlined the same contextual approach used by Lord Hoffman in the case of Investors Compensation Scheme Ltd v West Bromwich building society. This can be traced from the speech of Lord Wilberforce in the case of Prenn v Simmonds (1971) where he arguably felt as if time had arrived whereby courts looked beyond the words of the contract.[6]coincidently, he also noted that background information should be taken into consideration. Although, the case of Prenn v Simmonds were prior to Investors Compensation Scheme Ltd v West Bromwich building society, it arguably set a legal precedent for the adoption of the contextual approach in the 21st century.

[7]Continuing on, an example of one of the most primal shifts from the literal approach since the case of Investors Compensation Scheme Ltd v West Bromwich building society which initially  suggested placing emphasis on the natural meaning of the word, has been made in the case of Rainy sky SA and others v Kookim Bank (2011).[8] The case was dealing with the concerns over an interpretation of a term. [9]The facts of the case highlight the defendant bank was taking obligation to refund the instalments on ship builder’s default and the issue was if it expanded on the shipbuilder’s insolvency.  Court decided that the term covered shipbuilder’s insolvency. The Lords made a number of controversial statements driven from the case. They argued that when there are two constructs of a term, one in accordance with the business common sense should be adopted and the other rejected. This case, therefore proves how the literal approach of a focus on the method of interpretation of words in a contract has departed and a more contextual approach has been utilised.

On the contrary, it can be argued that there has been a shift back towards the traditional approach, as seen within the case of [10]Arnold v Britton (2015) and the speech of Lord Neuberger. The facts of the case depended on the long lease of a holiday chalet. There was a specific term included in the contract that service charge would be £90 in the first year, and would increase 10% per annum. The Lords decided that the fact that the sum of money paid for service charge would be considerably higher in a number of years was not the prime reasoning to depart from the words of the term. Lord Neuberger clarified that commercial sense and other background information should not undervalued when analysing the importance of the words used in the contract. [11]Similarly, in Multi- Link leisure developments Ltd v North Lanarkshire Council concerning the interpretation of a lease, Lord Hope held that ‘words… should not be changed, taken out or moved … until it has become clear that the language the parties actually used creates an ambiguity which cannot be solved otherwise’. [12]Lord Hope’s statement creates a focus on the literal approach emphasising the importance of word in a contract. Therefore, it can be concluded from these cases recently that the traditional approach in the interpretation of contracts has been reinstated.

In addition to this, it can be argued that due to the volume of information allowed under the broad definition of Investors Compensation Scheme, more recent restrictions have been placed on the use of background material, thus placing restriction over the extent of use of the purposive approach. For example, the case of BCCI v Ali (2001) states that there requires an element which highlights that the natural and ordinary meaning of the word produces an unreasonable result for further investigation to occur. [13]Lord Hoffman himself also highlights in Malik and Mahmud v BCCI (1998) that if the words in a contract are very broad and their meaning is clear to see, it would be unnecessary to investigate further. [14]Furthermore, the powerful approach of the majority in Cherry Tree Ltd v Landmain represents a significant encroachment into the wide- ranging applicability of the ICS principles. Lewison LJ thought that a similarly restrictive approach to background information was required when considering ‘negotiable and registrable contracts or public documents’. [15]As Lewison LJ explained, ‘the justification for the restrictive approach is that third parties might (not will) need to rely on the terms of the instrument under consideration without access to extraneous material’. Furthermore, due to the impact on third parties Lord Hoffman himself recognised that in some circumstances the scope of factual matrix may be limited. [16]This idea has been explored in subsequent cases and arguably also creates ambiguity upon any shift ‘from text to context’ in the interpretation of a contract. [17]For example, in Re Sigma, a complex commercial trust deed included a clause about how assets were to be distributed. [18] The supreme court excluded valid background circumstances which would not have been known to creditors since third parties who were unaware of ‘surrounding circumstances’ known only to the signatories of the contract should not be unfairly prejudiced. The case of Re Sigma to an extent protects third parties, just as the case of Cherry Tree Ltd and in doing so limits the purposive approach, as it majorly limits the use of background information. The concern over protecting third parties is also another reasoning behind courts now recently adopting a conservative and traditional approach towards the interpretation of a contract.

On the other hand, courts restrict the use of background information in order to protect third parties, however in Chartbrook Lord Hoffman clearly tackles the issue concerning the protection of third parties. Having recognised that the impact upon third parties was a reasoning for excluding evidence of prior negotiations from the process of negotiations his lordship acknowledged that “the law has sometimes to compromise between protecting the interests of the contracting parties and those of third parties. But an extension of the admissible background will, at any rate in theory, increase the risk that a third party will find that the contract does not mean what he thought. How often this is likely to be a practical problem is hard to say”.[19]it has been implied that the risk of prejudicing third parties may be sufficiently accommodated by the possibility of contractual estoppel. For example, if an assignee has acted to his detriment on the traditional meaning of the written document which does not correspond with a ‘liberal’ interpretation, the assignee may be protected by contractual estoppel. In Chartbrook, Lord Hoffman explained that ‘an assignee must either inquire as to any relevant background or take his chance on how that might affect the meaning the court will give to the document’. Although, this may place an excessive burden upon the assignee it can be argued that in the case of Cherry Tree the use of relevant background information would have been efficient and the third party would also not have been unfairly prejudiced if the information was taken into consideration, however the Court of appeal begged to differ.

Lastly, the role of ambiguity when interpreting a contract has caused judges becoming reluctant in adopting the purposive approach. For example, in the case of Oceanbulk Shipping & Trading SA v TMT Asia Ltd, Lord Clarke cited a speech of Lord Steyn, in which he said of Investors Compensation Scheme that ‘Lord Hoffman made crystal clear that an ambiguity need not be established before the surrounding circumstances may be taken into account’.[20][21]similarly, in Chartbrook, Lord Hoffman expressed that ‘there is no limit to the amount of verbal rearrangement or correction which the court is allowed’. [22]This highlights that judges are responsible to rewrite a particular term of contract in order for it to reflect what they feel a reasonable observer would understand the contract to mean, despite a term being clear and unambiguous. This arguably, undervalues original terms chosen by parties in their final written agreement, and thus may prove why judges and courts sway towards more of a literal approach when interpreting a contract.

Based on the arguments made in the essay, it can be concluded that the principles of interpretation of contracts have not changed significantly since the House of Lords decision in Investors Compensation Scheme Ltd v West Bromwich Building society. This is due to the fact that English law is still in favour of the traditional approach, interpreting contracts with its natural meaning despite of the judgements in the cases of Rainy Sky and Chartbrook. Further to this, Lord Hoffman himself emphasised the importance of clear language in the case of Investors Compensation Scheme as he argues that a reasonable person with all the background information that parties could have had when the contract was made should have no doubt about the meaning of the term.

Word count: 2,189

Bibliography:

Tableofcases:

  • ArnoldvBritton (2015) UKSC 36, [2015] AC 1619 [18]
  • ChartbrookLtdvPersimmonHomesLtd [2009] UKHL 38, [2009] 1 AC 11
  • InvestorsCompensationSchemeLtdvWestBromwichBuildingsociety [1998] 1 WLR 896
  • Cherry Tree Ltd v Landmain Ltd [2012] EWCA Civ 736, [2013] Ch 305
  • LEstrangevGracoub [1934] 2 KB 394, CA.
  • Malik v Bank of Credit and Commerce International SA (in liquidation) [1998] AC 20
  • Multi- LinkleisuredevelopmentsLtdvNorthLanarkshireCouncil [2011] UKSC 50, [2001] 1 WLR 2900 [23]
  • Oceanbulk Shipping & Trading SA v TMT Asia Ltd [2010] UKSC 44, [2011] 1 AC 662 [36], approving R (Westminster City Council) v National Asylum Support Service [2002] UKHL 38, [2002] 1 WLR 2956 [5].
  • PrennvSimmonds [1971] 1 WLR 1381

 

  • RainySkySAvKookminBank [2011] UKSC 50, [2001] 1 WLR 2900
  • Re Sigma Finance Corp (in administration) [2009] UKSC 2, [2010] 1 A11 ER 571

Secondarysources:

  • Davies P, JC Smith's The Law Of Contract (oxford university press 2016)
  • J Spigelman, ‘From Text to Context: contemporary contractual interpretation’ (2007) 81 ALJ 322.
  • McKendrick E, Contract Law, pg 46,51,73 (13th edn, 1990)

[1] ArnoldvBritton (2015) UKSC 36, [2015] AC 1619 [18]

[2] InvestorsCompensationSchemeLtdvWestBromwichBuildingsociety [1998] 1 WLR 896

[3] All Answers ltd, 'Manner in Which a Contract Is Interpreted' (Lawteacher.net, December 2019) accessed 19 December 2019

[4] L’Estrange v Gracoub [1934] 2 KB 394, CA.

[5]Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38, [2009] 1 AC 11

[6] Prenn v Simmonds [1971] 1 WLR 1381

[7] Investors Compensation Scheme Ltd v West Bromwich Building society [1998] 1 WLR 896

[8] Rainy Sky SA v Kookmin Bank [2011] UKSC 50, [2001] 1 WLR 2900

[9] Davies P, JC Smith's The Law Of Contract (oxford university press 2016)

[10] Arnold v Britton (2015) UKSC 36, [2015] AC 1619 [18]

[11] Multi- Link leisure developments Ltd v North Lanarkshire Council [2011] UKSC 50, [2001] 1 WLR 2900 [23]

[12] Davies P, JC Smith's The Law Of Contract (oxford university press 2016)

[13] Malik v Bank of Credit and Commerce International SA (in liquidation) [1998] AC 20

[14] Cherry Tree Ltd v Landmain Ltd [2012] EWCA Civ 736, [2013] Ch 305

[15] Cherry Tree Ltd [124]- [125]

[16] Mannai 779: ‘There are documents in which the need for certainty is paramount and which admissible background is restricted to avoid the possibility that the same document may have different meanings for different people according to their knowledge of the background’

[17] J Spigelman, ‘From Text to Context: contemporary contractual interpretation’ (2007) 81 ALJ 322.

[18] Re Sigma Finance Corp (in administration) [2009] UKSC 2, [2010] 1 A11 ER 571

[19] Chartbrook [40]

[20] Davies P, JC Smith's The Law Of Contract (oxford university press 2016)

[21] Oceanbulk Shipping & Trading SA v TMT Asia Ltd [2010] UKSC 44, [2011] 1 AC 662 [36], approving R (Westminster City Council) v National Asylum Support Service [2002] UKHL 38, [2002] 1 WLR 2956 [5].

[22] Chartbrook [25]

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