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

In Wood v Capita Insurance Services Limited [2017] UKSC 24, the Supreme Court has sought to reconcile the approach to contractual construction and interpretation adopted by the Supreme Court 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.

Facts

Mr Andrew Wood (the “Seller”) entered into a share purchase agreement (“SPA”) with Capita Insurance Services Limited (the “Buyer”) for the acquisition of the entire issued share capital of Sureterm Direct Limited (the “Company”), a car insurance broker. Following conclusion of the deal, the Company’s employees raised concerns about potential mis-selling of products to customers in the period prior to the acquisition. The Company conducted a review and reported its findings to the FSA. The FSA concluded that customers had been misled and the Company paid £1.35 million in customer compensation. The Buyer sought to rely on the following indemnity in the SPA in order to recover this sum from the Seller:

“The Sellers undertake to… indemnify the Buyer… 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 Seller argued that the Buyer could not rely on the indemnity because it only covered losses which were a result of a “claim or complaint” registered with the FSA. As the Company had self-referred to the FSA, the indemnity was not engaged. The Buyer argued that the indemnity set out two categories of losses: “damages, costs, charges…” on the one hand and “fines, compensation, remedial actions, etc.” on the other. According to the Buyer, only the second category of loss was qualified by the need for the claim to have been registered with the FSA by a customer.

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 decision (which we reported on back in September 2015) held that self-reporting was not within the language of the indemnity clause. 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 and upheld the Court of Appeal decision. 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 had altered the guidance given by the Supreme Court in Rainy Sky. He gave the following guidance which he considered consistent with Arnold and Rainy Sky:

• 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 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.

After a consideration of the detail of the clause, Lord Hodge decided that, had the indemnity 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 the indemnity 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, 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 Arnold “rowed 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 the 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.